Turkey:The business outlook

For members of

Economist Corporate Network

July 2011

Contents

• Executive summary

• Corporate comment

• Business outlook

• Market size and potential

• Operating environment

• By sector

• Policy outlook

• Economic outlook

• Key economic indicators

• Market size indicators

Executive summary

• Since its rapid recovery from recession Turkey has become one of the stars of the CEEMEA region, and indeed an important player amongst global emerging markets

• GDP growth and private consumption will remain robust in 2011 and into the medium term, fueling optimism about the market...

• ...despite concerns over the increasing size of Turkey‘s current-account defecit and some talk of overheating

• While Turkey‘s large population and strategic location make it a very promising market, some executives are starting to worry that HQ‘s growth expectations for Turkey need to be managed

• Nevertheless, our members place Turkey among their top four medium-term priority markets in CEEMEA

“We're having to manage increased expectations from headquarters. Everyone thinks the sky is blue here, but it's not as blue as we think.”

-Country manager, healthcare

“I think we’ll still enjoy nice growth in consumer spending over the next 18 months. Our markets are growing healthily, and there’s little slowdown in consumer spending.But while the cake will grow, how many slices will you cut? There are new products and competitors eating into our market, so our growth might be slower than that of overall consumption.”

-Country manager, FMCG

“We've got a young population…some new gadget comes on the market, and everyone's trying to buy it. They want, they demand, and they consume.”

-Country manager, IT

Corporate comment

Business outlook: Market size and potential (1)

• Turkey has rapidly become a key emerging market, high on corporate agendas—that’s partly thanks to its strategic location at the crossroads of Europe and Asia…

• ...and also due to the resilience of its institutions, especially its banking sector, during the financial crisis

• Size is another important factor: the Turkish economy has doubled in size since 2004 and will double again by 2020

• It’s about $700bn now, but will hit $1trn by 2015, making it as big as Mexico or South Korea

• The large consumer market is also one of Turkey's chief attractions as a place to do business

• The population is large, young, growing and inclined to consume rather than save

• GDP per head (at PPP) will be about $14,000 in 2011, climbing to more than $18,000 by 2015

Business outlook: Market size and potential (2)

• Our members expect Turkey to be one of the top performers in the region this year

• Firms that put Turkey in MENA say it will be the fourth best market—behind Saudi Arabia, UAE and Qatar

• Companies that consider Turkey as CEE say it will be the third top performer—behind Poland and Russia

• Two-thirds of firms in our CEE survey and three-quarters of those in our MENA survey say they are expanding investments in Turkey this year

• Not a single firm in either survey plans to cut spending in Turkey

• Medium-term priorities mirror 2011 expectations, with CEE respondents saying Turkey is their third most important mid-term market and those in MENA saying it is the fourth most important market

Business outlook: Operating environment (1)

• Turkish managers are highly regarded and are increasingly being moved around global operations

• However, some firms say this is creating a void in the local labour market and salary expectations can be quite high

• In the words of one senior executive: “I think the talent in Turkey is quite shallow. It’s hard to get Turkish expats to come back. There’s an issue of remuneration. Mid-level managers in Turkey expect higher packages.”

• Regulations are sometimes changed on a whim—overnight and without warning, and not in consultation with the business community

• As an executive from the tobacco industry noted, “In 2010 there was a big tax increase on cigarettes. Before this, about 4-5% of the Turkish cigarette market was illegal. Now it’s about 20% illegal in the past two months.”

Business outlook: Operating environment (2)

• As Turkey’s regional importance grows, many firms are considering shifting their hubs to Istanbul

• While the location makes strategic sense, executives say the government needs to focus on improving transparency

• The judicial system also causes frequent headaches; as an IT executive said recently, “The rule of law is a problem: justice reform is still required. To be going to court for any minor dispute is resulting in a lot of expenditure. There should be some arbitration mechanism to resolve this kind of conflict. There have been reforms, but the existing structure is still not working.”

