Dispelling rumors about an early election, Mehmet Şimşek, Turkey's deputy prime minister in charge of the economy, reiterated that throughout the history of the ruling Justice and Development Party (AK Party), they have never held early elections opportunistically, emphasizing that it is now time to focus on their comprehensive agenda in terms of reform.
Şimşek said the Turkish economy has overcome the negative impacts of last year's July 15 coup attempt and is back to pre-crisis levels in terms of economic growth, job creation and overall economic performance. Emphasizing that the high growth rate in the first quarter of this year will be maintained until the rest of the year, Şimşek said that in the short term, there is no question regarding growth outlook. However, he acknowledged that in the medium term, Turkey needs to implement more structured reforms to sustain growth performance of 5 percent or more, stressing that the government has implemented a very comprehensive reform agenda and is determined to deliver on structural reforms.
Emphasizing that Turkey's perception is much worse than the underlying reality, the deputy prime minister said the government will work hard to narrow the gap between perception and reality by improving the investment environment and attracting more foreign investments to Turkey.
Daily Sabah: As the deputy prime minister who is responsible for the Turkish economy do you believe that economy has fully recovered from the negative impacts of the July 15 coup attempt and what would be your response be to the criticism that the state of emergency has negative effects on investors and is hindering future investments?
Mehmet Şimşek: First of all, the last year's failed coup attempt was a big confidence shock for the Turkish economy, while there was some immediate fallout from the coup attempt; the government's appropriate response has limited downside of the economy in 2016. The measures that we introduced after the coup attempt recovered Turkey very strongly.
Turkey actually has experienced a V-shaped recession. With very strong recovery and we are back to pre-crisis levels in terms of growth, job creation, and overall economic performance. If you look at growth for example, we are now back above a 5 percent trajectory. The Turkish economy is now growing at more than 5 percent. This is a great performance considering the challenges Turkey have faced and the state of play regionally and globally.
But the reputation of fallout from the failed coup attempt that will take more time to fix that meaning there is now a big gap between perception and reality. Turkey's perception is much worse than the underlying reality. That is partly associated with the failed coup attempt. It is also partially associated with the fact that there is a huge campaign against Turkey by the Gülenist Terror Group (FETÖ), PKK and others. So unfortunately that is more difficult to overcome and more time is needed to fix it. If you look at the details, the tourism sector suffered immensely, the recovery is there but again it will take few years before we are back on pre-crisis terms. In certain areas, we fully recovered but if you look at the big picture, the macro picture of the economy, Turkey has recovered and is back to normal.
As far as the state of emergency, it has been a necessity to deal with very complicated threats. It does unfortunately, play to the hands of those who are campaigning against Turkey. While the state of emergency is purely there to deal with terror threats, the coup attempt, unfortunately it is an issue open for exploitation; some use that as pretext, as an argument against Turkey. Having said that, if you look at Foreign Direct Investment (FDI) inflows in the first five months of this year it is up significantly, relative to the same period once. That suggests while the continuation of state of emergency does not help with the perception, in reality investments continue to flow into Turkey.
Whether you look at the investments by portfolio managers in Turkish bonds and equities or you look at Foreign direct investment (FDI) across the globe, investments flowing to Turkey have increased significantly in the first half of this year relative to the previous year, which suggests that the actual impact of state of emergency's is not as much as it is stated. One also has to see that the state of emergency does not help with perception. While reality matters, some improvement in perception also would be helpful. That is why again we have to work hard to communicate our policies better. Ultimately it's the performance that matters, and I think our performance has surprised many but we still have a long way to go in fixing Turkey's reputation. Because reputation has been hurt by all these politically motivated efforts and clearly the situation in Turkey is not as bad as it looks and as many think but clearly we need to improve the reality further and narrow the gap between perception and reality.
DS: In the first quarter of this year, Turkey's economic growth was 5 percent. Can that be sustained?
M.Ş.: First of all outlook for growth is positive. In any other country, any other emerging market, if faced with the type of challenges Turkey has faced, the type of shocks Turkey faced, it would have gone into in prolong recession but Turkey has avoided that. That suggests that Turkish economy has been extremely resilient. If you look at the last 15 years, the real GDP growth has averaged 5.6 percent. But if you look at post crisis period where growth has been more subdued globally has been slower, Turkey has actually delivered between 2010 and 2016 a 6.7 percent GDP growth. This is the fastest growth rate among the Organization for Economic Co-operation and Development (OECD) nations and among sizable emerging economic markets. This rate is similar to the best, like China and India.
Last year we experienced multiple shocks but as I said Turkey's fundamentals are strong. Because of our strong fundamentals we were able to recover very quickly. Even in a year like 2016, the growth rate was 2.9 percent. We are now back to a 5-percent plus growth trend and this year's growth will be very strong.
