MENA Fund Review

MENA Fund Review

REGIONAL ROLE MODEL – 23RD JUL 2012

Turkey stands out from most other MENA countries for its political stability and economic

diversity. Sitting on the edge of Europe and the Middle East, it has benefitted from being a

bridge between both regions and taking on characteritics of each. It stands to profit further as

a bridge between developing economies in the east and developed countries in the west.

MENA Fund Review spoke to Cenk Utkan, marketing director, Strateji Asset Management,

Özgür Çati, group head of sales and marketing management, Yapi Kredi, and Alper

Gokpinar, director, Turkisfund about Turkey’s economic prospects and investment

opportunities there.

TURKEY has become a role model for the Middle East and North Africa. Its strong

economic base, politicalstability and prominent role on the world stage – the envy

of many in the region – are a result of strategic structural reforms that began over a

decade ago.

Its position has been solidified in recent years by the possibility of EU membership

and a growing role in the political arena as a result of the nearby Arab Spring

uprisings.

A number of economic factors have played in Turkey’s favour, including the increase

in global investment appetite after the FED’s expansionary monetary policy coupled

with accommodative monetary policies implemented across developed country

central banks. According to Alper Gokpinar, director, Turkisfund, Turkey benefited

greatly from the increase in inflow of capital and its asset management industry

gained momentum.

“After having successfully reduced inflation and interest rates to single digit levels,

investors only now started to have a longer term perspective on their financial

investments,” he says. “We believe that while these developments have contributed

to the growth of the asset management industry in Turkey, we are still very far from

mature levels. In fact, all indicators suggest that we are only at the very beginning of

a sustained period of expansion of the asset management industry in Turkey.”

Several factors set Turkey apart in the MENA region. Unlike a number of other

countries it is not an oil-dominated economy. Coupled with this, it is the most

industrialized country in the region. The combination of these factors mean it offers

investors good diversification away from oil related assets.

Turkey also has an entrepreneurial business culture, which is reflected in its growth

rate over the past decade, according to Cenk Utkan, marketing director, Strateji

Asset Management.

“In 2011 alone Turkey grew at 8.5 percent, which puts it in the top position alongside

China and Argentina,” he says. “This is in stark contrast with the debt doldrums of

the Western world including the EU and the US. We are also seeing an oversaturation

in the Chinese and Brazilian economies. China is controlled by a polit bureau and its property market has its own debt-laden problems. These issues have

taken their toll on China’s stock market returns since 2007.

“Turkey currently trades at a P/E of 11.5 which implies a 10 percent discount to the

MSCI Emerging Markets index. The Istanbul Stock Exchange returned 250 percent

since the Justice and Development Party (AKP) came to power in 2002. Our funds

returned circa 1700 percent during the same period.”

Liquidity and regulation also set Turkey apart from much of the region. The daily

trading volume on the Istanbulstock exchange is $1.5 billion a day and the total

market cap remains at $175 billion, which makes it easy to trade in and out of the

market. Foreigners represent around 70 percent of the average traded daily

volume, making Turkey a favoured destination with global investors.

Since 2001 capital markets regulations have been strengthened and adapted to the

EU entry criteria, according to Utkan. Asset managers submit their positions daily to

the regulator who checks concentration and position limits. A daily NAV is

ascertained for each regulated investment fund providing security for investors. The

returns and positions of each fund are also reported to the public in a transparent

way.

“That said the local asset management business still remains dominated by money

market funds and domestic equity investors only represent $700 million,” says

Utkan. “The government is clearly committed to increasing the savings industry and

has made important steps to liberalize the local asset management industry. The

regulator allowed 15 independent boutiques to launch asset management

businesses in the last couple of years. We believe these launches will change the

market structure of the asset management business, which is still dominated by

banks.

“The government also implemented a hedge fund law and a pensions reform

enabling private pensions schemes, which now amount to YTL15 billion.”