• Many firms say the government could make more of an effort to attract FDI—from improving the business environment to offering incentives to international firms

• Traditional retailers account for about 60% of the Turkish retail market, but continued growth in the number of large outlets will gradually reduce the predominance of small stores

• The largest five players in the Turkish retail market (Migros, BIM, Carrefour, Metro and Tesco) only account for a combined market share of 20%. But they all have plans to expand their presence in the market

• Rapidly changing consumption patterns in wealthier western parts of Turkey and an increased presence of foreign firms should support growth in branded goods sales

• Importers should be cautious of protectionism. As one executive at our recent Istanbul briefing pointed out: “The government is increasing the customs duty on imported apparel as a safeguard to protect Turkish apparel manufacturers. The duty is currently 12% but from July will go up by 30 percentage points to 42%.”

Business outlook: Consumer goods and retail

• The banking sector is far less vulnerable than it was before the 2001 crisis–-Turkish banks held up much better than many in Europe during the economic turmoil of ’08 and ’09

• The sector is poised for solid growth in the coming years, helped in large part by population and income growth

• Turkey has an estimated 6-6.5m unbanked households – a significant opportunity for retail banking

• In the words of a financial services executive at our recent Istanbul briefing: “We’re very optimistic….There’s a big young population that isn’t banked but will be soon.”

• A further wave of regulatory reforms to strengthen the financial system and attract foreign investment is expected in the coming years driven by changing regulation in the EU and the Basel III criteria, due to be implemented in 2019, which will strengthen bank capital requirements

Business outlook: Financial services

• The Turkish market has massive growth potential as incomes are rising, the railway system is inefficient and the majority of Turks travel by road

• The industry has rebounded strongly from the global financial crisis of 2008-09 and sales are likely to remain robust

• Just under 60% of all new vehicles and 70% of new cars are imported – meaning sales are closely linked to the strength of the lira and interest rates

• Although car ownership has risen rapidly over the past decades, three-quarters of households still do not own a car

• In the words of one senior executive at our recent briefing: “The automotive sector is very competitive. It’s about innovation, unique products and right-time delivery.”

Business outlook: Automotive

• With little in the way of oil or gas reserves and with energy consumption growth outpacing production, Turkey has long been a major energy importer

• This and its geographical location mean that Turkey will continue to play an important role as a regional pipeline crossroads

• Turkish consumers rank low on energy consumption per head in comparison with west European countries, using less than one-third of the energy that the average European consumes

• However, Turkey's large, young and increasingly urban population will continue to drive energy consumption growth, which is expected to outpace the rise in generation capacity

• Turkey will continue to rely on fossil fuels (coal, natural gas and oil) for electricity generation, but their share of total generation is expected to decline from 80% in 2009 to just under 70% by 2020 as renewables account for a greater share

Business outlook: Energy

• IT spending is forecast to remain around 1% of GDP in 2011-15. Telecoms revenue and investment, however, are projected to rise more rapidly

• We expect the mobile-phone penetration rate to rise from an estimated 85% in 2010 (a third of which were 3G mobile subscriptions) to just under 95% in 2015

• Mobile revenue growth will be mainly driven by increasing demand for mobile data services, following the roll-out of 3G

• All telecoms services are subject to relatively high levels of taxation. In addition to value-added tax, there is a special consumption tax on mobile-phone services

• There were an estimated 27.4m Internet users in 2010, up from about 11m in 2005. The ratio of users per 100 population reached an estimated 37.4% in 2010, compared with 15.8% in 2005. By 2015 we expect it to be about 56%, not too far behind that in Spain, Portugal and Greece

Business outlook: Telecoms and technology

• Turkey's healthcare system is undergoing a prolonged period of transition under the government's 2003-13 Health Transformation Programme. Its goals are to achieve better healthcare outcomes and wider access through the gradual introduction of universal health insurance

• The gradual extension of health insurance coverage, an increase in annual income per head, a growing population, a gradual rise in life expectancy and the size of the elderly population all point to a continuation of the strong upward pressures on healthcare spending

• We expect healthcare spending per head to rise from an estimated $633 in 2011 to above $900 in 2015

• Pricing of prescription and OTC drugs is difficult; as one senior executive says: “OTC laws have been under discussion for more than 20 years. They don’t comply with EU regulations, so we struggle with prices.”

