With an impressive record of rapid and resilient economic expansion, Turkey looks to the future with confidence in uncertain times. Since 2001 real growth has averaged more than 5% a year, an extraordinary rate for a middle-income country that imports most of its raw materials. A young and mobile population provides a natural tailwind to growth, while a high level of diversification in terms of products and markets has helped the Turkish economy bounce back strongly from recent global and regional crises.


An economically conservative, pro-business government has a firm grip on executive and legislative power, and it is taking a long-term approach to market reforms and development. The government has set a target of lifting GDP to $2trn and $25,000 per capita by 2023. Given Turkey’s growth record over the past decade, that is not implausible. Dollar GDP has quadrupled since 2001, from $196bn in 2001 to $787bn in 2012. The $2trn GDP target is one of many bold goals set for the republic’s 100th anniversary (see analysis). The government aims especially to boost the size of the financial and transport sectors, increase domestic savings and bring down persistently high current account deficits, the economy’s greatest vulnerability. “Turkey has tripled GDP per capita over the last decade. However, more work needs to be done to ensure that the gains of progress are distributed widely,” Tibet E ğ rio ğ lu, Adecco Group’s operational director for Eastern Europe and Turkey, told OBG.

In 2013 the economy appeared to be gradually re-accelerating amid an unpredictable mix of global financial and economic conditions. A recession in the EU, the main factor behind a slowdown in the real domestic growth rate to 2.2% in 2012, dragged on into 2013. Meanwhile, global financial conditions were very loose, helping to bring interest rates on Turkey’s foreign borrowings down to record lows. The country was expected to continue to navigate well, and forecasts for 2013 real growth range from the IMF’s 3.4% to some analysts who see a return to 5% or higher.


Given Turkey’s young and growing population, which is expected to surpass 76m in 2013, local producers benefit from a large domestic market that is eager to enjoy the fruits of rising wealth.

The economy is open and in a Customs union with the EU, and there are few restrictions on international trade and foreign exchange. Domestic household consumption came to 70% of expenditure-side GDP in 2012, according to Turkstat, a ratio equal to that of the US and unusually high for an emerging market.

Turkey enjoys a central location that facilitates diversified exports. To its north-west lies the EU, with more than 500m people and nearly a quarter of the global economy. To its north and north-east lie the vast, still underserved markets of the former Soviet Union. To its south-east lie the increasingly wealthy oil producers of the Middle East. To its south-west lies Africa, the world’s last great undeveloped frontier.

This central location plus thousands of kilometres of Aegean and Mediterranean coastlines also helped draw more than 31m foreign visitors to Turkey in 2012, making it the sixth-most-visited country in the world.

Energy Corridor 

In addition, Turkey is developing itself into an important energy transit corridor, with oil and gas pipelines coming from Iraq, Iran, Azerbaijan and Russia, and potential new lines or additions from Egypt, offshore Israel and Turkmenistan. Oil departs by tanker from a terminal in Ceyhan, and gas lines connect to the European network via Bulgaria.

Due to Turkey’s limited resources, pipelines are being used mainly to bring in fuels to feed the growing demands of households and manufacturers. A highly diversified manufacturing sector accounted for 16% of production-side GDP in 2012. The largest manufacturing sectors are automobiles, metallurgy, machinery, home appliances and textiles.

The government has put a high priority on developing Turkey’s potential as a transit hub for pipeline, rail, road, sea and air traffic. Several major projects are planned or have been mooted, including new motorways and bridges, another airport in Istanbul, a bigger gas line into Europe, and even a canal between the Black Sea and Mediterranean to divert shipping from the overly busy Bosphorus and Dardanelles. 

State Role

The role of the state in Turkey’s economy has transformed in recent decades; the state has reduced its position as owner and manager of major businesses while expanding its role as regulator of business and manager of macroeconomic policy. There has also a been a strengthening of the central government since the Justice and Development Party (AKP), led by Prime Minister Recep Tayyip Erdoğan, came to power in 2002. Erdoğan has enjoyed the support of a stable majority in parliament, allowing him to pursue systematic reforms at the pace of his choosing.