Essentially Turkey offers a combination of emerging markets growth, diversification

away from oil, a regulated and transparent capital markets law, and discounted

prices, according to Utkan.

“However, whilst the banking and brokerage businesses are well established the

local asset management industry is still at its infancy and there is plenty of room to

grow,” he adds.

One of the biggest boom areas of Turkey’s asset management industry as the

country has developed economically has been private equity. Attempts were made

to develop private equity in Turkey in the 1990s, but without much success.

“Traditionally businesses were funded by their principals and loans provided by local

banks based on relationships and a quick glimpse through the company’s recent

accounts,” according to Utkan. “As a result wealth was accumulated in the hands of

family conglomerates.”

Turkey began a process of economic liberalization and privatisation in the 1990s,

but growth came with high inflation and interest rates. Only in 2002 when the

country underwent radical political and economic changes was the door fully

opened for the industry to develop.

“For the first time Turkey had a stable conservative single party administration

which implemented economic reforms significantly improving the investment

climate for foreign investors,” says Utkan.

Today all the major private equity houses are present in Turkey including BC

Partners, Carlyle, Texas Pacific Group and Cinven and there are significant

investments made by investors from the Gulf. Other large domestic players are

Actera and Turkven who are backed by blue chip institutions.

“It is fair to say that not a day goes by without a foreign company snapping up a

Turkish asset,” says Utkan.

These economic and political changes combined with a high growth environment

have been attractive for private equity capital.

According to Özgür Çati, group head of sales and marketing management, Yapi

Kredi, “Relatively new and previously almost unregistered sectors such as waste

management, logistics, as well as IT, food and tourism sectors were the first targets

of private equity firms in Turkey.

“Compliance with EU regulations in such sectors may lead to additional need for

capital in the future and hence larger interest of private equity firms for the Turkish

market.”

According to Utkan, many commentators still wrongly perceive Turkey as a country

reliant on short-term money flows and portfolio investments.

“The fact that the private equity business has grown so significantly whilst the

public equity asset management remained so small contradicts this view,” he says.

“Most of the flows into Turkey in the last decade have been done though foreign

direct investment. Today private equity players are finding scarce investment

opportunities and are buying businesses at huge multiples. We believe the

opportunity to make outsized returns remains within the public markets.”

The long term outlook for Turkey’s economy and hence its asset management

industry looks positive. It has fully shed the boom and bust cycle that bedeviled its

economy in the 1990s. The average growth rate is now at a sustainable level just

above four percent and the country’s chronic inflation problems seem well in the

past. It is now the seventeenth largest economy in the world with a fully convertible

currency and liberal regime.

Confidence in Turkey’s economy is reflected in the fact that exports rose from

around $31 billion in 2001 to $135 billion in 2011despite the global financial crisis.

In addition, Turkey has a gradually strengthening middle class that fuels growing

domestic consumption. It also has strong energy, transport infrastructure, finance,

telecommunication, tourism, real estate, automotive, agriculture and retail

industries that attract a regular flow of foreign capital.

Alongside these relatively recent economic developments Turkey has 30 years of

uninterrupted democracy behind it and eight years of single party administration

with continuing electoralsupport.

“Macro policies have been developed to withstand internal political changes and

outside shocks,” says Utkan. “As a result GDP has tripled over the last decade from

$230 billion to $660 billion in 2011. GDP per capita is expected to reach over $12,000

by 2013. Turkey went into the crisis in 2008 and came out very quickly ahead of

everyone in the region. The debt ratings of the country have been consistently

upgraded over the last decade. Turkey is also the only country currently satisfying

the Maastricht criteria.”

The underlying drivers behind Turkey’s rapid reform are several. It has a large

domestic market of 75 million people. The population is relatively young with 26

percent under the age of 15 and 50 percent under 29. Based on UN projections,

Turkey willstill have the youngest population among European countries by 2050.

These factors have led to strong domestic consumption, which generates 70

percent of GDP.

