Turkey’s economy is experiencing a new stage of growth following hardships and political turbulence in the aftermath of the July 2016 failed coup d’etat. The hardships coincided with wide economic sanctions imposed by Russia, that undermined positive performance in the past two years. 

In a sign of positive improvement, the Turkish economy recorded significant growth in the first quarter of 2017 and and the financial markets were capable of restoring short-term investments, which resulted in relatively stable Lira-Dollar exchange rates. In fact, key drivers of economic improvement indicators include the Turkish-Russian rapprochement and packages of incentives and facilities offered by the government to Turkish and foreign investors over the past months. However, economic prospects will hinge on two key factors: political stability and the developments in Turkey’s economic partnership with its neighbors and the European Union in particular.

Signs of Recovery

The Turkish economy recovered gradually after two years of confusion spurred by security and political turmoil that was one of the negative consequences of the 2016 failed military coup, that were further exacerbated by the sanctions imposed by Russia  after Turkey downed a Russian jet fighter near the Turkish-Syrian border in November 2015. However, contrary to international expectations, Turkey’s economic performance improved significantly in the first three months of 2017. With accelerating growth rates peaking at a two-year high, the year-on-year GDP growth surged to around 3.5 percent in the fourth quarter of 2016. 

According to figures from the Turkish Statistical Institute (TUIK), the economic growth surge was due to growth rates of 3.2 per cent in the agricultural sector and 3.7 percent in the construction sector, while the highest rates of 5.3 percent and 5.2 percent were achieved by the industrial and services sectors, respectively. Drivers of the growth in the said period include government spending and exports, the two key contributors to the GDP growth, which grew 9.4 percent and 10.6 percent, respectively. Consumer spending grew 5.1 percent, while the gross fixed capital formation increased 2.2 percent.

Another sign of economic stability in Turkey was that the country’s financial and debt markets recovered their ability to attract new waves of foreign short-term investments which grew due to the improving performance and disappearance of the consequences of the failed military coup. In the first four months of this year, net foreign investments in Turkey’s shares and government bonds went up to USD 7.4 billion, which led to a rise in the lira/dollar exchange rate during June after the lira traded at 3.73 per dollar in the previous months.

Pillars of Economic Transformation

The recent recovery of the Turkish economy was driven by the following domestic and regional factors: 

1- Political Reforms. At the political level, the Justice and Development Party (AK Party) introduced political reforms, such as the April 2017 constitutional referendum. There are views that these reforms may lead to, according President Recep Tayyip Erdogan, more powers at a time when Turkish political parties and the civil society faced massive restrictions in the aftermath of the failed military coup. However, the economic circles have the view that these political transformations - and the referendum in particular-may allow the AK Party to continue to introduce more economic reforms that can positively impact the performance and improve the economy’s credit rating. 

Fitch Ratings said that the constitutional amendments approved by 51.4 percent of the Turks in the April 16 referendum may facilitate a revival of credit-positive economic reforms. At the same time, the rating agency noted that the country’s economic stability will depend on the quality of economic policies pursued in the coming period. 

2- Re-normalization of Relations. By the end of June 2016, Turkey-Russia relations started to improve after Ankara apologized for downing the Russian jet fighter. Later, quick measures were taken to gradually re-normalize economic relations. In June this year, the latest decision made by the Russian government within this context lifted most sanctions against Russia, including a ban on most food imports from Turkey, except tomato.

Moreover, Russia recently ended a ban on employing Turkish workers in the country and lifted restrictions on Turkish companies operating in Russia.  lifting the Russian sanctions spared Turkey’s economy huge losses estimated at USD 9 billion. In the past period, Turkey attempted to improve its economic relations with new partners to reduce its dependence on traditional Western allies. China, Iran and some Middle East countries were among these partners.

Among the first signs of Turkey’s improving economic relations with China was a December 16, 2016 deal Turkish lira-RMB swap deal worth 450 million Turkish liras ($132 million), while the People's Bank of China (PBOC) allowed direct trading between its yuan currency and seven foreign currencies including the Turkish Lira, as of December 12, 2016.

3- FDI Incentives. The Turkish government offered a range of facilities to foreign investments over the past months in a bid to recover investors’ confidence in the economy and revive investments. Most recently, the Turkish government introduced tax exemptions and incentives and allowed for giving citizenship to foreign investors. 

Recent tax facilities approved by the government include exemptions in several economic sectors including the property market. In February 2017, foreigners and Turkish expatriates were exempted from paying VAT when buying and holding residential and commercial properties, a move that can revive investments in the sector.  

The other decision to allow giving citizenship to foreign investors was made after amending the citizenship law in February 2017 where any investor is required to deposit USD 3 million in Turkish banks for three continuous years. Others who are eligible for Turkish citizenship include anyone who buys and holds a property worth at least USD 1 million, invests at least two million Liras in a commercial project or owns a company with at least 100 Turkish employees. 

4- Domestic Facilities. As per Law No. 6745 regarding investments, passed by the parliament in September 2016, a number of sectors - IT and innovation in particular- will benefit from tax and customs exemptions and other credit facilities, depending on the type of proposed projects, which can, in Turkey’s view, drive growth in the said sectors. Overall, the government plans to grant exceptions worth 112 billion over the coming three years, equivalent to 4.25 per cent of the GDP in 2017 and 2018, and 4.24 per cent for 2019.

Regarding lending and funding, the government sought to provide large funds to encourage the private sector and boost domestic investments. Among the most important financial measures was raising the volume of the Credit Guarantee Fund to 250 billion lira (USD 66.5 billion) in March 2017.

5- Sovereign Fund. The Turkish government set up a sovereign fund in August 2016 with initial capital of just 50 million lira (USD 13.6 million) and is aiming for it to manage USD 200 billion in assets as soon as possible to become among the biggest 20 sovereign funds in the world, according to forecasts by the Minister of economy Nihat Zeybekçi. The government’s plan to transfer government stakes worth billions of dollars to this new fund can allow it to use these assets to provide low-cost fund its long-term strategic and developmental projects. 

Indeed, in February this year, the government transferred the state's 49.1 percent stake in flag carrier Turkish Airlines - worth roughly USD 1 billion- and its 51.1 percent of lender Halkbank- worth some USD 2 billion- to the new sovereign fund. Stakes in state-owned Ziraat Bank, the Borsa Istanbul stock exchange and state-owned pipeline operator Botas have also been transferred.

Prospects

In fact, the Turkish economy ability to wither fluctuations emanates from structural strengths including a huge domestic market, a widely-diversified economy, a regulated banking sector, as well as growth supported by huge investments in infrastructure for the energy, transportation and healthcare sectors that are often funded through a partnership between the private and public sector.

Despite these strengths and the positive changes that the economy witnessed over the past months, the path ahead for the economy still holds many risks that emerged in recent years, including a new escalation in political and security turbulence across the country. Other economic projections indicate that the approved constitutional amendments would lead to a lack of the ability to hold executive authority to account, and undermine economic competitiveness thus depriving the Turkish market from receiving long-term investments. 

Moreover, the current developments of the crisis in Syria, increasingly-strained relations with the EU and a widening disagreement with the US Administration of President Donald Trump would together negatively impact the economy. 

In can possibly be concluded that that the despite performance of the Turkish economy is gradually improving due to ongoing economic reforms initiated by the government months ago, geopolitical risks will remain the largest threat for economic growth in the coming period.