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Turkey's Engine Shows Resilience

Author: Steven A. Cook, Hasib J. Sabbagh Senior Fellow for Middle Eastern Studies
November 21, 2008

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After almost six years of impressive growth, Turkey's economy is proving more resilient than analysts might expect, but nevertheless is showing signs that it is vulnerable to the global economic downturn. This resilience is derived in large part from the twin economic crises the Turkish economy experienced in August and November 2000. The severe economic contraction, which was the result of both economic mismanagement and problems in the banking sector, paved the way--with the help of the International Monetary Fund (IMF)--for an array of important economic and financial sector reforms.  Presently, Turkish banks are well capitalized and have relatively clean balance sheets, government debt is half of what it was in 2001, foreign exchange reserves are in the range of $80 billion, and the economy as a whole is more diversified.

Still, while Turkey may avoid the worst consequences of the crisis, there are some troublesome indicators. First, gross domestic product (GDP) growth in 2008 and 2009 is expected to be half of the 6 percent to 7 percent it has been over the last few years. This is primarily a function of the recession within the European Union, the destination for about half of Turkish exports. To ensure against the liquidity crisis afflicting other economies, the Turks have been pumping lira into the financial system, which has had inflationary effects. Thanks to economic reform, hyperinflation is a phenomenon of the past, but double-digit annual price increases have been a cause for concern. Under current global conditions, however, it remains unclear whether inflation will persist. Finally, the global financial crisis will sharply reduce the amount of foreign direct investment in Turkey. Foreign investment--about $20 billion in 2007--was an important engine of economic growth.

"With the global economic downturn, the economic populism that will deliver voters may be a short-run boon to the governing party, but it will likely weaken the Turkish economy in the long run."

The Political Equation

The other major issue that could have an adverse effect on the Turkish economy has little to do with global finance, but rather politics. In March 2009, Turks will go to the polls in municipal elections. The leaders of the Justice and Development Party (AKP), which has held the reins of government since late 2002, hope to deepen their lock on the political arena with a strong showing in towns and cities. At the same time, pressure is building from Turkey's influential business sector for the government to sign on to a new IMF stand-by agreement to further anchor Turkish economic reforms. From a purely economic perspective, this seems like a prudent measure, but Prime Minister Recep Tayyip Erdogan is resisting any agreement that would restrict the government's ability to spend freely in the run-up to municipal elections.

Since coming to power, Erdogan and his team have demonstrated remarkable discipline in pursuing economic reforms. They have been rewarded handsomely with strong growth and an unprecedented electoral mandate (the AKP won 47 percent of the popular vote in July 2007, largely on pocketbook issues). Yet the prime minister's reluctance to agree to a new IMF program indicates that some old and very bad habits of Turkish political leaders remain entrenched. With the global economic downturn, the economic populism that will deliver voters may be a short-run boon to the governing party, but it will likely weaken the Turkish economy in the long run.

"Turkish banks are well capitalized and have relatively clean balance sheets, government debt is half of what it was in 2001, foreign exchange reserves are in the range of $80 billion, and the economy as a whole is more diversified."

Regional Ramifications

This is not just a problem for Turkey, but for the United States as well. Over the last six years, as Turkey has benefited from wide-ranging political and economic reform, Ankara has played a more active diplomatic role in its surrounding regions, particularly in the Middle East. Moreover, given both the financial and political constraints on the United States going forward, Turkey will become an ever more important strategic partner in managing the conflict in Iraq, confronting Iran, working toward peace between Syrians and Israelis, and providing economic assistance (by way of investment) for Palestinians. Yet the combination of the economic crisis and what seems to be AKP's sudden lack of fiscal restraint will hamper Ankara's ability to help Washington.

Turkey's already insular tendencies would likely be reinforced should global economic troubles undermine the tremendous strides Turks have made since 2002. The downsides of globalization resonate deeply with many Turks. More importantly, Turkey's economic vitality contributed in many ways to its active and constructive approach to the Middle East and beyond. The perception, particularly in the Arab world, that Turkish society was progressing in fundamental ways that their Arab counterparts were not provided Turkish leaders, businesses, and diplomats clout that they had not previously enjoyed. The sapping of Turkish economic strength would certainly diminish Turkey's soft power.

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