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Its influence with Russia is dwindling and its economy is in dire need of foreign investment.
By: Ekaterina Zolotova
As a geopolitical
actor, Turkey’s greatest advantage is its domination of intersections.
It sits at the crossroads of Europe, Asia and Africa, and it controls
the passage of ships between the Black Sea and the Mediterranean. During
the first year and a half of the Russia-Ukraine war, these features
granted Turkey outsize influence. Immediately, Ankara blocked warships
from transiting the Turkish straits in a bid to contain the conflict. It
served as a mediator between the warring parties and, later, as a
guarantor of the U.N.-brokered Black Sea grain corridor. As the West and
Russia escalated their economic standoff, Turkey sensed an opportunity
to serve as a transit point for the goods trade and voiced ambitions to
establish itself as a natural gas trading hub.
But with the war
dragging on, the perks of being Turkey are fading. In the short term,
space for mediation has almost completely closed, while over the long
term, Turkey’s advantages are challenged by the emergence of alternative
trade routes. If relative neutrality ceases to be profitable, it may
prompt Ankara to seek stability through closer alignment with the United
States.
End of the Road
Turkey’s dream of
regional leadership will be difficult to achieve if it is
simultaneously battling energy price volatility, a fragile economy, an
unstable society, and threats to regional trade stemming from an
intensifying conflict in the Black Sea. Therefore, after years spent
trying to defy economic gravity, newly reelected President Recep Tayyip
Erdogan apparently has embraced serious reform.
The Turkish
economy is weighed down by a significant trade deficit and extremely
high inflation, which peaked in October 2022 at 85.5 percent and is
forecast by the central bank to finish 2023 at 58 percent. After
securing another five-year term in May, Erdogan assembled a new economic
team charged with reducing the country’s large external imbalances,
restoring fiscal discipline and, most important, moving away from an
unorthodox monetary policy. (Despite inflation creeping higher, Turkey’s
central bank beginning in 2021 cut interest rates to as low as 8.5
percent from 19 percent.) New Finance Minister Mehmet Simsek, a moderate
who previously held the same post from 2009 to 2015, raised taxes and
worked to charm foreign investors and executives. Meanwhile, new central
bank chief Hafize Gaye Erkan embarked on the perilous path to wind down
an expensive bank scheme that shields lira deposits from foreign
exchange depreciation. She also hiked Turkey’s key rate for the first
time since 2021; after an unexpectedly large increase last week, it now
sits at 25 percent, up from 8.5 percent.
![Turkey | Interest Rate]()
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So far, Turkey’s
policy normalization has not paid off. The first two rate hikes turned
out to be too weak, and inflation started to accelerate again. Relative
to last year, consumer prices rose 38.2 percent in June and 47.8 percent
in July. Real estate prices have kept soaring, and consumer confidence
fell in August. The Turkish lira accelerated its slide against the
dollar, peaking at 27.2 per dollar. It strengthened to 25.5 lira per
dollar after the most recent rate hike before weakening again the very
next day.
![Turkey | Inflation]()
(click to enlarge)
![Turkey | Exchange Rate]()
(click to enlarge)
Besides
inconclusive reforms, Ankara is threatened with the sudden diminution of
its regional influence and transit-state status. First, the Bosporus
has ceased to be Russia’s only warm-water outlet for cargo. In August,
the first Russian train carrying commercial cargo arrived in Iran
through the Incheh-Borun border crossing with Turkmenistan en route to
the port of Bandar Abbas and then Saudi Arabia. The route, part of the
International North-South Transport Corridor, enables Russia to export
goods to Saudi Arabia at nearly half the usual cost in customs tariffs.
Separately, exports of Russian oil and oil products started to shift
from the Azov, Caspian and Black seas to ports on the Baltic and in the
Far East.
