In November 2014, Spanish bank BBVA increased its stake in the Turkish bank Garanti to 39.9%, making it Garanti’s largest share holder. At the time, BBVA President Francisco Gonzalez hailed the deal as “one of the bank’s best investments in the future” because “Turkey is an important, and a young country.” Both judgements are reasonable – 50% of Turkey’s population is under 30. BBVA’s CEO did admit that the region suffers geopolitical tensions, but argued that they were more than compensated by Turkey’s potential for economic growth. In fact, even as he spoke, there were very good reasons to doubt Turkey’s potential for economic growth.
Like other emerging economies, the fate of the Turkish economy in recent years has to a large extent been decided in the US Federal Reserve Bank. The implementation of Quantitative Easing (QE) released trillions of dollars onto markets in search of good returns. With interest rates in the U.S. at historic lows, much of this money flowed into emerging markets, including Turkey, in the form of foreign portfolio investment (FPI). This sudden massive injection of capital drove housing and stock market bubbles and potentially unsustainable deficits on the current account. Deficits on the current account driven by FPI pose a particular problem: normally a deficit on the current account would cause the local currency to weaken, as demand for imports exceeded that for exports, but in this case the demand for the local currency generated by the portfolio investment itself doesn’t allow that to happen. One of the self-correcting mechanisms for the current account deficit is removed. A second problem with FPI is that easy come, easy go. Foreign investors like it because it is reasonably easy to withdraw quickly, unlike Foreign Direct Investment (FDI) – governments dislike it for the same reason.
The sustainability of much of the Turkish economy is thus dependent on the maintenance of FPI, largely by US investors. This in turn depends on decisions taken Fed Chair Janet Yelloen. Already previous signs of monetary tightening have caused sharp corrections in Turkey’s stock market. The IMF has reported significant capital outflows from emerging markets this year as investors anticipate further US monetary tightening. So far this has not happened as continued weaknesses in US economic data have persuaded Yellen to hold back on raising interest rates. But sooner or later the Fed will begin to normalize, and will do so for internal economic reasons without considering the impact on emerging markets like Turkey. At that point the capital outflow will accelerate, leaving Turkey with collapsing house and stock markets and an unsustainable deficit on its current account. The Turkish Lira will also depreciate rapidly. Although that, in the longer term, should help with the current account deficit, in the shorter term it increase Turkey’s problems in servicing its dollar-denominated foreign debt. Indeed, given Turkey’s dependence on imported fuel and raw materials for its manufacturing sector, it is not clear that a depreciating currency will help much with the current account deficit. In short, within the next year or so, Turkey is likely to face a perfect storm of collapsing house and stock markets and currency and unsustainable current account deficit and foreign debt, all provoked by decisions taken in Washington over which Turkey has no control.
Turkey’s economic problems are not the only challenges it faces: it also faces severe political and geopolitical challenges. The geopolitical challenge is essentially four-fold: Turkey’s rejection by the EU; the collapse of neighbouring states of Syria and Iraq; the consequent rise of both Islamic State and the Kurds; and the resurgence of Russia and Iran. Although no-one is keen to proclaim it out loud, it is clear that Turkey will never enter the EU. If there remained a slight opening still prior to the economic crisis, that has disappeared with the Eurozone crisis and the rise of anti-immigration parties across the EU. This has forced Turkey to re-think its geopolitical alignment, a task made harder by the disintegration of its two neighbours to the south. The fragmentation of Iraq and Syria threatens Turkey with an immigration crisis as well as the risk of instability crossing the border. The rise of an ever more confident Kurdish pseudo state in northern Iraq threatens Turkey’s internal political stability as Turkey’s own Kurds become more assertive. The rise of Islamic State poses even greater threats. Turkey has withstood US pressure to engage with Islamic State forces directly, which has soured relations with Washington, but the danger of cross-border infiltration remains, with the risk of attacks on western tourists the most direct threat to Turkey’s economy. If Turkey looks to shift its geopolitical re-alignment to the East, reviving the Pan-Turkic ideas of previous governments, it is confronted by Russia and Iran, both geopolitically assertive despite western sanctions, and ultimately China carving out its new Silk Road. Although Turkey might once have hoped to play between Moscow and Beijing, the extent to which western policy has driven Russia and China together has limited the scope for this. And then, of course, there is Greece …
Turkey’s domestic political problems are partly driven by geopolitical factors, in particular the growing confidence of the Kurds, and partly by the character of its President Erdogan. Erdogan’s increasingly authoritarian attitudes and intolerance of criticism have alienated even some of his supporters. At the same time the country remains divided between the secularists, mainly from the professional and military classes, and the Islamists, more small businessmen and farmers. The recent elections complicated the political scene, with the irruption of the Kurdish HDP into the parliament. Far from winning the 330 seats it needed to change the constitution to give more powers to President Erdogan, the ruling AKP lost its parliamentary majority, although it is still the largest party. Negotiations continue to form a government, with the increase in the powers of the president one of the key issues. Any coalition government formed, however, will have major policy divisions which will limit its ability to respond agilely to Turkey’s economic and geopolitical crises. At the same time there is evidence of increasing political violence and social unrest.