DS: So the GDP growth can be sustainable?
M.Ş.: In the short term there is no question surrounding the outlook for growth. In a medium-term basis, clearly more structured reforms are needed to sustain 5 percent or plus growth. That is why; right now we are working hard on making sure that we implement much needed reforms to help put turkey on a high growth level.
Let me give you a sense of the growth outlook for the next year or two. First of all, external demand led by European recovery is supportive of strong growth in Turkey. Our key trading partners are recovering that is good news. About the disruption in our traditional markets in the Middle East and North Africa (MENA) region I would argue that the worst is behind us and hopefully some improvement is likely going forward.
On the domestic front, political uncertainty has largely diminished, policy uncertainty is also diminishing. Improved visibility and predictability should help maintain strong momentum in the Turkish economy. For the past few years private sector investments have been sluggish and that is not unique to Turkey. But Turkey had probably more than its fair share of shocks. So we believe that there is a pent-up in investment demand, there is a delayed investment demand. My government has introduced very generous incentives to boost investments. It also introduced strong incentives in employment and we have been successful in job creation. Job creation is supportive of sustainable economic growth. More importantly, we believe that now capacity utilization is rising fast that investments actually begin to emerge, private sector and investments are likely to expand and that would be the main engine of growth. A combination of stronger external demand, improved visibility, pent- up investment demand and rising employment should help support sustainable growth. That is in the relatively of short term but in the medium term clearly, it depends on our ability to introduce and effectively implement further structural reforms.
DS: You just mentioned that the government has some initiatives mechanism in order to revitalize economic activities such as the credit guarantee fund and tax postponing and so on. There are also some criticisms that claim the AK Party government, which has been good at implementing tight fiscal policy in the last 10-15 years, is now giving up this policy. What is your response to this?
Last year, as I said there was a big confidence crisis and if we did not provide some fiscal support the risk of recession would be very high. We prevented a major confidence shock from pushing Turkey into a recession. There was an appropriate response. We had fiscal space and we deployed it to help Turkey avoid an unnecessary recession and we were very successful. Of course, no measures come without any side effect. One of the key initiatives that we took was this credit guarantee arrangement. It was aimed at preventing the credit crunch.
The banks faced such a big shock and weakness, in the tourism sector and other sectors and they were reluctant to lend. In particular, SMEs were almost starving to capital. We stepped in and we helped ease these concerns. We provided TL 25 billion ($7.11 billion) from the budget that could be leveraged to TL 250 billion of credit guarantee. This is actually a very successful scheme with some side effects. If today, we are able to say that Turkey is back, strong, and fully recovered it is partially due to these smart initiatives. The credit guarantee system does not necessarily means that money committed to the credit guarantee fund is going to be lost. In fact, this year its impact on the budget is about couple of hundred million lira which is considerably small. Some of the loaners may perform badly in the future. But even in that case imagine in a five year basis its impact might be less than around half a percent GDP which is also considerably small.
Therefore, the concerns about fiscal slippage are less to do with our efforts to revive the economy. There are more structural aspects to it. Turkey went through a very long election cycle. In 2014 we had two elections. In 2015 we had two elections. In 2016 we had a failed coup attempt. In 2017 we had a referendum. Because of all these, unfortunately, we were unable to push our reform agenda as aggressively as we had planned. Secondly, that also had some negative implications for our fiscal position. If you look at the central government budget the deficit this year is likely to be around 2 percent. That is still well below Maastricht criteria. If you look at the debt to GDP ratio it's just under 30 percent. It is less than half of the Maastricht criteria which is 60 percent. It is also significantly below the emerging market average. If you look at the debt to GDP ratio in the emerging market universe its average is over 47 percent. My point is that, yes there has been a negative trend in fiscal position, but that is partially in response to the shocks that we experienced, it is partially to do with our ability to deliver our reforms. Going forward of course the challenge is to contain the deficit and avoid further slippage, through structural reforms put your key on solid fiscal feet again. Turkey has done this in the past and we can do it again.
DS: Could you please provide information on structural reforms that are currently on your reform agenda?
We have a very broad, comprehensive reform agenda. As far as in the big picture is concerned, clearly we need to improve the investment environment. This is a key issue. Turkey needs more investments. We need to revive domestic investments but also attract international investments. A strong focus is going to remain on improving investment climate and here we use the World Bank's Doing Business Report as a guide book. We hope that through our reform efforts we will enhance Turkey's standard. That is the first thing. Secondly, we would also like to push a number of tax reforms that will help, broaden Turkey's tax base, simplify tax code, enhance tax payment rights and overall help improve sustainability of strong fiscal position. Many aspects of that reform are ready and we hope that we will be able to push this reform to Parliament soon.