“This strong domestic market limits export dependency during times of crises,” says

Utkan. “We are also seeing the emergence of a growing middle class with increasing

purchasing power funneled into healthcare, technology and education. For example

Abraaj made its exit from Acıbadem private hospitals at a sale price of $1.65 billion to Khazanah. TPG sold its stake in Mey Içki, a spirits maker at $2.1 billion to Diageo.

Carlyle has a significant stake in Bahçeşehir colleges.”

Another driver of Turkey’s growth has been its ability to tap relatively unpenetrated

markets quickly. For example Iraq has become Turkey’s third largest

trading partner as Europe’s share has declined and Turkish Airlines has become a

global player exploiting Istanbul as a hub between Europe and the Middle East.

Turkey has also benefited from being located at the heart of a region rich in oil and

natural gas resources, at the crossroads of the world’s energy map and a primary

energy bridge reaching out to Europe.

According to Yapi Kredi, “It should be noted that the better participation of [MENA]

region’s countries to the world economic system will boost the aggregate demand

in the region, which will create new markets for Turkish producers, contractors and

investors. Global warming and rising demand is a driving factor behind agriculture

of Turkey becoming a strategic sector. Turkey’s large lands are suitable for

cultivation with appropriate climate.”

While other countries in the MENA region felt the impact of the global financial crisis

and Arab Spring, Turkey escaped relatively unscathed and with potentially

improved long-term trade prospects. The first direct impact of the Arab Spring was

rising oil prices. Turkey’s total energy bill is almost $48 billion, more than six percent

of GDP so any upward movement in energy prices affects the country’s foreign

balances. Rising oil prices may however be offset by a better trading environment

across the MENA region, according to Yapi Kredi. The Arab Spring may be the

catalyst to a more liberal economic environment in the region, he believes. Higher

purchasing power across the Middle East and North Africa could boost Turkish

exports

“The share of MENA in Turkish exports already increased from below 10 percent in

2006 to 20 percent in 2011,” he says. “Hence Turkey could partly offset diminishing

demand from her main trade partner Europe.”

It should also be noted that Turkey had already bitten the bullet in 2001 by not

defaulting and implementing an IMF backed austerity package. Regulations on the

banking sector were strengthened and most banks had strong balance sheets in

8. As a result banks made an incredible come back in 2009, according to Utkan.

“The country has a nice problem to solve as it is trying to cool off the economy

rather than trying to revive it,” he says. “Going into 2011 the current account deficit

had risen to ten percent of GDP. The currency was sold off and the markets were

punished. The government increased the collateral ratios on banks and

implemented an interest rate corridor to micro manage the money supply during

the crisis.

“Debt to GDP remains at 40 percent which is low. Turkey’s CDS spreads remain at

historical lows. Inflation remains at 8.8 percent down from 30 percent in 2003. The

budget is running at a 2.2 percent budget deficit, which is over the EU defined

budget balance of -3 percent. We are sanguine on banks this year as their

fundamentals remain strong whist their stock price declined due to global investor

bearishness towards financials.”

Turkey’s ties to the East also helped to shelter it from the effects of both the global

financial crisis and the Arab Spring. It has long pursued a zero problems with

neighbours policy as well as signing numerous bilateral trade treaties and

implementing visa-free travel agreements. Over time Turkey’s foreign policy has

shifted from quasi-isolationism towards neighbors to fostering and taking

advantage of the cultural and historical links it shares with other countries in the

region.

“Diplomatic and commercial ties were forged and improved with most of the

countries subject to the Arab Spring,” says Utkan. “Following the uprisings the Turkish foreign policy stance has been to back pro democracy movements in the

Middle East. This is visible from its policy towards Palestine to Syria. As a result

Turkey became a credible soft power within the region.”

Turkey’s pro democracy stance during the Arab Spring uprisings had an initially

negative impact on trade volumes with some countries, including Libya and Syria.

