After days of protests, ballooning from a niche sit-in over green space in Istanbul to country-wide demonstrations calling for a change in government, Turkey’s Deputy Prime Minister Bulent Arnic conceded “we do not have the right and cannot afford to ignore people. Democracies cannot exist without opposition.” This insight is better late than never, but recent market movements have focussed attention on the relationship between socio-political stability, image and economic prospects in Turkey.
Emerging markets are often dependent on capital from abroad to finance expenditure. This can be due to underdeveloped domestic capital markets or the desire of foreign investors to buy into good growth potential where domestic creditors simply can’t meet the demand for funds. Alternatively, emerging markets — like developed markets — sometimes take in foreign capital to finance current account deficits. The former usually comes in the form of foreign direct investment or long-term portfolio investment, whereas the latter is typically made up of short-term portfolio investment.
Since Erdogan took office in 2003, Turkey’s current account deficit measured on a moving average basis has grown a staggering 14 fold.
Table 1. Turkish current account deficit (12 month moving average), 2003-2013
Source: Central Bank of the Republic of Turkey; Bloomberg
Short-term investment is, by definition, far more mobile than long-term investment. Leaning heavily on short-term investment is precarious position to be in for any country, but this is especially true for countries exposed to strong reputation risk. If alarmed, investors can pull out of a country in a moment’s notice and leave the country starved of capital.
Since 2010, Turkey has become increasingly reliant on short-term foreign investment. Were investors to stage a mass exodus, Turkey would find itself lacking the resources to fuel its historically strong growth, keep inflation subdued, and service its debts — all trumpeted achievements of the last decade. This could explain, in part, the recent tumult in Turkish equity, credit, and currency markets.
Figure 2. Short-term and long-term foreign investment in Turkey, 2007-2013
Source: Turkey Data Monitor; BBC
Another key source of growth for many emerging markets is tourism. As in economic performance, Turkey as a tourism destination has shot up the league tables since 2003. Turkey is now the sixth most popular tourism destination in the world. The country’s tourism industry is valued around $30 billion. Services comprise around 63 per cent of the Turkish economy, and tourism comprises a significant chunk of Turkish services. Any hit to the country’s image as a safe holiday destination could seriously bruise economic growth.
Although talk of a “Turkish Spring” has been played down by many commentators — indeed, I would also caution against such comparisons — patterns in post-Arab Spring tourism in Egypt, Tunisia, and other such countries act as a warning to Turkish politicians. Tourist arrivals in Egypt fell by 4.5 million following its episode of political upheaval. This was a key drag on the Egyptian economy.
In terms of tourism, Turkey actually benefitted from the Arab Spring, as the country was seen as a substitutable product but without the risks. This time, that relationship could be reversed.
Admittedly, tourism as a per cent of total employment is somewhat lower in Egypt than in Turkey (14 per cent in the former and 8 per cent in the latter). Nevertheless, a significant drop in foreign footfall could pose a real threat to the country’s economic prospects.
The direct impacts of the demonstrations on the Turkish economy, such as strikes and damages to property, are likely to be minimal. The real threat comes from falling out of favour with those bringing cash into the country. Investors and holiday-goers, like the Turkish electorate, have been voting for Erdogan over the last decade by bringing their money to Turkey. And also like political votes, those economic votes are likely to disappear unless the current situation is managed delicately.