Turkey’s Sustainability Issue After the Rating Upgrade – Part II

What Does It Mean for Investments?

Turkey’s investment to GDP ratio of around 23% is one of the lowest among its peers and it needs to increase its investment rate with an aim of raising the value added of its domestic production and hence exports. From a growth perspective, Turkey needs an investment ratio of around 30% if the potential growth is desired above 5%. According to sector experts, Turkey needs to invest at least $10bn every year for greater energy independence and a total of $350bn on energy and infrastructure to meet Government’s 2023 targets.

If Turkey is to accelerate its investment ratio going forward, domestic and/or foreign savings will automatically have to catch-up. The critical question is in which proportion of domestic/foreign savings mix will be used to finance the investments:

Is the savings ratio increase plausible with the current real interest rates?

On the domestic savings front, the biggest obstacle seems to be the level of real interest rates. Having a lower motive compared to 1990’s for precautionary savings, households and private sector channel a lower share of their increasing disposable income to savings. While level of education and higher female labor participation rate might help over the longer-term to increase domestic savings, incentivized private pension scheme seems to be only proposed solution in the current low real interest-rate environment. The year-to-date accumulation in the state-incentivized scheme leaves room for optimism but skepticism should remain on whether the scheme alone can be a panacea for the entire low saving ratio problem.

Rating upgrade would facilitate cheaper and longer-term borrowing …

If the domestic savings cannot meet the increased investment demand, Turkey will have to increase its reliance on foreign savings. Due to external debt sustainability issue, what Turkey needs is not more of the same kind of financing to increase its investments. In this respect, the recent upgrades to investment rating would definitely serve Turkey if it facilitates the conversion of the current financing mix to longer-term and cheaper debt. But what would be better is if Turkey can increase its investments via non-debt creating flows, i.e. foreign direct investment until higher investment ratio results in lower current account deficits.

Result: ‘Sustainable long-term finance is the key to success*’

Turkey needs to increase its investment ratio as it needs to raise the value added of domestic production and surpass the middle-income trap. While increasing its traditionally low level of investments to higher levels, it needs to make sure that external debt sustainability does not become a stability problem. Financing of the investments should be long-term and more importantly sustainable.

Increasing the 14% domestic savings ratio is what the policy makers are working on but given the domestic saving’s high level of sensitivity to real interest rates, the current low real rate environment is likely to be an obstacle. With the improvement in the political and economic dynamics that the recent rating upgrade is based on, Turkey has a chance to change the composition of external debt to cheaper and longer-term financing; yet, the ideal situation would be the acceleration of foreign direct investments, as a non-debt creating flow until when higher level of investments results in lower current account deficit figures. In this respect, the impact of the rating upgrade is more limited as FDI decisions are not necessarily restricted by the sovereign ratings as much credit and portfolio flows are.

* Quoting O. Deschamps speaking at the EBRD 2013 Annual Meeting Panel on ‘Transformation of Turkey as a Business and Investment Hub’, May 10 2013