However, in the long term its stance is likely to prove popular with pro democracy

movements that have taken power across parts of the region. In addition, Turkey’s

political model is being seen as a blueprint for many of these pro-democracy

movements.

Turkey’s support for the ongoing uprising in Syria is a more complicated issue. Prior

to the recent unrest relations between the two countries were good. The legal

framework of economic relations was strengthened with the Free Trade Agreement,

mutual abolishment of visas and the completion of several bilateral agreements in

2009 and 2010. Total trade volume between Turkey and Syria rose to around $2.3

billion in 2010 from $800 million in 2006 and the number of Syrian tourists visiting

Turkey increased more than seven-fold to about 900,000 in 2010 from 126,000 in

2002.

According to Yapi Kredi, “This increase in the momentum of political and economic

relations ceased abruptly with the uprising in Syria. Turkey tried to urge restraint

from the Assad government and organised the Friends of Syria conference to help

resolve the conflict in a peaceful manner. The ultimate outcome of the power

struggle in the country will determine the regional economic and political balance

that also includes Iraq and Iran. Sectarian tensions are likely to rise in the near term.

Syria will try to leverage its close relations with traditional allies Russia and Iran.”

The loss of trade with Syria has had a particularly heavy impact on Turkish cities

close to the Syrian border such as Gaziantep and Kahraman Maras.

More damaging though for the Turkish economy has been the ongoing nuclear

dispute between Iran and a number of world powers, according to Yapi Kredi.

“Iran has been a primary energy supplier to Turkey but due to the threat of US

sanctions, Turkey’s sole petroleum refiner Tupras had to scale back cheaper oil

purchases from Iran,” he says. “Turkey’s economy is highly dependent on energy

imports. The bulk of the country’s annual $75 billion current account deficit is driven

by the energy bill.”

Turkey’s policy of fostering new relationships where cultural ties already exist has

extended far beyond the Middle East to India where the Mughals used to rule prior

to the English, as well as Central Asia and China. A recent trade delegation to China

began its negotiations in the far western Chinese province of Urumchi where

Uyghur Turks make up a large part of the population.

Many Turkish firms are operating in China and Turkey in turn seen a number of

Chinese firms moving into the services and white goods sectors. Companies from

the Far East view Turkey as not only a market in itself but also as a door into Europe.

The investment focus in general has shifted away from the West towards the East,

according to Utkan.

“International investors are looking for new investment opportunities which are

getting scarcer,” he says. “Turkey provides a sound market infrastructure with

regulated and transparent capital markets. Also Middle Eastern investors have

historically invested in Europe and the Middle East. Today a lot of it is being

repatriated back into the region and more profitable countries such as China and

Turkey.”

Cooperation between Turkey and the Far East extends beyond trade. There has also

been increased military cooperation with China. “There is no doubt that the balance of power is shifting from the West to the East,”

according to Utkan. “The MENA region has ample commodity resources whilst

countries such as China and Turkey are rapidly expanding and need energy sources.

Turkey’s economic strength comes in large part from harsh lessons learned a

decade ago. During the 1990s and early 2000s Turkey’s economy suffered from high

inflation and periodic boom and bust cycles. The 2001 financial crisis was

“devastating” for the country and led to almost an annual contraction in GDP of

almost 10 percent. Turkey learned its lesson and with the establishment of a singleparty

government enacted structural economic reforms including the foundation of

an independent banking supervisory body, BDDK.

“Turkey’s banks are currently among the healthiest in Europe due to strong capital

bases and low degrees of leverage,” according to Yapi kredi. “The government’s

strict adherence to fiscal discipline during the past decade led gross public debt/GDP

ratio to decline to less than 40 percent whereas fiscal deficit/GDP ratio improved to

1.5 percent of GDP. Turkey also reduced the tax rate for corporations to 20 percent

from 33 percent. All of these developments led to strong economic growth, led by

domestic consumption and investments.”