The election results could not have been known in November last year, but all the other factors were already in place to some degree. This raises the question of what kind of geopolitical and geoeconomic analysis did BBVA carry out before deciding on its investment in Garanti, especially since the same set of conditions have led HSBC to pull out of Turkey. This is not to criticize BBVA’s decision. Successful investments in high risk environments often enjoy high returns (although public statements at the time of the investment did not suggest that the BBVA leadership saw it as a risky investment). Rather it seeks to point out the difficulties that companies, even large companies, have in analyzing the complex inter-relationships between economic, political and geopolitical factors when making investment decisions. Turkey is interesting in that not only does its economic future depend on national political and regional geopolitical factors, but also on monetary policy decisions made in another continent. It is not alone in this. Most emerging markets were recipients of FPI after the Fed introduced QE, in most cases it drove current account deficits and asset market bubbles, and most are now highly vulnerable to capital flight if the Fed raises interest rates. This includes much of Latin America, which is already suffering from the collapse in commodity prices as the Chinese economy slows. This is highly relevant to a bank like BBVA, which also has a significant presence in Latin America, on which it depends for much of its profitability. If Yellen decides to raise interest rates, BBVA could find several of its key markets entering into economic crisis at the same time.
Again I stress, this is not intended as a criticism of BBVA, which may in any case be proved right in the end. BBVA is the case study simply because Turkey is an interesting example. What it makes clear is that companies must make a thorough political and geopolitical analysis of a country before taking significant investment decisions. But this is not enough. The analysis must run broader to include all the markets in which the company is operating and factors at a global level that could affect the economic stability and growth of the country being considered. In the case of an investment in Turkey this must include the regional geopolitical factors, but also the impact of US monetary policy on investor decisions about Turkey, as well as the impact of those same decisions in other countries where the company has exposure, for example in Latin America, which then brings in the impact of China’s economic performance on commodity prices. The latter makes the point that the analysis must be tailor-made to the company and the specific investment decision. What might be a reasonable risk for one company, because hedged by investments in other countries with a contrary risk profile, might be highly dangerous for another company already exposed to similar risks, with the same causal triggers, in other countries. Expensive off the shelf country reports from Anglo-American geopolitical consultants do not cut it.
In short, companies need company-specific, four dimensional analysis leading to a 4-D strategic vision of the investment opportunity. The four dimensions are:
- 2 dimensions of space – the analysis/vision must be holistic across all the markets the company is operating and all countries and governments that can affect the political and economic performance of the investment country.
- 1 dimension of time – the analysis/vision must be dynamic through time, both in the sense of looking both backwards and forwards, and understanding that the analysis itself must constantly evolve.
- 1 dimension of depth – the analysis must dig down through the different levels of political, geopolitical, economic, social, security and cultural factors and pull them together into a holistic vision.
Such a 4-D strategic vision can then serve as the basis for business diplomatic strategies that can mitigate the risks and even uncover opportunities in challenging investment environments. In an ever more volatile and unpredictable international business environment, the costs of getting this wrong can be severe.