Turkey: A cautious approach

Narrowing the current account gap and correcting the underdevelopment of the Anatolian provinces are just two of the goals of the Turkish government’s latest investment incentive scheme, announced in early April. The plan, which specifically aims at replacing intermediate goods imports with locally manufactured products, has won accolades from the private sector and business organisations, even as economists caution that more fundamental structural reforms will be necessary.

The plan offers companies that make substantial investments in Turkey a passel of benefits, including corporate tax breaks, insurance premium support, investment interest support, access to land for Greenfield investments, VAT reductions and other tax write-offs. General support is available to all sectors, but the government is focusing on the automotive, space and defence industries, as well as wind power, pharmaceuticals and transport infrastructure.

Announcing the plan, Prime Minister Recep Tayyip Erdoğan told reporters, “The basic goals of the new incentive scheme are to decrease the current account deficit and raise production and investment for high export-dependent intermediate goods”.

The architects of the current programme have also categorised every Turkish province according to its level of social and economic development, with highly developed areas such as Istanbul and Ankara in the first region and the poorest areas of east and southeast Turkey falling into the sixth region.

According to Zafer Çağlayan, the minister of the economy, an investment of TL5m ($2.76m) could earn support of TL1.3m ($718,046) if implemented in the first region, but as much as TL5.2m ($2.87m) in the sixth. Additionally, the employer-paid, social security premiums for companies in the sixth region would be covered by the government.

The government has high expectations for the new plan, promising increases in formal sector employment of 10% in third-tier regions and 70% in fourth-tier areas. However, Ozan Acar, an analyst at Ankara think tank TEPAV, argued that without upgrades in basic services in underdeveloped regions, incentives to invest there are little more than compensation payments.

“The most important impediment to development in these areas is missing public inputs,” Acar told OBG. “It’s hard to find skilled workers, and the transport and electricity infrastructure is lacking.” Turkey’s current account deficit morphed in 2011 from a perennial headache to a critical threat to macroeconomic stability. The deficit exploded 67% last year, from $46.6bn to $77.8bn, threatening the central bank’s foreign currency reserves. The imbalance of Turkey’s current account is driven by persistent trade deficits, stemming from a dependence on imported energy and intermediate goods for manufacturers.

With the current account deficit approaching 10% of GDP – an unprecedented level – the government is scrambling to balance trade in the near term. Taxes on consumption for certain products, including alcohol and tobacco, mobile phones, and large automobiles, were introduced in October to slow down imports.

However, the real driver for Turkish imports is structural, and addressing this will require improvements in research and development, innovation and technology. Machinery, for example, made up nearly half of all imports in 2010, suggesting that the current account deficit will not be reversed without substantial upgrades to Turkey’s industrial production capacity.

There are a few reasons, however, why Turkey’s incentives scheme may not be the magic solution to the current account deficit. Firstly, macroeconomic fundamentals stipulate that an increase in domestic investment, which the government is hoping to elicit, must be financed by domestic savings or foreign capital inflows.

With the 2009 recession having demonstrated what happens when foreign money leaves Turkey, the government is keen to avoid unnecessary dependence on foreign capital. Domestic savings, however, have historically been weak, averaging just 16% in the years prior to the 2008-09 crisis, and dipping since then.

There are also concerns that the programme will gloss over the need for structural reform of the Turkish economy. A survey conducted by the American Business Forum for Turkey for the past five years offers a sobering assessment of the Turkish competitive environment. Americans doing business in Turkey give the government high grades for its macroeconomic performance, but report little progress on critical issues, such as taxation, the court system, intellectual property, corruption and contracting.

Moreover, researchers who have studied previous Turkish incentives programmes argue that rather than boosting economic competitiveness overall, incentives often mask the competitive disadvantages of the economy by compensating firms for unprofitable investments.

It is difficult to evaluate Turkey’s latest bid to boost investment without considering the government’s other micro- and macroeconomic policies. The commercial code taking effect in June 2012, for example, should mitigate some of the legal problems historically faced by investors. Moreover, greater investment, combined with a rise in domestic savings, could produce the growth required to address Turkey’s stubbornly high unemployment rate in a sustainable fashion.