A gradual privatisation of formerly pervasive state ownership of business, under way since 1984, has accelerated since 2005 as valuations of Turkish companies have risen. Most recently the government has been privatising the generation and distribution of electricity as part of a major liberalisation of Turkey’s traditionally inefficient power sector, which has hampered growth as prices for imported fuels have risen.

The government completed the privatisation of power distributors in March 2013 with $3.5bn in sales of four regional grids, including $3bn paid for the two larger grids by a joint venture between Germany’s E.ON and Turkey’s Sabancı Group. Privatisation of electricity generation capacity has moved more slowly and is about 55% complete. A liberalised energy market is expected to be introduced in 2014 or 2015.

Besides privatisation, the government has reduced its presence in financial markets by bringing down the public debt relative to GDP. Previously, the state’s large issues of sovereign bonds paying high real interest rates had crowded out capital raising by businesses. However, the government still holds a powerful position in the financial sector, owning three of the country’s largest banks. The state also remains a sizeable player in construction, where state-owned Emlak Konut is a major developer and also plays an important role in doling out public land to the private sector.

Some unappealing old traditions also survive, namely corrupt bureaucracy, spotty tax collection and cronyism. Turkey has significantly improved its score in Transparency International’s Corruption Perceptions Index, moving from a score of 3.2 on a scale of zero to 10 in 2002 up to 49 on a scale of zero to 100 in 2012. The World Bank’s Ease of Doing Business Index shows gradual improvement in most areas since 2004, but still ranked Turkey a middling 71st overall out of 185 ranked countries in 2013 with a score of 64.5 on a scale of zero to 100. Turkey scored poorest on ease of construction permits, while business taxes were the most improved area, as tax rates including payroll taxes have come down from 53% to 41.2% since 2007.


However, tax collection remains weak, and many businesses underreport profit and payroll to evade payment. The result is unfair competition for companies that report honestly and reduced revenues for the state. As personal incomes tax revenues are also weak, the government compensates with high consumption taxes, also called indirect taxes, particularly on petrol. Since a series of petrol tax hikes in 2012, Turkey has been in a tight competition with Norway for the dubious honour of having the most expensive petrol in the world.

According to Hayrettin Kaplan, the general manager of Turk Eximbank, Turkey’s reliance on indirect taxes is an important disadvantage for exporters. “If you compare Turkey to China for example, they are supporting producers with low-priced energy supplies. We need a structural shift in our tax system towards direct taxes. To do that, we have to solve the problem of the underground economy,” he told OBG.

Soft Landing

Turkey’s economy rebounded strongly from the 2008-09 global financial crisis, with real GDP up by 9.2% in 2010 and 8.8% in 2011, according to Turkstat data. When the reported growth rate peaked at 11% in the first quarter of 2011 (later revised up to 12.4%), the Wall Street Journal dubbed Turkey “Eurasia’s rising tiger”. However, the concern also arose that, like a tiger, Turkey’s economy might be good at short sprints but not endurance. Somewhat similar to China’s post-crisis policy, Turkey had used monetary policy and state banks to encourage a boom in private borrowing. Outstanding loans were growing at alarming rates, by 34% in 2010, and the current account deficit reached 10% of GDP in 2011.

A new central bank chairman appointed in April 2011, Erdem Başç›, set his sights on reining in the credit boom and bringing down the current account deficit. But as he was introducing a new monetary policy designed to better cope with loose global monetary conditions, market winds changed as a crisis on the EU’s periphery deepened and spread. Başç›’s efforts shifted to managing the slowdown as Turkey’s exports to the EU were hit hard. Growth fell sharply, to 2.2% in 2012, but Turkey’s performance was impressive given that much of emerging Europe fell into recession. Başç›’s monetary policy, derided in 2011 for being confusing, was lauded by the end of 2012 and credited with engineering a “soft landing” from the rapid growth of 2010-11 (see analysis).

The Banker magazine named Başç› “Central Bank Governor of the Year” in January 2013. “The central bank’s policies have been quite successful,” Cem Doğan, the chief economist at the Turkish Industry and Business Association (TÜSİAD), told OBG. “This is the first time that we have had a managed slowdown of growth in Turkey.”