Another one is judicial reform. Last year we did two important items on our judicial reform agenda. All of them were introductions of the so called regional appeal courts. Until recently, millions of cases were being handled by the supreme appeal court. Now, 80 percent of all court cases are going to be handled at the regional level. That should help improve the quality of the judicial process. It should also help speed up the justice system. Our justice ministry is currently working on a number of other critical items. Last year we also introduced a reform into expert witness system this year we are looking at expanding modern arbitration mechanism. Create more specialist courts and find the ways of other court settlements for disputes between the state and citizens. So that is a critical area because we need to restore the confidence to the judiciary system. Reform is the only way to do it and we have a strong commitment.
Another key area of reform is enhancing quality of human capital stock in education. Access to education in Turkey has been boosted by the current government, my government. There are equal opportunities for everyone. From preschool all the way to the PhD level, the entirety education is free. The government provides scholarships and subsidizes loans to students. We have invested substantially into the education system. We have invested in physical space, creating over 270,000 classrooms, more than doubling number of universities. We have hired over 60,000 teachers. So across the board, we have invested very heavily in education. Education is now our number one spending item in the government budget. That is good news. But quality of education still needs further improvement. And that requires teacher's training strategy, which is in place, it requires expanding preschools which implemented to make it as compulsory by the end of 2019, help improve in teaching the foreign languages, and a strong focus on essentially technical schools and training centers.
So we have a very comprehensive education reform. Almost all items are to be introduced and implemented. One key area, a key target in education is to boost private share in the education sector and to do that, we have been giving extremely generous incentives to private entrepreneurs. But also we have been sponsoring poor kids to attend private schools. So Turkey has this multi-form strategy to improve the quality of education. Of course we are also making use of technology in classrooms. With tablet PCs, smart boards, Wi-Fi and online learning.
Another key area of reform is the labor market. Last year we introduced a few critical items such as the introduction of private employment agencies, and easing restriction on part time employment. But of course the work is not finished; we still have more to do. In particular we need to renew the labor code, to help improve labor mobility but also make labor market more flexible. Another area is public administration. Turkey is moving to a presidential system. Over the next couple of years, we have to adopt a legal framework, it is needed for the new presidential system and that will also ultimately evolve in the public sector administration. That is another important area that we continue to focus on. I can go on and on. Maybe one last item is reforms that will help Turkey move up the value chain. That means that we need to provide more support for the R&D innovation and entrepreneurship eco-system. Last year we took a number of steps such as a new patent law, more generous incentives, R&D incentives, now we are looking at restructuring the Turkey Development Bank to support hi-tech startups.
We are looking at introducing crowdfunding; we are hopefully going to introduce upgraded legislation to facilitate it. So access to finance, last year we introduced a reform that would help small and medium sized enterprises use their mobile assets, machinery equipment, to access credit. So further steps will allow these lines help Turkey's R&D innovation entrepreneurship eco-system. This is critical because, Turkey needs to move up further in terms of the value chain. We believe that we can do that. Our reform program is very comprehensive. Over the next 12 months, we believe that we will make significant progress. Progress was due back in 2013, but with so many domestic and external and regional shocks getting in the way that has prevented us from achieving a critical mass in terms of strong momentum in reforms. But the worst is behind us. We have, however, great opportunity and we are now working very hard and over the next few months, it will become very visible that we have improved across the board.One other area is important, this is not related to economics, but we can't really separate them.
Turkey is also committed to improving standards of his democracy, and continues to boost the fundamentals of freedoms, and strengthening the rule of law. Turkey is not going to walk away from its aspirations to build a stronger, rule of law based, well-functioning democracy. Some setbacks, and the introduction of the state of emergency, have raised question marks. We believe that we are quickly getting back to normal. As we make progress ultimately Turkey will show, for the sake of all its citizens, that it will continue to enhance the standards of democracy, the rule of law, and it will continue to boost the fundamentals of freedom and through that we will achieve a sustainable high level of prosperity.
DS: What are some of the challenges implementing this reform agenda? I'm asking this question because there are some rumors about early elections.
M.Ş.: First of all, early elections are out of the question. As President Recep Tayyip Erdoğan made it clear and Prime Minister Yıldırım made it clear. If you look at the ruling Justice and Development Party's (AK Party) history we have never opportunistically brought forward the elections. It is out of the question. The challenge is that reforms are difficult to introduce but not impossible. Turkey has shown that you could make reforms and the reforms something we owe to future generations. Not delivering reforms is like essentially failing on our promises to our children. So we do not have a choice. Turkey will ultimately deliver these reforms. But the means for the delivery of these reforms are sometimes difficult. It tends to be, obviously, regional and geopolitical challenges, domestic shocks. Now we hope that geopolitical tensions will be contained and won't escalate. I think as far as domestic shocks are concerned, I can't imagine any climate that is worse than last year. Even last year, we have shown our commitment to reforms. We pushed a number of reforms such as partial labor market reform, R&D reform, a new patent reform, a reform to help SMEs access finance and reforms that boost auto enrollment in private pension. I think the environment today, is much more conducive to introducing reforms and effectively implementing them. So I can't imagine what would throw us off course other than a geopolitical crisis.