Despite these strengths risks remain. Perhaps the biggest economic risk is Turkey’s

high current account deficit, which rose to around nine percent of GDP in 2011. The

Central Bank has been following an unorthodox monetary policy, trying to rein in

credit growth and manage a “soft landing” for the economy,” according to yapi

kredi.

“Moreover, the government has recently introduced certain incentives for import

dependent sectors such as petrochemicals that will improve the trade balance

through the domestic production of previously imported products. New incentives

for the private pension system have been introduced that aim to improve the

currently low level of savings rate in the domestic economy.

“One other weakness in the economy is the share of ‘unrecorded economy’. This

leads to a low tax base for the government and relatively higher share of tax on

consumption. Turkey has one of the highest tax rates on petroleum.”

Turkey’s vulnerability to high oil and energy prices, as it is an importer of oil, is also a

risk for the economy and political intervention in the Central bank has also had

negative impacts on the stock market despite the sound fundamentals of Turkish

firms

“Foreigners constitute 70 percent of investments on the Istanbul Stock Exchange,”

says Utkan. “Most of these investors are macro allocators into the large cap index

constituents. In times of increasing volatility these investors tend to sell their

holdings without any regard to the fundamentals of the underlying companies.”

Global financial conditions also pose a risk to the Turkish economy, according to

Golpinar.

“Turkey is set to be hurt by potential reversals in global risk sentiment,” he says.

“While the effects of such a scenario will clearly depend on the magnitude of the

financialstress levels, we believe that downside risks for the Turkish economy are

somewhat limited due to the Central Bank’s continued focus on pursuing a flexible

interest rate policy and the government’s proactive focus on policy coordination.”

The long-term outlook for investment opportunities in Turkey is highly positive. All

the ingredients are there for growth, including political and economic stability,

proximity to the key European and MENA export markets, favorable demographics,

rapid urbanization.

“Turkey’s economic potential has been well recognized by foreign investors as

manifested by the Foreign Direct Investments (FDI) into the country,” according to

Yapi Kredi. “FDI inflows reached $10.9 billion in the first nine months of 2011, more than doubling the amount of FDI Turkey attracted in 2010. According to latest OECD

estimates, Turkey is expected to be the fastest growing economy of the OECD

members during 2011-2017, with an annual average growth rate of 6.7 percent. Key

sectors that will benefit the most are consumer discretionary, durables, automotive,

pharmaceuticals and technology.”

The country’s relatively low inflation environment has also helped to create a strong

base for economic stability going forward that willsupport continued growth,

according to Golpinar.

“Turkey has one of the strongest banking sectors in the world with capital adequacy

ratios well above standards set by Basel and with experience in dealing with financial

crises,” he says. “With the fiscal discipline and an externally-oriented growth model

Turkey is much more resilient to economic shocks and has also gained investors’

confidence. That confidence brings additionalstability to the country’s financial

markets.”

In Strateji’s view considerable future investment opportunities in Turkey will be in

alternatives. International and local investors have done well from Turkey’s stock

market in recent years but are beginning to look elsewhere, Utkan believes

“There is an opportunity to design lower volatility equity long/short products

reducing volatility whilst delivering returns over cash,” he says. “The government is

also promoting the growth of the asset management industry in order to increase

the savings rate of the country and reduce the current account deficit. Given the

high multiples in the private equity and property market we feel that public equity

investing will deliver the most superior opportunities in Turkey.”

Confidence in Turkey’s economy is reflected in the fact that exports rose from

around $31 billion in 2001 to $135 billion in 2011despite the global financial crisis.

In addition, Turkey has a gradually strengthening middle class that fuels growing

domestic consumption. It also has strong energy, transport infrastructure, finance,

telecommunication, tourism, real estate, automotive, agriculture and retail

industries that attract a regular flow of foreign capital.

Alongside these relatively recent economic developments Turkey has 30 years of

uninterrupted democracy behind it and eight years of single party administration

with continuing electoralsupport.

