Friday, March 22, 2013

Investing in Turkey: Risks & Rewards

DISCLAIMER: I am not an investment professional or adviser. The following describes my thoughts and observations on the country specific risks and rewards in relation to long term investments in Turkey and is not intended to offer any investment advice. If you are considering putting your money into an investment in Turkey, or anywhere else for that matter, consult with professionals.

I recently attended a seminar on The Incentive Program of Turkey. The Department of State also offers some notes on the investment climate in Turkey.

Rewards to investing in production in Turkey

First, take a look at the map below (courtesy of the CIA World Factbook) to put Turkey's geographical location in context. The city of Istanbul joins the continents of Asia and Europe. To repeat the old cliche, Turkey forms a bridge between the East and the West.

[ Turkey and the region ]

Just looking at the list of destinations served by Turkish Airlines gives one a good idea of the markets one can reach from Turkey. Not only is Turkey well connected with Europe, but locating there brings major population centers in Asia and Africa within reach.

In some cases, being in such easy reach of such countries means one doesn't even have to officially export to those countries. The ease of travel brings with it the so-called "suitcase trade" which began in earnest in the late 80s and early 90s when citizens of former Iron Curtain countries started traveling to trade stuff in open bazaars in Istanbul. For example, a former Soviet officer might have brought Soviet army coats and bought leather goods and other items not commonly found in those countries to take back and sell.

Today, a similar potential exists for countries in North Africa and the Middle East where there is immense potential for economic growth and very little domestic industry to satisfy new consumer demands. In addition, goods produced in Turkey, a predominantly Muslim country, might be more attractive to populations of Muslim countries, even if they bear a non-Turkish brand.

This is not to say the Turkish domestic market by itself is not attractive. On the contrary, the stable currency and rapid economic growth experienced over the past decade in addition to the much younger population composition than in Europe means increasing demand for consumer goods. Even with the oppressive sales taxes, Turks spend a lot of money on everything from clothing to electronics to cars.

Turkey has invested a lot in infrastructure over the past decade. Areas that used to be served by low quality two lane country roads now have separated highways connecting them with larger commerce centers. There is vast untapped potential in historically poorer sections of the country, especially in the east and southeastern regions. Established centers of commerce such as Istanbul, Izmir, Antalya and the capital Ankara, are teeming large groups of ambitious young professionals who frequent shiny new shopping centers with a lot of disposable income: According to the World Bank, Gross National Income (PPP, current international $) almost doubled from about $8,700 in 2003 to $16,940 in 2011.

So, locating production in Turkey can bring a firm closer to a young population living in a growing economy with good infrastructure and highly educated workforce as well as proximity to other large markets such as rich Gulf countries, Russia and former Soviet Republics, Europe and North and even Central Africa. In most cases, compared to those countries, Turkey offers a more predictable legal environment, easier access to financial markets, and more open trade.

Risks to investing in Turkey

All of the points above and even more were well outlined in the presentation of the official from the Ministry of the Economy of Turkey during the seminar.

What was not highlighted were the risks that are mostly out of the control of the Government of Turkey. Chief among those is the region where Turkey is located. If you look at the map again, all the wonderful potential represented by the countries within easy reach of Turkey comes with real and present risks. North and Central Africa are unstable. Iran is collaborating with North Korea in its nuclear program and threatening to wipe out Israel. Rich Arab countries face dangers of domestic instability due to Iran's meddling. Syria is in active civil war right across the border from Turkey. In Northern Iraq, the Kurds are at odds by the Central Iraqi government which is now basically a client of Iran. The Turkic former Soviet Republics, such as Azerbaijan, Turkmenistan, Kazakhstan etc are run by authoritarian governments where rules are arbitrary, and unrest is not uncommon including the long lasting conflict between Azerbaijan and Armenia.

Many, if not all, of these hot and lukewarm conflicts present a danger of spilling over into Turkey. Along the Southern border, there are already more than 100,000 registered Syrian refugees living in camps or rented private accommodations. Given the porous border, with a local population well versed in smuggling stuff in either direction, there is no accounting for how many others have crossed into Turkey. Back in January, there were a number of stories of Syrians crossing into Turkey, renting vehicles in Mediterranean tourist towns, and taking them back into Syria to use as improvised fighting vehicles. Most of these refugees are not allowed to work, and as the civil war shows no signs of abating, their situation can be a source of conflict.

In addition, while recent developments in the process of bringing peace to the region, Turkey's southeastern and eastern provinces, along the borders with Syria, Iraq, and Iran, face the danger of unrest due to clashes between Government forces and armed Kurdish guerrillas. In most Southeastern towns, the PKK can basically order shop-owners to shut-down at a moment's notice. While the security situation has improved by orders of magnitude since the 90s, the threat of interruption of commerce or sabotage is still present.