Business outlook: Healthcare & pharmaceuticals

Policy outlook

• A resounding victory in the general election on June 12th 2011 has allowed the Justice and Development Party (AKP) to form a single-party government for a third consecutive term, with prime minister Recep Tayyip Erdogan at the helm

• Economic policy will continue to be tailored to maintaining an open, largely market-driven economy with prudent public financial management and a well-regulated financial sector

• Reforms in areas such as taxation and employment are likely to be implemented and steps may be taken to make investment, export and employment incentives more effective in order to improve external competitiveness

• Privatisation will continue, but the pace will depend largely on market conditions

Economic outlook: Growth

• After the severe 2008-09 recession, GDP growth rebounded to 8.9% in 2010 due to strong domestic demand growth

• Economic growth will remain strong in 2011, at least 6%, due to robust credit growth and a booming domestic market (private consumption is forecast to increase by 7% in 2011)

• Turkey grew by 11% in Q1, making it the fastest growing major economy in the world

• A slight slowdown of GDP growth to 4.5% is forecast in 2012 as we expect monetary policy to be less accommodating, before economic growth picks up moderately to average 5-5.5% a year in 2013-15

• Although unemployment is expected to remain high over the next few years and wage growth is likely to be moderate in real terms, household spending growth will remain strong

Economic outlook: Inflation and exchange rates

• Low interest rates, a weaker lira and rising commodity prices put some upward pressure on inflation; but we expect the strong rebound in economic activity to moderate and short-term interest rates to rise, which should help to keep inflationary pressures under control

• We are therefore forecasting that consumer price inflation will average 6.4% in 2011 (down from 8.6% last year) before rising only marginally to around 7% in 2012

• The Turkish lira will weaken against the US dollar to TL1.60-1.70:US$1 during 2011-15, compared with TL1.50:US$1 in 2010

• Against a weakening euro, we expect the lira to depreciate to TL2.22:€1 in 2011, before recovering ground to TL2-2.10:€1 through 2015

Economic outlook: External sector

• The weakness of many of Turkey’s main markets for exports of goods and services (the EU and Russia) resulted in a sharp fall in exports in 2009

• Although picking up, exports will not return to pre-crisis levels until 2012-13, when demand recovers in EU markets

• Likewise, FDI, which surged in 2005-07, dropped steeply in 2009 (from $22bn in 2007 to just $8bn in 2009)…

• … but will pick up by 2012 and surpass pre-crisis levels in 2013-14 thanks to privatisations and cross-border mergers and acquisitions (in the energy sector in particular)

• Turkey’s current-account deficit is growing, driven by a credit-fuelled rise in import demand and higher oil prices

• The size of the deficit makes Turkey potentially vulnerable to changes in international sentiment

Key economic indicators

Source: Economist Intelligence Unit

  2010 2011 2012 2013 2014 2015

GDP (% real change pa) 8.9 6.0 4.5 5.2 5.4 5.2

Private consumption (% real change pa) 6.6 7.0 5.5 5.2 5.2 5.1

Government consumption (% real change pa) 2.0 3.5 4.0 4.5 4.5 4.5

Gross fixed investment (% real change pa) 29.9 20.0 8.3 8.5 8.0 7.5

Exports of G&S (% real change pa) 3.4 4.3 4.0 7.3 8.7 9.6

Imports of G&S (% real change pa) 20.7 18.3 9.0 8.9 9.2 9.9

Industrial production (% change pa) 13.1 8.7 5.0 5.5 5.5 5.5

Budget balance (% of GDP) -3.6 -2.0 -1.4 -1.7 -1.7 -1.4

Consumer prices (% change pa; av) 8.6 6.4 6.9 5.8 4.8 4.0

Exchange rate LCU:US$ (av) 1.50 1.60 1.66 1.67 1.65 1.65

Recorded unemployment (%) 12.0 11.3 9.4 9.2 8.8 8.5

Current account balance/GDP -6.6 -8.0 -7.0 -6.0 -5.4 -5.2

Inward direct investment (US$bn) 9.1 12.0 17.5 22.5 25.5 26.5

Market size indicators

  2011 2015

Population (million) 74.0 76.7

Nominal GDP (US$bn) 750 1,094

GDP per head (US$ at PPP) 14,040 18,250

Private consumption per head (US$) 7,530 10,450

Total imports (US$bn) 213 256

Private consumption (% of GDP) 74.3 73.2

Government consumption (% of GDP) 14.6 14.3

Gross fixed investment (% of GDP) 21.7 23.7

Source: Economist Intelligence Unit

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