“Macro policies have been developed to withstand internal political changes and

outside shocks,” says Utkan. “As a result GDP has tripled over the last decade from

$230 billion to $660 billion in 2011. GDP per capita is expected to reach over $12,000

by 2013. Turkey went into the crisis in 2008 and came out very quickly ahead of

everyone in the region. The debt ratings of the country have been consistently

upgraded over the last decade. Turkey is also the only country currently satisfying

the Maastricht criteria.”

The underlying drivers behind Turkey’s rapid reform are several. It has a large

domestic market of 75 million people. The population is relatively young with 26

percent under the age of 15 and 50 percent under 29. Based on UN projections,

Turkey willstill have the youngest population among European countries by 2050.

These factors have led to strong domestic consumption, which generates 70

percent of GDP.

“This strong domestic market limits export dependency during times of crises,” says

Utkan. “We are also seeing the emergence of a growing middle class with increasing

purchasing power funneled into healthcare, technology and education. For example

Abraaj made its exit from Acıbadem private hospitals at a sale price of $1.65 billion

to Khazanah. TPG sold its stake in Mey Içki, a spirits maker at $2.1 billion to Diageo.

Carlyle has a significant stake in Bahçeşehir colleges.” Another driver of Turkey’s growth has been its ability to tap relatively unpenetrated

markets quickly. For example Iraq has become Turkey’s third largest

trading partner as Europe’s share has declined and Turkish Airlines has become a

global player exploiting Istanbul as a hub between Europe and the Middle East.

Turkey has also benefited from being located at the heart of a region rich in oil and

natural gas resources, at the crossroads of the world’s energy map and a primary

energy bridge reaching out to Europe.

According to Çati, “It should be noted that the better participation of [MENA]

region’s countries to the world economic system will boost the aggregate demand

in the region, which will create new markets for Turkish producers, contractors and

investors. Global warming and rising demand are driving factors behind agriculture

in Turkey becoming a strategic sector. Turkey’s large lands are suitable for

cultivation with the appropriate climate.”

While other countries in the MENA region felt the impact of the global financial crisis

and Arab Spring, Turkey escaped relatively unscathed and with potentially

improved long-term trade prospects. The first direct impact of the Arab Spring was

rising oil prices. Turkey’s total energy bill is almost $48 billion, more than six percent

of GDP so any upward movement in energy prices affects the country’s foreign

balances. Rising oil prices may however be offset by a better trading environment

across the MENA region, according to Çati. The Arab Spring may be the catalyst to a

more liberal economic environment in the region, he believes. Higher purchasing

power across the Middle East and North Africa could boost Turkish exports

“The share of MENA in Turkish exports already increased from below 10 percent in

2006 to 20 percent in 2011,” he says. “Hence Turkey could partly offset diminishing

demand from her main trade partner Europe.”

It should also be noted that Turkey had already bitten the bullet in 2001 by not

defaulting and implementing an IMF backed austerity package. Regulations on the

banking sector were strengthened and most banks had strong balance sheets in

8. As a result banks made an incredible come back in 2009, according to Utkan.

“The country has a nice problem to solve as it is trying to cool off the economy

rather than trying to revive it,” he says. “Going into 2011 the current account deficit

had risen to ten percent of GDP. The currency was sold off and the markets were

punished. The government increased the collateral ratios on banks and

implemented an interest rate corridor to micro manage the money supply during

the crisis.

“Debt to GDP remains at 40 percent, which is low. Turkey’s CDS spreads remain at

historical lows. Inflation remains at 8.8 percent down from 30 percent in 2003. The

budget is running at a 2.2 percent budget deficit, which is over the EU defined

budget balance of -3 percent. We are sanguine on banks this year as their

fundamentals remain strong whist their stock price declined due to global investor

bearishness towards financials.”

Turkey’s ties to the East also helped to shelter it from the effects of both the global

financial crisis and the Arab Spring. It has long pursued a zero problems with

neighbours policy as well as signing numerous bilateral trade treaties and

implementing visa-free travel agreements. Over time Turkey’s foreign policy has

shifted from quasi-isolationism towards neighbours to fostering and taking

advantage of the cultural and historical links it shares with other countries in the

region.