Over the past few years, Iran has made threatening noises regarding missile defense systems placed on Turkish soil. And, while economic activity between Turkey and Russia has been expanding over the past few years, Russians have also made noise about such systems. On top of that, the Russian government supports the Assad regime in Syria, while the Turkish government actively works against it. Turkey has some control over Russia's access to the Mediterranean. The crisis in Cyprus has opened a way for Russia to establish a serious presence in the Mediterranean. Given the Montreux Convention rules Turkey may have to sit back and watch while the Russians firm up their presence in the Eastern Mediterranean, in a safer location than Syria, which may enable them to project their influence in North Africa with greater ease.

Domestically, the only political opponents of the current government favor more government control over markets and less open trade. From afar, it seems to me that the only alternatives presented to the current policies involve going back to the mindset of a state planing organization, tighter price and wage controls, greater income redistribution. To be frank, I am not a fan of the current government's policies either, but that is because I believe the only way to create growth and wealth in the long run is for the government to stick with ensuring security, order, and a well functioning court system through which private parties can enforce contracts. In recent years, the Turkish government has extended more and longer tentacles into many private areas, chief among them real estate, where the government comes in and builds large residential complexes that compete directly with existing real estate. When one looks at Turkish newspapers, not a day goes by without a new regulatory regime is announced in many areas of economic activity. Consumption taxes are high. A gallon of regular unleaded gasoline costs almost $10 at current exchange rates. A brand name 40" TV which you can buy for about $600 in the U.S. costs about $900 in Turkey. Cell phone bills are almost doubled over the plan cost due to taxes. So, while the Turkish economy has become much more open and much more dynamic than any time in its history, the government is by no means small. Plus, efforts to integrate with the European Union mean regulations regularly flowing from Brussels to Ankara.

Incentive Programs

The incentive programs that were the topic of the seminar I attended are targeted toward firms that are interested in establishing physical production facilities in Turkey. They have a distinct import substitution feel to them in that firms that would like to produce in Turkey goods that are already imported by Turks are given certain preferences. This seems to be motivated by a desire to close Turkey's trade deficit.

Personally, I have never warmed up to the idea of import substitution. Once a government fulfills its basic duties of providing security and law and order, people can make longer term production, consumption, saving, and investment plans. Obsessing about whether specific goods are produced at a specific location leads to a misallocation of resources. I stand by this point of view whether it involves rescuing GM or giving special incentives to firms to, say, make their TV sets in Turkey. But, that is neither here nor there, so let's move on.

The incentive programs vary by region and industry. The region that is given the highest preference, Region 6, includes the provinces Ağrı, Ardahan, Batman, Bingöl, Bitlis, Diyarbakır, Hakkari, Iğdır, Kars, Mardin, Muş, Siirt, Şanlıurfa, Şırnak and Van, all of which are historically poorer regions of Turkey, closer to conflict zones.

This historically neglected status also presents opportunities for finding a cheaper labor force that is willing to work hard and a firm producing goods that are likely to be demanded by the local populace can benefit from the high potential growth rates that generally come from starting with a lower base as well as taking advantage of cross-border trading opportunities.

It is hard to tell the actual effect of the incentives on a given firm's bottom line, as they are listed as offsets from the status quo and one needs to be intimately familiar with the existing structure to be able evaluate each incentive in each region. That is, it is one thing to say program X in region Y will lower labor costs by Z%. It is a whole different ball game figuring out what they would be without the incentives and then comparing those costs with potential profits, taking into account the availability of other alternatives for the specific production activity.

That requires getting in touch with people who at least have a firm grasp of the laws and regulations in Turkey. The Ministry of the Economy has a an office to provide details. In addition, in the U.S., the office of the commercial attache at the New York Consulate or the office of the commercial counselor at the Turkish Embassy in Washington D.C. can provide assistance.


As I said at the outset, I am not qualified to offer investment advice. I have no clue if it would be a good idea for a specific business to invest in Turkey. I have tried to outline my perspectives on the risks and rewards associated with investing in production facilities in Turkey. I believe there are huge untapped opportunities both in Turkey and the region. But, then, they only represent a potential and they are subject to risks one does not often face when building production facilities in places like the U.S. However, now that EU has established that it has no qualms about confiscating bank accounts to rescue troubled banks —and I really would never have thought 10 years ago that I would say such a thing— Turkey, which weathered the international financial crisis rather well, might represent a better location to reach European markets than any country in the EU.

I tried to outline some factors that are hard to control for and that must be taken into account by anyone contemplating a project that may pay off in five or maybe 10 years. I do have a soft spot in my heart for the country of my birth, but I did try to give as unbiased a perspective as I could.

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