Current Account Deficit Improves

The government also played a role in cooling the economy by hiking taxes on gasoline, luxury cars, new home purchases and cigarettes. The reduced demand did much to improve the current account deficit, as imports shrank by 2% in dollar terms in 2012 after growing by 30% in 2011. Moreover, exports remained positive, and were boosted by sales of gold to Iran in exchange for imports of natural gas. In sum the 2012 current account deficit was brought down to 6% of GDP.

This led ratings agency Fitch to upgrade Turkey to investment grade in November 2012. Some $30bn of portfolio investment flows poured into the country during the second half of that year. Yarkın Cebeci, the executive director at JP Morgan’s branch in Turkey, told OBG, “People have seen the resilience of the Turkish economy. When nearly all of Europe suffered a recession, we didn’t see much here. Now people are thinking that if Turkey was so successful in times of stress, in a better climate it will just fly.”

However, while overall growth remained positive in 2012 thanks to improved net exports and increased public spending, domestic private demand actually contracted in 2012. Domestic household consumption shrank by 0.7% in real terms, while private investment (or private gross fixed capital formation) shrank by 4.5%, according to Turkstat. As Nihan Ziya Erdem, an economist at Garanti Bank, told OBG, “When you look at total GDP, you see a soft landing. But in terms of domestic demand, it was a hard landing. That had a big impact on the current account deficit.”

Large capital flows into Turkey in late 2012 and early 2013 were also driven by increased monetary stimulus in the US and Japan. The latter’s was particularly aggressive, at twice the scale of the US stimulus relative to GDP. As Özgür Altuğ, chief economist at brokerage BGC Partners, said, “The talk is of a ‘Mrs Watanabe’ effect, meaning Japanese housewives are looking for somewhere they can earn yield on their savings and finding it in places like Turkey. However, it’s not just Japan that has loose monetary policies and carry trades. It’s practically all developed markets.”

Inflation, after hitting a low of 6.2% year-on-year (y-o-y) in December 2012, re-accelerated to 7.3% yo-y by March 2013. However, Başç›, the central bank governor, has made clear he will carefully manage credit expansion rates to head off any possible overheating. He has declared a target of 15% annual growth in lending, but clarified in April 2013 that the target was not an absolute ceiling. Y-o-y bank lending growth reached 19% in February 2013, according to the Banking Regulation and Supervision Agency. 

Central Bank Goals

The hallmark of Başç›’s policy is what he has called “the three fives”: targets of 5% real growth, 5% inflation and a 5% current account deficit. As with his 15% lending target, the three fives are long-term goals, not strict ceilings that imply immediate policy reaction whenever breached. Though there have been calls from some quarters of government for Başç› to loosen policy and pursue a higher rate of growth of around 6%, he appears to have the support of Erdoğan and certainly of the deputy prime minister for the economy, Ali Babacan. As Gizem Öztok Altınsaç, an economist at brokerage Garanti Yatırım, told OBG, “Babacan is completely supporting the central bank. What is different about the current economic management is that it is meant for the long term. The central bank’s policy stance isn’t just for the current situation. These policies will continue for years.”

While the central bank manages the current account deficit through monetary policy, the government has pursued reforms aimed at reducing the deficit over the long run by boosting domestic saving. As the World Bank said in a study published in 2011, Turkey’s domestic savings rates had declined sharply since the late 1990s, as a steep drop in private savings overwhelmed the government’s decreased borrowing. The World Bank estimated that Turkey would need to invest 25-30% of GDP to realise its economic potential, but noted that domestic savings had dropped to less than 15% of GDP. High current account deficits were compensating for low domestic savings, and that was not sustainable, the World Bank argued. This conclusion has broad support among domestic and foreign economists. As Erdem told OBG, “The most important issue for the Turkish economy is the low savings rate. Turkey needs to finance its trade, particularly energy imports. If we had a higher savings rate, we would have lower current account deficits. But it is not an easy thing to change.”

Explaining The Low Savings Rate

Economists see many reasons for low savings rates. One is that Turkey’s democratic society, open economy and Customs union with the EU ruled out many tactics used by some emerging market countries to boost savings, such as capital controls, restrictions on imports, mandatory exchange of foreign currency income and other types of so-called financial repression.