“Diplomatic and commercial ties were forged and improved with most of the

countries subject to the Arab Spring,” says Utkan. “Following the uprisings the

Turkish foreign policy stance has been to back pro democracy movements in the

Middle East. This is visible from its policy towards Palestine and Syria. As a result

Turkey became a credible soft power within the region.” Turkey’s pro democracy stance during the Arab Spring uprisings had an initially

negative impact on trade volumes with some countries, including Libya and Syria.

However, in the long term its stance is likely to prove popular with pro democracy

movements that have taken power across parts of the region. In addition, Turkey’s

political model is being seen as a blueprint for many of these pro-democracy

movements.

Turkey’s support for the ongoing uprising in Syria is a more complicated issue. Prior

to the recent unrest relations between the two countries were good. The legal

framework of economic relations was strengthened with the Free Trade Agreement,

mutual abolishment of visas and the completion of several bilateral agreements in

2009 and 2010. Total trade volume between Turkey and Syria rose to around $2.3

billion in 2010 from $800 million in 2006 and the number of Syrian tourists visiting

Turkey increased more than seven-fold to about 900,000 in 2010 from 126,000 in

2002.

According to Çati, “This increase in the momentum of political and economic

relations ceased abruptly with the uprising in Syria. Turkey tried to urge restraint

from the Assad government and organised the Friends of Syria conference to help

resolve the conflict in a peaceful manner. The ultimate outcome of the power

struggle in the country will determine the regional economic and political balance

that also includes Iraq and Iran. Sectarian tensions are likely to rise in the near term.

Syria will try to leverage its close relations with traditional allies Russia and Iran.”

The loss of trade with Syria has had a particularly heavy impact on Turkish cities

close to the Syrian border such as Gaziantep and Kahraman Maras.

More damaging though for the Turkish economy has been the ongoing nuclear

dispute between Iran and a number of world powers, according to Çati.

“Iran has been a primary energy supplier to Turkey but due to the threat of US

sanctions, Turkey’s sole petroleum refiner Tupras had to scale back cheaper oil

purchases from Iran,” he says. “Turkey’s economy is highly dependent on energy

imports. The bulk of the country’s annual $75 billion current account deficit is driven

by the energy bill.”

Turkey’s policy of fostering new relationships where cultural ties already exist has

extended far beyond the Middle East to India where the Mughals used to rule prior

to the English, as well as Central Asia and China. A recent trade delegation to China

began its negotiations in the far western Chinese province of Urumchi where

Uyghur Turks make up a large part of the population.

Many Turkish firms are operating in China and Turkey in turn has seen a number of

Chinese firms moving into the services and white goods sectors. Companies from

the Far East view Turkey as not only a market in itself but also as a door into Europe.

The investment focus in general has shifted away from the West towards the East,

according to Utkan.

“International investors are looking for new investment opportunities which are

getting scarcer,” he says. “Turkey provides a sound market infrastructure with

regulated and transparent capital markets. Also Middle Eastern investors have

historically invested in Europe and the Middle East. Today a lot of it is being

repatriated back into the region and more profitable countries such as China and

Turkey.”

Cooperation between Turkey and the Far East extends beyond trade. There has also

been increased military cooperation with China.

“There is no doubt that the balance of power is shifting from the West to the East,”

according to Utkan. “The MENA region has ample commodity resources whilst

countries such as China and Turkey are rapidly expanding and need energy sources.

Turkey’s economic strength comes in large part from harsh lessons learned a decade ago. During the 1990s and early 2000s Turkey’s economy suffered from high

inflation and periodic boom and bust cycles. The 2001 financial crisis was

“devastating” for the country and led to an annual contraction in GDP of almost 10

percent. Turkey learned its lesson and with the establishment of a single-party

government enacted structural economic reforms including the foundation of an

independent banking supervisory body, BDDK.

