Turkey's Shift to a More Open Economy - BusinessWeek

Image by Argenberg via Flickr

Applying for EU membership has sped up reforms, and that has helped the country weather the current crisis

By Stanley Reed

Turkey cannot escape the ravages of the global recession. But this time it may avoid the pains that often afflict this promising country in a downturn. For the Turks, a recession usually goes like this: A wild boom triggers high inflation, the currency collapses, and the poorly managed banking sector, hooked on speculative trading and foreign debt, has a near-death experience. Turkey has a well-educated workforce, proximity to Europe, and a shrewd management class. But financial fragility, including a meltdown that sparked riots in 2001, has kept it from entering the first rank of emerging market economies.

In the current turmoil, to everyone's amazement, things have been different. The economy has been dealt a body blow as exports have stalled. While structural problems still exist, in both the political and regulatory spheres, the financial system has held firm even as U.S. and European banks have hovered on the brink. "This is the first recession in which we didn't have a crisis," says Murat Ulgen, chief economist at HSBC (HBC) in Istanbul. Credit goes to reforms, backed by the International Monetary Fund, that curbed inflation and forced banks to bolster their balance sheets. The increased presence of foreign banks also spurred locals to improve their game. Most important, Turkey has welcomed investment and stepped up efforts to become a real player in the global economy.

This change in attitude has raised Turkey in the eyes of multinationals. Foreign direct investment surged from $1.1 billion in 2001 to $22 billion in 2007, before dropping back to $18 billion in 2008. Even though the figure is expected to fall to $9.1 billion this year, executives seem confident Turkey will bounce back. With a population of 76 million, Turkey is an attractive consumer market, and all those youthful workers at Europe's doorstep have turned the country into a workshop for export industries such as cars, aerospace, appliances, and textiles. "We put Turkey in the same category as Brazil, Russia, India, China, and South Africa," says Ali Faramawy, a vice-president of Microsoft International (MSFT) in Istanbul. Microsoft's software sales in Turkey are growing at 20% to 30% a year. "It's not difficult to see Microsoft Turkey doubling in size in a relatively short time," Faramawy adds.

Two things have made Turkey more of a player. The enforced discipline of applying for European Union membership has worked wonders. And Prime Minister Recep Tayyip Erdogan, who has headed a moderately Islamist government since 2003, has pushed largely pro-business policies. Building on the ideas of Kemal Dervis, the former World Bank official who took charge of the Turkish economy during the 2001 crisis, Erdogan has slashed corporate taxes, tightened intellectual property protections, and set up an investment promotion agency. He also launched Turkey's EU negotiations. While the talks have been tortuous, they have pressured Turkey to make changes in a wide range of areas—from improving women's rights to easing protectionist policies. "The whole EU process affects business positively," says Umran Beba, Istanbul-based president of PepsiCo (PEP) for Southeast Europe.

As Turkey shifts from an inward-looking economy to a more open one, local business leaders realize they will need to remake their companies to meet increasing competition. That will require investment in technology and communications, creating a big opening for companies from IBM (IBM) to Cisco Systems (CSCO) to Google. (GOOG) Eray Yuksek, general manager for IBM in Turkey, figures that, excluding telecom, Turkish companies are spending only about $2 billion on information technology. "That's nothing, nothing" in a country with an economy of Turkey's size. "It's a huge opportunity for us," he says.

"STAGING GROUND"

Other areas of the Turkish market beckon. In 2005, General Electric (GE) spent $1.75 billion for 25% of GarantiBank. It now leads the Turkish loan market in most categories and is reporting 3.5% nonperforming loans, below Turkey's industry average of 4.5%. GE's now 21% share is worth $3.4 billion. The company has a venture that makes aircraft engine components, and it's opening a facility to supply locomotives for Europe.

Turkey's trump card is its location. You can sense that Turkey, and especially Istanbul, is at a crossroads by spending an evening at one of the ancient city's exquisite restaurants along the Bosporus, the glowing ribbon of water that separates Asia and Europe. The country is not just close to Europe but also to the former Soviet Union and the Middle East. The area from the Balkans to Kazakhstan has the potential to be fast-growing for years to come. Ferdinando Beccalli-Falco, Brussels-based CEO of GE International, sees Turkey as a "staging ground" for penetrating the region. Yesim Toduk, founder of Istanbul executive search firm Amrop International, says she spends much of her time finding Turks to work for companies in Azerbaijan, Kazakhstan, Russia, and Saudi Arabia.

Investment flows from the East as well. The United Arab Emirates-based Oger Telecom, controlled by Lebanon's Hariri family, owns 55% of Turk Telekom, the fixed-line operator. Kuwaiti Finance House, an Islamic bank, has set up Kuveyt Turk to pursue Islamic banking. Investment firms that mainly channel Gulf money, including Dubai-based Abraaj Capital, which owns a Turkish hospital chain, are active in the country. Middle Eastern investment has soared to a cumulative $6.3 billion since 2004.

This year, though, both multinational and Turkish companies had a rough time. Aynur Bektas, the owner of Hey Tekstil, a textile concern with 4,000 employees, coped by ramping up production 25%, trimming prices, and doubling her customer base. Turkey's textile industry has been slammed, but her sales are up 10%. "Others were not so well prepared," she says.

When export demand slumped, Turkish consumers took up some of the slack. The government introduced a Buy Turkish program, including tax incentives, to encourage Turks to open their wallets. That benefited Arcelik, a unit of Koc Group, Turkey's largest conglomerate. The company churns out 12,000 washing machines a day in a factory in the sunbaked industrial town of Cayirova, an hour's drive from Istanbul. In January and February, output fell to 60% of capacity as demand for washers plummeted in Europe. "Those were the worst months. Now it's coming back," says production manager Alp Karahasanoglu. Production is up 20% since February, and he is planning for expansion. The plant will make about 2.3 million machines this year, but that will grow to 4 million units as export markets recover, he predicts.

Recovery will take time. The Organization for Economic Cooperation & Development predicts growth of 2.6% in 2010, after a 5.9% plunge in gross domestic product this year. Still, the Istanbul Stock Exchange is up 77% this year, and the lira has climbed 23% against the dollar since March.

One factor affecting investor confidence in the economy is the Prime Minister himself. Some Turks worry about the Islamist roots of his Justice & Development Party. The fear among secularists is that Erdogan wants to turn Turkey into a version of Saudi Arabia, forcing women to stay at home and banning alcohol. If that is his goal, Erdogan has a long way to go in Istanbul. While some women wear head scarves, plenty don't. And at night the alleyways of central Istanbul are crowded with tables of young people quaffing mugs of Efes beer.

Critics also complain that Erdogan has slowed the pace of reform. And investors were shocked when the government recently fined Dogan Yayin, Turkey's largest media group, $2.5 billion for back taxes and penalties. The company's publications have criticized Erdogan in the past. Another cause for anxiety: taxes. The tax regime hits some industries, such as telecom, harder than others, while half of wage earners aren't legally registered and don't pay taxes. That puts multinationals that play by the rules at a disadvantage to local rivals. "The tax system is a disaster," says A. Rahsan Cebe, managing partner of Cushman & Wakefield in Turkey and chairman of the lobby group American Business Forum in the country. Some businesspeople also think Erdogan should negotiate a new loan with the IMF, which would stabilize long-term finances.

Still, most observers are betting that moderation will prevail and Turkey will stay on a reform path. Adem Dogan, a 27-year-old Istanbul plumber, sees a bright future. He has expanded his business by spending $400 a month to advertise on Google. Says Dogan: "Before we had 100 customers, now we have 2,500."

With Merve Kara in Istanbul