A second reason is simply the young age of the population, as people do most of their saving between middle age and retirement. A third is Turkey’s tradition of very high inflation, which taught people to spend money when they have it – a habit that seems to persist even as inflation has slowed dramatically in recent years. A fourth reason is the rapid rise in incomes since 2002, which makes savings from previous years less useful relative to current income, and so teaches people not to save. As a fifth reason, there has also been an improvement in the public health care system, lessening the need for precautionary savings.


Such psychological factors are hard to fight, so the government has looked for practical ways to encourage saving. The highlight of the effort is a reform of incentives given to individuals to invest in private pension funds (see Insurance chapter). Previously, following international practice, the government allowed payments into pension accounts to be deducted from taxable income, but due to widespread avoidance of income taxes, that incentive had limited reach. Beginning in January 2013, the government switched to offering matching payments of up to 25% of personal contributions to pension accounts, with certain limits and restrictions on early withdrawals.

The government also sees an underlying, much older reason for low domestic savings in the religiosity of a segment of Turkey’s population, who avoid regular banks due to Islam’s position against usury. The government has strongly encouraged the growth of a domestic Islamic banking sector, most recently by launching issues of sovereign sukuks, the Islamic equivalent of bonds, in 2012. The sukuk issues give domestic Islamic banks, termed “participation banks” locally, a safe and liquid investment option that they had long been missing from their portfolios (see Capital Markets chapter). Another tactic, also largely aimed at the religious, has been to permit banks to open deposit accounts denominated in gold. Because the accounts are covered by public deposit insurance, they provide additional protection to those who save and also bring gold into the financial system where it can be used to raise funds. Doğan of TÜSİAD told OBG, “The Turkish economy should maintain an investment rate of around 20% to 24% of GDP. To do that we need a savings rate of around 16% to 18%, which would leave a current account of 4-6% of GDP. So the government needs to add about 3-4 percentage points to the savings ratio. We believe that’s achievable given time.”

Rebounding Exports

Turkey appeared in early 2013 to be again demonstrating its resilience with a re- acceleration of merchandise exports, despite continued recession in Europe. Confirming the rebound, however, requires some sleuth work. Also, given the uncertain global economic climate, it was too early to judge if the rebound would be sustained. Getting a clear picture of trends in Turkey’s foreign trade has been complicated in recent years by the inclusion in official data of shipments of gold bullion, used to pay for natural gas imports from Iran due to international sanctions that block payments to Iran’s banks. Turkey mines little gold, so to make these payments, it simply imported and re-exported gold. Due to the effects of these bullion shipments, which peaked in 2012, official data seemed to show a mild slowdown of merchandise exports in 2012 continuing into early 2013. Excluding bullion, however, Turkey’s merchandise exports actually slowed sharply in 2012. Total merchandise exports except gold bullion grew by 4.3% in dollar terms in 2012, down from 19.3% growth in 2011, according to Turkstat data. That was about in line with expectations, given slowing global trade growth and recession in the EU, Turkey’s main export partner. Excluding bullion, total merchandise exports re-accelerated in early 2013, growing 7.2% in the first two months of the year over the same months of 2012. Turkey’s industrial production also showed a mild acceleration starting in late 2012.

Remarkably, the export rebound in early 2013 was driven by exports to Europe, despite no sign of a letup in the EU’s recession. Merchandise exports to the EU were up 6.2% in the first two months of 2013 over the same months of the previous year, even while the EU’s total merchandise imports from outside the union shrank by 4.5%, according to Eurostat. A sustained rebound in exports to Europe would be an important turnaround. Exports to the EU were a key driver of growth until 2007. Merchandise exports to the EU’s current 27 members grew from €16bn in 1999 to €47bn in 2007, while Turkey’s share in the region’s merchandise imports, excluding its internal trade, grew from 2.1% to 3.3%. In the years since, however, Turkey’s share of EU merchandise imports has declined, to 2.7% in 2012, due mainly to high exposure to the southern European countries that have been hardest hit. Merchandise exports to the EU in 2012 at €48bn were little changed from 2007.