“Turkey’s banks are currently among the healthiest in Europe due to strong capital

bases and low degrees of leverage,” according to Çati. “The government’s strict

adherence to fiscal discipline during the past decade led gross public debt/GDP ratio

to decline to less than 40 percent whereas fiscal deficit/GDP ratio improved to 1.5

percent of GDP. Turkey also reduced the tax rate for corporations to 20 percent from

33 percent. All of these developments led to strong economic growth, led by

domestic consumption and investments.”

Despite these strengths risks remain. Perhaps the biggest economic risk is Turkey’s

high current account deficit, which rose to around nine percent of GDP in 2011. The

Central Bank has been following an unorthodox monetary policy, trying to rein in

credit growth and manage a “soft landing” for the economy,” according to Çati.

“Moreover, the government has recently introduced certain incentives for import

dependent sectors such as petrochemicals that will improve the trade balance

through the domestic production of previously imported products. New incentives

for the private pension system have been introduced that aim to improve the

currently low level of savings rate in the domestic economy.

“One other weakness in the economy is the share of ‘unrecorded economy’. This

leads to a low tax base for the government and relatively higher share of tax on

consumption. Turkey has one of the highest tax rates on petroleum.”

Turkey’s vulnerability to high oil and energy prices, as it is an importer of oil, is also a

risk for the economy and political intervention in the Central bank has also had

negative impacts on the stock market despite the sound fundamentals of Turkish

firms

“Foreigners constitute 70 percent of investments on the Istanbul Stock Exchange,”

says Utkan. “Most of these investors are macro allocators into the large cap index

constituents. In times of increasing volatility these investors tend to sell their

holdings without any regard to the fundamentals of the underlying companies.”

Global financial conditions also pose a risk to the Turkish economy, according to

Gokpinar,.

“Turkey is set to be hurt by potential reversals in global risk sentiment,” he says.

“While the effects of such a scenario will clearly depend on the magnitude of the

financialstress levels, we believe that downside risks for the Turkish economy are

somewhat limited due to the Central Bank’s continued focus on pursuing a flexible

interest rate policy and the government’s proactive focus on policy coordination.”

The long-term outlook for investment opportunities in Turkey is highly positive. All

the ingredients are there for growth, including political and economic stability,

proximity to the key European and MENA export markets, favorable demographics,

rapid urbanization.

“Turkey’s economic potential has been well recognized by foreign investors as

manifested by the foreign direct investments (FDI) into the country,” according to

Çati. “FDI inflows reached $10.9 billion in the first nine months of 2011, more than

doubling the amount of FDI Turkey attracted in 2010. According to latest OECD

estimates, Turkey is expected to be the fastest growing economy of the OECD

members during 2011-2017, with an annual average growth rate of 6.7 percent. Key

sectors that will benefit the most are consumer discretionary, durables, automotive,

pharmaceuticals and technology. The country’s relatively low inflation environment has also helped to create a strong

base for economic stability going forward that willsupport continued growth,

according to Gokpinar.

“Turkey has one of the strongest banking sectors in the world with capital adequacy

ratios well above standards set by Basel and with experience in dealing with financial

crises,” he says. “With the fiscal discipline and an externally-oriented growth model

Turkey is much more resilient to economic shocks and has also gained investors’

confidence. That confidence brings additionalstability to the country’s financial

markets.”

In Strateji’s view considerable future investment opportunities in Turkey will be in

alternatives. International and local investors have done well from Turkey’s stock

market in recent years but are beginning to look elsewhere, Utkan believes

“There is an opportunity to design lower volatility equity long/short products

reducing volatility whilst delivering returns over cash,” he says. “The government is

also promoting the growth of the asset management industry in order to increase

the savings rate of the country and reduce the current account deficit. Given the

high multiples in the private equity and property market we feel that public equity

investing will deliver the most superior opportunities in Turkey.”