DS: How do you evaluate the German government's statement that it will ask the European Commission to freeze the negotiations for the Customs Union update?
M.Ş.: First of all, the Customs Union is in our interest and in European interest, it is a two way track. So, I think if the progress of upgrading Customs Union poses victim of, let's say tension between Turkey and Germany, which would be very unfortunate for the EU and Turkey. In fact, Europe would be shooting itself in the foot. Why not upgrade the Customs Union with Turkey? Turkey is now the fifth largest trading partner of the EU. If we upgrade the Customs Union, trade volume between Turkey and the EU can be boosted from $150 billion to $300 billion. Trade has been traditionally been the engine of growth and job creation. So the EU is not going to be doing this as a favor by upgrading the Customs Union. Of course it is also in our interest but it is a two way track, it is a mutually beneficial initially. In fact, in my perspective, it's a low-hanging fruit that the EU and Turkey can make progress.
I understand the difficulties with Germany, politically right now, those types of statements. Germany is one of our critical partners, an ally, and a friend. We hope that Germany's anger resentment, frustration will ease. Because we want to have a constructive dialogue with Germany, address our differences through dialogue. I always recommended to our friends in Europe that we should be talking more with each other and not talking about each other or shouting at each other. But Turkey has gone through a very difficult period in last a few years and there have been communication issues, problems and there has been number of issues that are poisoning the atmosphere. So we need to work together to address these problems. I think our European friends should be more open to our concerns regarding existential threats from the PKK, FETÖ, Daesh and terror in general. They should show more solidarity, a bit more empathy and more understanding.
Of course, we also are aware that Europe has gone through a difficult period. We should also understand the difficulties that some of our partners have been facing domestically. We are also aware that FETÖ, the PKK and the others are working hard to disrupt the partnership between Turkey and the EU. But we never doubt that Turkey needs the EU, and the EU needs Turkey, it's as simple as that and the Customs Union is one of the core components of this long lasting mutually beneficial relationship. I think that the EU commission is well aware of the significance and importance of upgrading the Customs Union with Turkey and the benefits it involves for both Turkish and European citizens. So that is while it is unfortunate that we are here today but I don't see, hopefully, a permanent fall-out from the current disputes, exactly the opposite. I think we should have better dialogue, and communicate better, and hopefully address our differences and hopefully to put the Turkey and EU accession talks and the Turkey-EU Customs Union back on track.
DS: Turkey has recently established a sovereign wealth fund and it's under spotlight because of its structural difference than other world examples. What are the positive and negative aspects of this?
M.Ş.: If you look at classical sovereign wealth funds, they usually are a product of surpluses either fiscal surplus or external surplus but Turkey has neither of those. However Turkey has a large number of state owned enterprises and therefore sits on huge assets and so one way of thinking about the sovereign wealth fund, is to think about these state owned enterprises as a being restructured to unlock the potential value. Another way to look at it is to use these assets to raise significant long term international capital to help support Turkey's infrastructure and growth. The aspect of the sovereign wealth fund is that it also serves as venture capital or private equity, to invest in promising hi-tech start-ups to support Turkey's entrepreneurship and Turkey's efforts to move up the value chain.
It is too early to judge Turkey's sovereign wealth fund. Because it has barely been months since the establishment of the paper. It will take some time before progress is made.
DS: There are some views that the health of the banking system will be negatively affected with the new regulation that allows banks to demonstrate real estate as equity. What is your opinion regarding this issue?
M.Ş.: I think that there is clearly a misunderstanding here. The Turkish banking sector regulation and our supervisory framework are in line with Basel norms and therefore we are not going to do anything that would endanger the health of the banking sector. The Turkish banking sector today is well capitalized its capital adequacy ratio is two times over global requirements which is over 16 percent. The Turkish Banking sector has solid asset quality. If you look at the non-performing loans ratio, despite these multiple shocks, it is barely over 3 percent. The Turkish banking sector remains highly profitable. If you look at returns on equity, it is almost 15 percent. So the banking sector is healthy, well capitalized, well supervised and regulated and that is not going to change. Turkey will maintain high standards. Because we were burned twice in banking in 1994 and 2001 and we are not going to let that happen again.