Not Missing Sarkozy

While the economic news from Europe has been grim, a recent political change there has been in Turkey’s favour. The defeat of Nicolas Sarkozy in France’s 2012 presidential election removed Europe’s leading opponent of Turkey’s bid for EU membership. The bid had been stalled for years due largely to Sarkozy’s resistance, and partly because Erdoğan took umbrage and reacted by putting the bid on the backburner. As Murat Üçer, an advisor to Global Source Partners, told OBG, “They didn’t want us, and we didn’t think we needed them anymore. I personally think EU accession is a must. Turkey needs the institutional anchors of Europe.”

The new French president, François Hollande, lifted some formal objections that had frozen Turkey’s accession process, opening the way for talks to be renewed. Although no one expected quick progress, the improved climate was welcomed by members of Istanbul’s business community. There was also some hope that fortune could smile on Germany’s Social Democrats in that country’s general elections due late in 2013. The Social Democrats are more favourable to Turkey’s EU bid than Angela Merkel and her ruling Christian Democrats. “The process of EU accession is itself important, in terms of transforming the economy and society,” Doğan of TÜSİAD told OBG. “The Customs union has been quite effective in reshaping the Turkish economy.” Similarly, JP Morgan’s Cebeci said, “One thing we don’t put into our forecasts is the possibility of EU accession. If it happens, that could lead to some significant additional catch-up growth.”

Re-Balacing Trade

While the EU will likely always be its main export market, Turkey has been diversifying its exports to other regions. The EU’s share of merchandise exports, excluding gold bullion, dropped from 56% in 2007 to 42% in 2012, according to Turkstat. Diversification got under way much earlier, when the current, moderately Islamist ruling party came to power in 2002. Since then, the government has worked intensively on building up long-neglected relations with Muslim neighbours to the south and east.

The policy came at a fortuitous time, when rocketing oil prices were making many of Turkey’s Muslim neighbours vastly wealthier. The benefits in terms of higher levels of exports have been impressive. In 2002, Turkey exported $4.7bn of merchandise to the Middle East, South Caucasus and North Africa, representing 13% of merchandise exports. In 2012, excluding gold bullion, Turkey exported $41bn of merchandise to those regions, or 29% of total merchandise exports.

The Middle East and North Africa of course remain troubled regions. Iran, the Middle East’s second-largest economy, is under international sanctions over its nuclear programme. The Arab Spring of protests against authoritarian regimes has so far been an economic setback, as Egypt’s new leadership has failed to turn around a collapsing economy and Syria has descended into civil war. Turkey’s exports to Egypt appeared to be weakening in the first two months of 2013. However, trade with Libya recovered to reach new peaks in 2012 after that country’s war in 2011, giving some hope that trade with Syria could similarly rebound when peace is restored there.

The six Gulf Cooperation Council countries have become important trade partners, accounting for 6% of Turkey’s merchandise exports during 2012, excluding gold bullion. Egypt and Azerbaijan are also notable markets, taking 3% and 2% shares of merchandise exports, respectively. But the greatest success story of the past decade in Turkish trade has been, to the surprise of many, Iraq, which accounted for 8% of merchandise exports in 2012, making it the second-biggest market for exports after Germany.

Kurdish Relations

The bulk of trade in Iraq is with the ethnic Kurdish region, which has emerged since the US-Iraq war in 2003 as that country’s wealthiest and most secure region. The Kurdish region is eager to cooperate with Turkey, largely due to its poor relations with the central government in Baghdad. Turkey’s burgeoning relationship with Iraq’s Kurds is helping redraw the Middle East’s geopolitical map and helping to drive an historic albeit tentative peace agreement between Turkey and the outlawed Kurdistan Workers’ Party (see analysis). The resolution process is seen as a potentially enormous game-changer for Turkey’s domestic economic and democratic development. The benefits of trade with northern Iraq also could be great, but that relationship poses the risk of drawing the country into a conflict with the Iraqi central government in Baghdad.

