BACKGROUND: Through the 1990s and into 2000, the Turkish economy was hostage to a combination of fractious coalition governments, a poorly regulated financial sector and the very high returns on Treasury bills and bonds, which often offered real annual returns of 30-40 percent. The system collapsed in February 2001 when a run on the Turkish Lira plunged the country into a deep recession. In 2001 as a whole, Turkish GDP contracted by 7.5 percent. In May 2001, Turkey’s ruling tripartite coalition government agreed an Economic Stabilization Program with the IMF, backed by what would eventually become over $30 billion in IMF loans. The program succeeded in stabilizing the economy, but failed to save the coalition partners. In November 2002, the AKP swept to power as Turkey’s first single-party government in more than a decade.
Turkish GDP had returned to growth in the first quarter of 2002. When it took office, the AKP continued to implement the Economic Stabilization Program formulated by the previous government, maintaining strict fiscal discipline and reducing the returns on Treasury paper. The stability resulting from a single party government and the AKP’s vigorous political reform program to secure a date for the opening of accession negotiations with the EU reassured and encouraged foreign investors. While, without easy returns on bills and bonds, Turkish banks were forced to focus on lending to corporations and consumers.
"The crisis affects all countries" - "2001 experience"
The result was one of the longest sustained periods of high economic growth in Turkey. In the period 2002-2006, Turkish GDP grew by an average of over 6 percent per year, the Turkish Lira appreciated and annual inflation fell to single digits after averaging over 60 percent per year during the previous decade. Foreign investor confidence in Turkey received a further boost with the opening of EU accession negotiations in October 2005. Foreign Direct Investment (FDI) in Turkey rose to $20.2 billion in 2006, up from $9.8 billion in 2005 and compared with an annual average of around $1 billion in the decade before the AKP came to power. There was a similar increase in foreign portfolio investment. By the end of 2006, around two thirds of the free float of the Istanbul Stock Exchange (ISE) was owned by foreigners.
However, Turkish industry is heavily dependent on imports of raw materials and semi-finished goods. The strong Turkish Lira thus reduced the cost of industrial inputs and imported consumer goods, but fuelled a rapid increase in the foreign trade deficit from $7.3 billion in 2002 to $34.4 billion in 2004 and $52.3 billion in 2006. The current account deficit grew from $1.5 billion in 2002 to $15.6 billion in 2004 and $31.9 billion in 2006.
Nor did the impressive GDP growth figures result in a commensurate increase in employment or income levels. Unemployment stood at 10.7 percent at end-2002, 10.5 percent at end-2004 and 10.5 percent at end 2006. Although there was a huge increase in corporate and consumer borrowing in 2002-2006, real wages and salaries remained almost unchanged.
IMPLICATIONS: In May 2005, the AKP signed another three-year loan agreement with the IMF. In addition to providing Turkey with $10.8 billion, the deal also reassured foreign investors as it provided for the IMF to continue to monitor the AKP’s economic performance. However, when the deal expired in May 2008, the AKP chose not to renew it. Still flushed with its re-election by a landslide in July 2007, the AKP apparently believed that its economic reputation no longer needed IMF endorsement.
But the AKP also refused to heed the unmistakable signs that the pace of economic growth had begun to slow. After claiming the credit for the boom years of 2002-2006, AKP officials seemed incapable of accepting that the economy could falter while they were in government. Anyone who called for measures to address the impending economic slowdown was simply accused of being a politically-motivated doom-monger. Yet the figures published by the Turkish Statistical Institute (TURKSTAT) were unequivocal. In 2007, Turkish GDP grew by 4.6 percent, down from 6.1 percent in 2006, 7.4 percent in 2005 and 8.9 percent in 2004. In 2007 Turkey’s foreign trade deficit widened by 20.1 percent to $62.8 billion, while its current account deficit rose by 19.7 percent to $38.2 billion. Although FDI rose by 5 percent in 2007 to $22.1 billion, a large proportion of the inflow was for deals concluded in 2006.
