With the release this week of a European Commission progress report advising the beginning of membership negotiations with Turkey, there is a decidedly sunny aspect to market watchers these days, even if the rest of the country has been suffering some severe rain storms and flooding. Notwithstanding the conditional terms imposed by the Commission, Turkey appears to be on track for eventual membership. However, to fully earn its place in the European club, the Turkish economy still has to avoid a number of potential snares.
Yet for the moment, any perceived dangers have not been sufficient to offset confidence in the Turkish economy. Optimism has been fuelled not just by the European Union, but by the IMF too. "Turkey is on its way to becoming a tiger economy", a Fund survey claimed back in September, while IMF Deputy President Anne Krueger has also lavished praise on Ankara's performance this month.
Such a positive atmosphere saw the Istanbul Stock Exchange 100 index up 41% on mid-May lows by early October.
Meanwhile, foreign investors are likely to be paying a lot more interest in Turkey now. According to recent predictions by the Institute of International Finance (IIF), as much as 60% of the portfolio equity that flows into Europe's emerging markets will target Turkey next year. This the IIF attributes to Turkey's solid economic performance and increased rate of privatisation, translating into $2.8bn of foreign direct investment (FDI) in 2005, with $2.4bn expected to be achieved by the end of 2004.
This represents a major development in FDI, which has traditionally been microscopic in Turkey. This capital flow is also likely to accelerate if Turkey gets a firm date to start EU accession talks in December, when EU heads of state will make the final decision.
Removing some past blocks to FDI will also become easier once Turkey becomes committed to a process of continuous convergence with EU standards. Once traditional deterrents to FDI have been removed, Turkey should really be able to cash in on its proximity to Europe, Asia and North Africa and its market of over 70m potential consumers in an expanding economy.
Meanwhile, optimistic projections regarding increased levels of FDI may provide Turkey's unemployed with reason for hope. For the time being though, domestic growth continues to be the closest source of relief. A drop in the rate of unemployment to 9.3% in the second quarter of 2004, marks a considerable improvement from the 12.4% registered in the first quarter of the year. Economic growth may at long last be trickling down to the ranks of the unemployed.
Yet a continuation of strong growth does pose its own set of risks. Many analysts hold that the economy needs to slow down in 2005, given that the current account deficit is expected to reach 4-4.5% of GNP by the end of 2004. Underlining the current account deficit has been strong investment demand and the release of postponed consumer expenditure, driving a widening trade deficit. A continuation of unbridled growth could perpetuate the deficit burden. This of course goes on the assumption that the government's tight monetary and fiscal policy does not succeed in sufficiently narrowing the deficit in the coming months.
But concerns over Turkey's debt burden are not shared by all - and particularly not by those who compare circumstances today to those that triggered the 2000-2001 financial crisis. As Hakan Aklar, an economist for AK Securities, recently told the OBG, "Banks were not as robust [back then] as in 2004, and there was no floating exchange rate."
Chances of the current account causing any kind of crisis are therefore widely thought unlikely. Certainly, Finance Minister Kemal Unakitan has shrugged off deficit fears. He rightly points out that before the ruling Justice and Development Party (AKP) came to power, debt levels had reached 90% of GDP. With debt projected to be around 68% by the end of the year, 2004 looks positively bright by comparison. Official claims that debt levels will narrow to 60% of GDP in five years time do not seem unrealistic.
A similar logic has allayed fears regarding Turkey's $30bn trade deficit.
"Such a deficit might have been a big problem for Turkey five to ten years ago," State Minister Kursad Tuzmen told the OBG in September, "given that the volume of trade at that time was an estimated at $60bn. But now, with the volume of two-way trade amounting to roughly $150bn, the problem is less acute."
Yet in spite of such comforting thoughts, fiscal challenges do still lie ahead. Three-fourths of total budget spending is now non-discretionary, which suggests that the government is constrained in its ability to control expenditure, according to the IMF. Despite a disciplined fiscal approach over the last three years, the Turkish administration's room to manoeuvre is narrower than it might otherwise have been - with tax rates forebodingly high.
Although the burden of debt is comfortingly low by historical levels, state coffers remain in the red - a fact that no amount of reassurance can deny. Turkey, according to the Oyak Bank Economic Review for September, is expected to repay $70.3bn of foreign debt over the 2005-2007 period. The IMF in the meantime has invested as much as one-fourth of its total global lending in Turkey, a figure standing at $23bn so far.
Increasing tax revenue by targeting Turkey's huge unregistered economy could of course help to relieve the burden.
"What Turkey needs is an improvement in the systems of control and data base management, coupled with the independence of the tax administration" according to Aklar from AK Securities. Meanwhile, other analysts argue that the unregistered economy is an indispensable engine of growth and that tampering with the engine might upset the positive momentum.
Meanwhile, efforts continue to try and reduce the debt, strengthen the economy and encourage a vibrant private sector. This more specifically involves tax, social security and other reforms along with efforts to strengthen the banking and financial sector. At the same time, the IMF has pointed to the need for increased public investment in infrastructure and social programmes, plus the fiscal reforms that such a shift would imply.
Now, with the prospects of a date for EU accession talks looming large, Turkey is unlikely to stray off this narrow path. Ankara is gearing up to present a three-year economic programme to the EU in December 2004, and will be keen to reflect in the best possible light Turkey's progress at home - whether in terms of political reform or in the strength of the economy.
With growth averaging 6-7% over the last two years and 2004 recording single-digit inflation, Ankara has grounds for some confidence. Dubbed a potential tiger economy by the IMF, Turkey feels that it has earned its stripes. But stability can only be achieved through a continuation of disciplined reform and prudent fiscal judgement. Snares and pitfalls could otherwise get the better of an emerging heavyweight.
