The US and EU sanctions
Both the EU and the US are contemplating new sanctions following the Cyprus-drilling conflict and the purchase of the S-400. Erdogan seems defiant on both counts and further sanctions seem equally unavoidable.
Turkey’s armed forces have been planning a major offensive in Northern Syria against the US-backed Kurdish Protection Units (YPG), in defiance of US and EU warnings for possible conflict escalation. A sense of urgency has been added to Erdogan’s preparatory works to invade Syria as Britain, France, Saudi Arabia and the U.A.E have responded positively to US calls to send troops to areas held by the YPG.
Russia is tacitly encouraging further cracks in relations with the West by allowing Erdogan a certain range of freedom in Syria, against the Assad regime’s wishes.
The potential for a peaceful and amicable dispute settlement with the drilling operation in Cyprus’s EEZ with the EU is small. The discord is not between Turkish and Greek Cypriots – Erdogan can’t be seen to be a third party and an onlooker as energy resources are being discovered and he is sidelined.
The EU’s dependence on the Refugee Agreement with Turkey is neither with its limitations nor in monetary terms that important to dampen other macroeconomic risks.
The potential for further conflict escalation can hardly be overrated – considering US and EU companies’ involvement and the overall connotation of Erdogan’s assertive policies.
Macroeconomic framework
Disregard for geopolitical environment, antagonizing key allies in NATO and the EU further fuel fresh waves of a sovereign credit rating downgrade, currently below investment grade. This threatens economic recovery, increasing debt levels and cost of refinancing debt. The notions that a weak Turkish currency will favor exports of products manufactured in the country is only half-true – insofar that trade barriers (including revisions of tariffs) are not put in place – either as part of sanctions or as a ‘natural’ step in the escalation of tensions not only around Cyprus but the export of resources via Turkey.
Turkish Lira volatility will rebound in heightened risks and price volatility for Turkish stocks, undermining hopes for a recovery from the recession in 2018. Although gains in recent local elections by the opposition in Istanbul, Ankara and other major cities have quelled extreme doom and gloom forecast, the political risk of a polarized society and administration of President Erdogan continue to draw concern. On the national level, he does not have any adequate counterbalance.
The negative and positive synergies between economic and political determinant remain unclear, but the challenges of sanctions and instability abound and major investments in the country are being postponed as EU capital is pulled back.
Turkey’s GDP growth in 2018 was reported at 2.8% but the number here should be taken with a grain salt as the economy entered a technical recession with three consecutive quarters of decline. Data for Q1 2019 shows a positive quarter over quarter increase, but the level of economic activity remains down 2.6% y/y.
Official estimates of the Turkish government sounds bullish, but trends in consumption remain weak, aided by higher unemployment and inflation eroded income base.
Source: Turkish Ministry of Finance / Trading Economics
Unemployment hovers above 14% up from 10.1% for June last year, which suggests economic recovery will be slow.
Growing budget deficits amid tepid economic growth and a weak labor market will certainly affect tax receipts and the ability of the government to honor promises of subsidies. Turkey has already downsized its private equity capital contribution to the NPP Rosatom builds.
Turkey’s gross public debt to GDP ratio is relatively low at only 32%, but the bulk of the foreign debt is private. Weakened currency increased the debt servicing costs and the level of foreign currency-denominated debt has reached 50% up from just 27% back in 2012. The debt exposure of the government should be judged against the prospect of possible sanction escalation and limited access to financial and capital markets.
In the balance
Turkey is certainly a major economy that attracts legitimate investors’ interests. Its virtues and handicaps should be carefully weighed and their dynamics assessed over time. The S-400 purchase is not an isolated act when judged against the Turk Stream and the Akkuyu NPP, there is a system and a strategy line behind, marking the country’s turn from a critical asset of NATO and the EU to a potentially growing liability.
It is not by chance that the nuclear power plant was contemplated by President Erdogan as a prelude to developing facilities to enrich uranium and then developing nuclear weapons – which is essentially the Iranian track. The same applies to the S-400 – the agreement with Russia provides for multiple defense and licensing agreements as Turkey will be able to produce the SAMs domestically.
The cracks in the relationship between Turkey and the West following the recognition of the fact that Turkey stands little chance of accession to the European Union and/or rejoining the F-35 fighter program, seem permanent. Just a day before the commemorative events dedicated to the anniversary of the failed coup, President Erdogan stated in no uncertain terms his strategic shift: “Despite our political and military pacts with the Western alliance, we see the biggest threats coming from there as well.” Based on elaborate and objective foreign policy analytics, this is hardly a surprise or a last-minute change of mind. It is more of an acknowledgment of the basic fact that Erdogan’s power base at home is anti-West, neo-Ottoman, radical Islamic and good relations with the West does not add votes to the AKP.
It is immaterial whether Erdogan’s split with the West is the result of his misperception or a conscientious value shift – the end product is an unintended negative development, on which he is not likely to repent or revert.
Ankara’s reaction to the first wave of sanctions from the West invites the next rounds amid a self-fulfilling prophecy of a strategic and lasting breakup in relations. The only mitigation factor remains in the change of power in Ankara with politicians willing to return to Kemal Ataturk’s legacy. However, this is not an immediate option.
How long this will take is beyond the control of any strategic investor in Turkey regardless of deals or promises made by President Erdogan.
History gives ample proof that dictators either fall without advance warning or last long based on circumstances beyond the reach of the corporate world.
End part two
Why are S-400 and Volkswagen investment in Turkey intertwined? – part one