But even if the AKP was in denial, international investors were becoming increasingly concerned about the vulnerability of the Turkish economy. When the global financial crisis broke in early October 2008, the Turkish Lira lost nearly 40 percent against the US dollar in the space of three weeks. Yet even this was not enough to convince the AKP that it needed to take action. On the contrary, AKP officials proudly declared that the Turkish economy was strong enough to simply weather the turmoil. In late October 2008, Prime Minister Recep Tayyip Erdogan declared: “Thanks be to God, the crisis has bypassed Turkey.”
In fact, the full impact of the crisis had not even begun to be felt. In 2001, the crisis had started in the financial sector and spread to the rest of the economy. But, in late 2008, Turkey’s vulnerability was its ailing “real” economy. As the inflow of foreign funds declined, sales to the country’s main export markets in Europe fell and companies and consumers, who had already taken on too much debt, began to struggle to make payments. Yet the AKP still did not draw up a comprehensive set of measures to try to reduce the impact of the crisis, choosing instead to focus on bolstering its popular support in the run-up to the March 2009 elections.
In December 2008, the AKP finally accepted that its optimistic rhetoric was insufficient in itself to reassure increasingly wary foreign investors and invited the IMF to Turkey to discuss a new loan agreement. On January 26, 2009, after over two weeks of negotiations with a Turkish delegation headed by Economics Minister Mehmet Simsek, the two sides reached an agreement. But, when Simsek presented the deal to Erdogan for his approval, the prime minister rejected it. Erdogan had objected to the IMF’s insistence on limits on government spending and greater transparency with regard to central government transfers to local authorities; amid accusations that the AKP was diverting resources – including distributing foodstuffs and even domestic appliances to impoverished voters – to regions where it hoped to increase its vote in the March 2009 elections.
On February 9, 2009, Erdogan publicly announced that he would never allow the IMF to impose conditions which were against the “country’s interests”. What this meant became clear when the budget figures for January 2009 were released on February 11, 2009. They showed a deficit of TL 3.0 billion, an increase of 465.8 percent on January 2008. The expenditure items included TL 51.7 million in “social aid” to poorer members of the community, up from TL 2.2 million in January 2008.
In mid-December 2008, TURKSTAT announced that in the third quarter of 2008, Turkish GDP grew by 0.5 percent compared with one year earlier. Most analysts expect negative growth during the fourth quarter of 2008 and a contraction of up to 5 percent in GDP in 2009. These expectations were reinforced by a sharp downturn in foreign trade in the fourth quarter of 2008. In 2008 as a whole, the foreign trade deficit grew by only 11.2 percent to $69.8 billion, while the current account deficit widened by just 8.4 percent to $41.4 billion.
Further signs of the depth of the impending economic downturn came in the statistics for economic activity inside the country. In January 2009, Turkish industrial production fell by a record 21.3 percent compared with January 2008. In early March 2009, Turkish bankers warned that 2009 could see an unprecedented level of nonperforming loans as companies, particularly small and medium-sized enterprises, fail to meet their repayment schedules. The economic downturn is also expected to fuel a further rise in unemployment. In mid-February 2009, TURKSTAT announced that in November 2008 the unemployment rate in Turkey already stood at 12.3 percent, up from 10.1 percent in November 2007. Youth unemployment rose to 23.9 percent in November 2008, up from 20.0 percent twelve months earlier.
CONCUSIONS: The AKP government has continued to refuse either to take measures to alleviate the impending recession or to amend its official target of 4 percent GDP growth for 2009. On March 7, 2009, Erdogan dismissed the rise in unemployment in November 2008 as being attributable to “seasonal factors”, without explaining how they could have been absent twelve months earlier.
The economic boom of the AKP’s first years in power was based on a combination of factors, not all of which were sustainable. The pace of economic growth had already begun to slow even before the global crisis broke in October 2008. However, the AKP’s refusal to admit the scale of the problem threatens to deepen the impending recession. Perhaps most worryingly, the resultant increase in economic hardship and unemployment is likely to exacerbate already dangerously high societal tensions, with potentially substantial consequences for the social fabric of the country.
AUTHOR’S BIO: Gareth Jenkins is an Istanbul-based journalist and expert on Turkish affairs.