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Turkish devaluation to fuel growth

27 August 2014


The devaluation of the lira has not yet produced a major benefit to the economy but the effect appears only to have been delayed by a few months, finds Nicholas Clayton

Read more: devaluation lira M&A FDI

The depreciation of the Turkish lira over the past two years has driven down prices for foreign investors, but with the market still adjusting to changing risk perceptions and financing conditions, Turkey has yet to see a major uptick in foreign direct investment (FDI).

With a backlog of delayed deals created by the volatile first half of 2014, analysts and bankers say the country is likely to see a flurry of cross-border activity after the August 10 presidential elections.

On January 24, the lira dropped to 2.34 to the dollar - 24% below its value at the start of 2013. The Central Bank of the Republic of Turkey responded by raising interest rates by 550 basis points and the currency has since largely stabilised, recovering to 2.09 as Global Investor/ISF went to press. However, this remains far short of its position on January 1 2013 of 1.78 to the dollar.

Turkey's real GDP rose 4.3% in the first quarter of 2014 on a year-on-year basis, beating the consensus expectation of 4.0% growth. This was driven largely by 11.4% growth in exports and a boost in public spending, on the outset of an election year. The Turkish trade deficit also narrowed in April to $7.2bn, a 30.3% year-on-year drop.

But beyond the broad numbers, analysts point to several weaknesses for deal-makers. Although in the first half of the year there was an frise in M&A deal volume, overall M&A value dropped 29.9% in the first half of 2014 compared with the same period in 2013, according to data compiled by Mergermarket.

In addition, more than half the country's $7.7bn deal value consisted of the privatisations of three thermal plants, a marina and a port, from which the government reaped $4.9bn, and on July 15, the government finalised the sale of a 10-year tender to operate the national lottery, Milli Piyango, for $2.75bn.

Although several foreign consortia were reportedly interested in bidding on these assets earlier in the process, in the end none of them attracted bids from foreign groups. This reflects a wider drop in foreign entries, as a wave of protests and scandals over the past year have chilled the investment climate.

The depreciation of the lira itself was accelerated by the announcement of a high-level corruption inquiry in December, which implicated several members of the ruling elite, including the CEO of Turkey's state-owned Halk Bank. Already suffering from the tapering of quantitative easing (QE), the lira took a nosedive.

Concerns about political stability had already been piqued when the country saw a wave of anti-government protests beginning last May centred around Istanbul's Gezi Park. Coupled with escalating conflicts in neighbouring markets, these events have caused investors to delay deals and wait for a sign of stability.

Overall, cross-border M&A value in Turkey dropped 28.5% in the first half of 2014 compared to same period last year, according to Mergermarket data. One Istanbul-based banker says while he has not seen deals completely terminated, the succession of negative events has led the boards of his corporate clients to "keep pressing the pause button", leading to a bottleneck of stalled financings and acquisitions.

Things do appear to be turning around, however. Turkey's capital markets have largely rebounded, with the main Istanbul stock index reaching its highest level in July since just before the Gezi Park protests last year. Should the ruling party win the presidential election as expected, analysts say there could be a busy fourth quarter full of deal-closings that have long been on hold.

Ahmet Kesli, founding partner of Group Law Firm, says despite recent events, foreign firms would be wise to enter Turkey sooner rather than later. With a steadily expanding economy, a median population age of 30.4 years and rapidly increasing consumption, nearly all sectors in the country are primed for growth, Kesli says.

An increasingly popular way for foreign firms to invest in Turkey, he says, has been to partner local firms bidding on infrastructure projects and other public private partnerships (PPPs). Many international firms have chosen to avoid the risk of the tender processes and have instead become involved as lenders or equity partners in infrastructure PPPs after the winner has been announced.

Public-private partnerships
Last month, Turkish deputy prime minister Ali Babacan announced that the country was hoping to attract $700bn in infrastructure investment by 2023, with $200bn of that garnered through the country's PPP model. According to Development Ministry data cited by Hurriyet Daily News, Turkey has signed 167 project contracts worth a total of $88bn since the government passed its first PPP legislation in 1994.

However, it has been only in the past few years that the Turkish government has used PPPs as a means of attracting capital for mega-projects. Last year, the government concluded a deal with Italian construction company Astaldi to build the $6.9bn Gebze-Izmir toll road in a consortium with five Turkish construction firms.

It is also expected to reach financial close later this year with a Turkish construction consortium on the $29bn PPP to build and operate Istanbul's Third Airport for 25 years.

Kesli says Turkey is likely to see the financial close for the first of its hospital PPPs shortly after the presidential elections. Turkey is aiming to add 28,000 beds to its national hospital capacity through PPP tenders, which are currently at various levels of completion. All and all, the hospital projects are expected to require about $14bn in investment and include government-guaranteed bed fees to the operators of the complexes.

Another Turkish sector all but guaranteed to grow is energy. Turkey's energy demand is expected to rise about 7% annually through 2020 and prices are already high. In the first quarter of 2014, Turkey had the highest consumer energy prices among OECD countries, with a price index 16% higher than the OECD average.

Although the largest electricity generation assets in the Privatisation Authority's portfolio have already been sold, it plans to launch tender processes for its remaining thermal and hydro plants before the end of 2014, according to a source close to the authority.

Speaking at the Turkey Private Equity & Venture Capital Summit in June, Nadia Cansun, a partner at Bezen & Partners, said investments in greenfield renewables in the country were highly attractive. But with untested regulations and a bottleneck of projects awaiting approval, it may be 12 to 15 months before the ideal time to invest in solar power in particular.

Across the renewable space, she added, foreign investors thinking of entering would need to be comfortable with the risks attached to being a pioneer in the sector.

But beyond the lowered barriers to entry for tenders and privatisations, the depreciation of the lira over the past year may also make private sector acquisitions more feasible. In addition to favourable exchange rates bringing down asking prices, many Turkish companies may be more amenable to buyout offers now that they have seen their debt ratios climb after years of borrowing in foreign currencies.

Most active Turkish companies have some form of foreign currency denominated debt on the books.

However, it is unclear just how much dollar and euro-denominated debt is outstanding. Emre Deliveli, an economics correspondent for Hurriyet Daily News, says that in 2012, Turkish companies had easy access to dollar financing at 4%, while lira debt was often nominally around three times as expensive at 11% or above. When the lira hit its nadir in January, those companies were suddenly looking at debt burdens that were at least 20% higher than previously.

Dependent lira
But the Istanbul-based banker says Turkish banks have remained liquid and domestic financing continues to be relatively easy to obtain. Therefore, he says he sees no obvious cheap deals in the market, provided the lira remains stable.

The lira's stability, however, is difficult to bank on. "The lira is totally dependent on the global environment," Deliveli says, noting that if current conditions persist, "we will not see the same pre-crisis liquidity in Turkey again for another 10 years".

Throughout the summer, the central bank has made modest cuts to interest rates, dropping the one-week repo rate from 8.75% to 8.25% on July 17. Meanwhile, inflation hovers just above 9%. In a statement at the time of the cut, the bank said the adverse exchange rate issues were "gradually tapering off" and pointed to rising food prices as the main factor delaying the decline in inflation.

The bank added that it expected the current account deficit to continue to improve. But developments in the region could still pose problems. The worsening conflict in Iraq in particular is already putting a dent in the recovery of Turkish exports. Iraq is Turkey's second-largest export market, worth $12bn annually, and the Turkish Exporters' Assembly announced on July 15 that exports to the country had already declined 30% over the year.

Deliveli says the central bank will continue to make small stabilising adjustments, but the full end to QE expected in October will still make a mark


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