The second
challenge to Turkey’s regional status follows from the termination in
July of the Black Sea grain deal, which facilitated the safe travel of
Ukrainian grain through the sea’s contested waters and elevated Turkey’s
significance as a transit country for grain from Eurasia to the
developing world. Erdogan has nothing to show for his efforts to revive
the deal but is due to visit Russia in early September to try again. In
the meantime, Kyiv declared the waters around six Russian Black Sea
ports to be part of the war zone. Moscow has repeatedly launched
missiles and drones at Ukraine’s seaports as well as port infrastructure
on the Danube, which Ukraine and the West rely on to replace the Black
Sea routes. Ukrainian and EU efforts to establish alternate routes can
only further eat into Turkey’s significance in the grain trade.
Appeals to Foreign Investors
In summary,
Turkey’s temporary boost from bridging the divide between Russia and the
West is fading, and its gradual return to economic orthodoxy is
yielding few immediate benefits. Even if its policy U-turn reduces
inflation and stabilizes the lira, it is unlikely to do away with
Turkey’s chronic trade deficit. Nor will it solve Turkey’s government
debt (about 31.2 percent of gross domestic product) or the debts of the
central bank, which has borrowed a ton of foreign exchange from domestic
banks and other governments to defend the lira. Therefore, to
accelerate the repairs to the economy, Turkey will need to attract
foreign investment.
But the circle of
investors who are ready to put their money in Turkey is limited. Russia
is not an option because of sanctions, the enfeebled state of the Russian economy
and the volatility of trade flows. Simsek, the finance minister, said
Turkey wants to restart EU accession talks, but the bloc has its own
problems with inflation and a sluggish economy, and anyway, the
accession process is measured in years and could be facing major reform.
Ankara has had
more success with its new outreach to the Gulf countries. In July,
Erdogan signed $50 billion worth of deals during a three-day tour of the
Persian Gulf. Turkey and Saudi Arabia recently implemented a plan to
increase bilateral trade and signed a memorandum of understanding to
cooperate on the mining of critical minerals. How many of these
agreements will materialize is an open question. The Gulf states will
expect results from Turkey’s economic reforms. Turks’ rising hostility
toward Arab migrants could also become an issue; the country still hosts
approximately 4 million Syrian refugees and more than half a million
Iraqis. Turkish authorities have started removing Arabic from business
signs, and the interior minister said all Arabic shop signs would be
replaced by the end of the year. Finally, Turkey’s regional ambitions
are not always popular with Arab states. For example, Egypt, the United
Arab Emirates and Saudi Arabia are wary of Turkey’s economic interests
in Sudan and its increased presence in the strategically important Horn
of Africa more generally.
The country with
perhaps the most to offer is the United States. The U.S. is Turkey's
second-largest destination for exports after Germany. The U.S. is ready
to invest, especially in a country that hosts critical U.S. military
bases and that plays a pivotal role in the ongoing confrontation with
Russia. In addition, Turkey has an educated workforce and strong
industrial base, but it could use help moving into more high-end
manufacturing (more than half of Turkish manufacturers are engaged in
low-tech production) – something that would also suit U.S. interests.
The main obstacle
to greater U.S. investment in Turkey is the poor state of bilateral
relations. A month before Turkey’s elections in May, Ankara accused
Washington of trying to create a Kurdish terrorist state near Turkey’s
borders, and Erdogan was furious when the U.S. ambassador to the country
met with his main political rival and head of the opposition coalition.
However, both sides seem ready to turn the page on this ugly chapter of
relations. They recently held their largest joint military exercises in
seven years, involving warships, Turkish F-16s and U.S. F-18s. Also,
Selcuk Bayraktar, the head of the Turkish drone maker, toured the USS
Gerald R. Ford at the U.S. ambassador’s invitation while the carrier was
visiting the port of Antalya.
Turkey has not
set aside its ambition to become a significant Mediterranean power, but
it was becoming too difficult to sustain its previous course. Under
intense Western pressure, Russia is turning toward Asia and the BRICS,
building trade routes that bypass Turkey and becoming less conciliatory
on issues of common interest like the collapsed grain deal. Meanwhile,
Turkey’s new economic team is implementing reforms but can’t deliver
miracles. The country needs foreign investment, and investors are
waiting for clarity – including on Turkey’s strategic alignment. One way
or another, Turkey will have to put things in order not just
domestically but also in its international relations, especially with
the United States. |