Flightless

THERE is much to make investors jittery about Turkey. It is becoming ever more involved in the chaos in neighbouring Syria (see article). The Kurdish insurgency in the east of the country appears to have restarted. Politicians are still wrangling over a coalition after an indecisive election in June. The country may be in for a period of unstable, short-lived government or even a fresh election. Worse, Turkey has long been identified as one of the most vulnerable emerging markets, with slowing growth, a large current-account deficit and high corporate dollar-denominated debt. It is little wonder that the lira has been one of the world’s weakest currencies this year.

Fans of the Justice and Development (AK) party and its longtime leader (now president), Recep Tayyip Erdogan, like to boast of its stellar economic record since first forming a government in 2002. It is true that, after the bumpy 1990s and the humiliating bust of 2001, which ended in an IMF bail-out, AK presided over a decade of strong growth with relatively low inflation. The banks are solid and well-capitalised, foreign investment has soared and Turkey has acquired an investment-grade credit rating from some agencies. The country is this year’s chair of the G20, a club of big economies, and Mr Erdogan wants it to be one of the world’s ten biggest economies by 2023 (it is 18th now).

Yet a closer examination finds AK’s record far less shiny. During its time in government, economic growth has been, at best, middling by emerging-market standards. It has recently slowed sharply: GDP is expected to expand by barely 3% this year after only 2.9% growth in 2014 (see chart). Thanks partly to the tumbling lira, inflation is stuck at around 8%. Unemployment, at almost 10%, remains high. Turkey’s consumer-confidence index recently touched a six-year low.

Turkey’s external position also makes it peculiarly vulnerable. The combination of low saving and high investment means that it has long run a large current-account deficit: in 2014 it was, at 6% of GDP, proportionately the biggest in the OECD, a club mostly of rich countries. Dani Rodrik, an economist at Harvard University, points to what he calls the deteriorating quality of Turkish growth. Over recent years, any given level of growth has been associated with a rising current-account deficit, not a falling one.

Foreign-currency borrowing in Turkey is high and rising, especially among non-financial businesses. The economy’s total external financing needs are now put at around $200 billion a year. According to the IMF, the foreign debts of banks and other companies shot up from around 5% of GDP in 2008 to 18% of GDP in 2013. With the lira’s fall making such loans more expensive to service, these numbers are worryingly high.

Some investors take comfort from Turkey’s robust public finances, in contrast to the 1990s (and to neighbouring Greece). Public-sector debt has fallen from 80% of GDP in 2001 to only 33% today. Yet it is not the public sector that is the problem. The fear that the private sector’s borrowing binge will lead to a crisis is exacerbated by the prospect of higher interest rates in America, expected as soon as September. That is likely to draw capital away from emerging markets.

These worries are heightened by a loss of faith in Turkish institutions. When the central bank began raising interest rates in early 2014, Mr Erdogan attacked it for being part of the “interest-rate lobby”. He insists that high interest rates cause inflation, not the other way round. A perceived weakening of the rule of law also makes it hard to attract foreign investors. Earlier this year the head of the Turkish employers’ federation roused Mr Erdogan’s ire by saying, “A country where the rule of law is ignored, where the independence of regulatory institutions is tainted, where companies are pressured through tax penalties and other punishments, where rules on tenders are changed regularly, is not a fit country for foreign capital.”

The slump in Turkish growth is not just a short-term or cyclical problem. As one London-based analyst argues, it is structural, reflecting domestic as well as external imbalances. Turkish savings are too low. Regulation is excessive: Turkey comes bottom of the OECD league for product-market regulation. In the World Bank’s rankings for ease of doing business, Turkey comes 136th for building permits, 79th for starting a new business and 109th for resolving insolvency. Labour-market participation is low, especially among women, for whom it has actually fallen under AK’s tenure. Turkey has no technology industry to speak of and spends little on research and development. Many economists reckon it is caught in a middle-income trap, from which it can escape only through substantial structural reforms.

Sadly, none of the parties jostling for a place in government seems interested in that. Under AK, investors were reassured by the presence of the experienced Ali Babacan as a deputy prime minister in charge of the economy, but he is stepping down. Some hope for a return of the man who, with the IMF’s help, rescued Turkey in 2001: Kemal Dervis. That would depend on AK forming a coalition with the main opposition Republic People’s Party (CHP), but it has not yet settled on a partner. The jitters seem likely to last.