Iranian Gas For Goods

A further tightening of US sanctions on Iran in February 2013 could force that country to import more goods from Turkey. Previously, sanctions blocked payments to Iran in international currencies, but Turkey was able to pay in lira, which intermediaries then exchanged for gold bullion and exported to Iran, sometimes via third countries. Under the tighter sanctions regime, Turkey should pay Iran only with lira deposits in a Turkish bank, and that bank should only release the funds for purchases of qualified consumer goods. Those rules were negotiated as part of the renewal of a waiver the US government gave Turkey condoning its imports of Iranian gas. The intention of the tighter rules on payments is to deprive Iran’s leaders of fungible assets by forcing them to trade gas for consumer goods, similar to the “oil for food” sanctions regime imposed on Iraq in the 1990s.

There was no data available as of April 2013 to confirm that the new sanctions regime was working, but its potential to boost exports was considerable. Turkey does not publish full details of its energy imports, but it imported at least $10.7bn of gas, oil and oil products from Iran in 2012 (likely to be nearly all gas), according to Turkstat. Turkey exported $3.4bn of goods to Iran in 2012 plus $6.5bn of gold bullion. If, for example, it instead sold $6.5bn of additional goods to Iran in a year, that could add about 0.8% to GDP.


As of April 2013 the near-term economic outlook remained uncertain. Recession was continuing in Europe, and an anticipated revival of growth in the US and China had yet to show up. However, according to Üçer, a weak China could have an upside for Turkey. “As long as sentiment is broadly positive, a slowdown in China isn’t that negative for Turkey. We could even get some benefit from lower commodity prices,” he told OBG. Meanwhile, Altuğ said that he expected looser policies in Turkey. “The government will be pro-growth going forward,” he told OBG. “The prime minister wants to become the next president. To do that, the country has to create jobs. The economy needs to create 700,000 jobs a year just to keep a stable unemployment rate.” In the longer run, the balance of risks appears to be in Turkey’s favour. The opportunities for improvements and growth across the Middle East, including in Turkey’s neglected southeast, outweigh the potential for existing crises there to worsen or new ones to erupt. Although Europe appeared unlikely to rebound soon, it will eventually.

Meanwhile, emerging markets will increasingly drive global growth with trade among themselves. Turkey’s open economy model might miss some short-term gains by eschewing such tactics as export subsidies and import restrictions, but that restraint has also made it into one of the more competitive emerging markets, demonstrated by its high average growth rates combined with relatively high incomes.

Turkey needs to be wary of falling into the “middle-income trap”, though there is no good evidence that countries in its income bracket are especially prone to severe slowdowns. With developed markets providing little growth impetus to the global economy, Turkey will have to compete for export markets against mostly lower-income countries. To thrive, an approach more like those of Korea, Taiwan and traditional developing markets may be called for, which would entail building respected international brands and concentrations of innovative businesses. “Our labour costs are going up and that’s a problem for exporters. Our companies need to create their own brands and invest in R&D and advertising,” Kaplan told OBG.

Staying competitive will likely require reforms to the country’s labour rules, which guarantee generous severance payments to laid-off employees but are often circumvented by the hiring of unofficial labour. “We have rigidities in the labour market, especially over severance payments. Unregistered employment is around 35% of the labour force. The ratio is highest in agriculture, and also high in services and construction,” said Doğan. It will likely also require bringing more women into the workforce. Only 29% of Turkish women were employed in January 2013, compared to 70% of men. Having a small labour force relative to the size of the population has made the economy highly sensitive to inflationary impulses. As Erdem told OBG, “To avoid the middle-income trap, Turkey will have to increase female participation.”

It is also important for the Turkish labour market to recognise and properly regulate temporary agency work, a move which would likely create jobs and help reduce the informal sector. This reasoning, together with a need to provide agency workers with job security and guarantee them reasonable working conditions, has been the basis of frameworks such as the International Labour Organisation Convention 181 (1997) and the EU Agency Work Directive (2008).“It is key that the government and parliament pass the draft law on temporary agency work that has been under discussion for several years. The Turkish Employers’ Federation, as well as our sector’s federation, the Private Employment Agencies Association, are in favour of implementing the new law,” E ğ rio ğ lu said. Üçer spoke more broadly to the issues of the labour market and further investments in education and training. “The next 10 years will be quite a bit more challenging than the last. Turkey has to work hard on its human capital. That glass is both half-empty and half-full. This is not a particularly cheap labour environment or an especially well-educated one. However, it is a very hopeful spot in a very troubled world.”