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Special Report | February 20182
Going forward, if high frequency indicators, such industrial production and retail sales are
anything to go by (see Chart 2), the growth outturn for the final quarter of 2017 should remain
strong, though there is the likelihood that it will start to be adversely affected due to
unfavourable base effects and the expiry of some of the stimulus measures introduced in the
aftermath of the failed coup attempt. Despite this, we envision full year growth in 2017 coming
in at north of 6%, a figure which, if realised, will be well above the previous year’s outturn of
3.2%. For 2018, our sense is that growth is likely to moderate somewhat and come in to the
tune of around 4%. Of note here is that the government will not want growth to fall much less
than the aforementioned figure for fear that it will adversely impact its electoral popularity at the
forthcoming elections in 2019.
…Thanks to a range of initiatives introduced on the part of the authorities…
Mindful of the likely negative impact of the failed military coup on the Turkish economy –
through confidence and related channels – the Turkish authorities sought to backstop growth
through a number of measures:
 On the fiscal side, the government instigated a major reduction of value-added tax on white
goods (kitchen appliances) and on furniture1
. This helped to cushion consumer spending
and private consumption more broadly, as Chart 1 appears to bear out.
 Beyond traditional fiscal measures, the government also took steps to set up a TRY250bn
(~US$65bn) Credit Guarantee Fund (CGF). This, in our mind, was perhaps the most
significant step taken by the government and was set up to encourage local banks to lend
to small and mid-sized businesses by offering partial Treasury guarantees on any non-
performing loans at up to 7% of all loans.
1
Consumption taxes on air conditioners, refrigerators, washing machines, dish washers, vacuum cleaners and some small home appliances
were reduced from 6.7% to zero. Elsewhere, VAT on wood, plastic and office furniture was also decreased to 8%.
(Source) Turkstat, BTMU (Source) Macrobond, BTMU
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Chart 1:CompositionofTurkish GDPgrowth has
broadened...
Private Cons.
GFCF
Gov. Cons.
Net exports
Change in inventory
Headline GDP (%)
(Contribution, percentage points)
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-3
0
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Jan/12
Jan/13
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Chart 2:...While highfrequency indicators appearto
suggest that growth will continue to remainrobust
Retail Sales (3m MA,%y/y) IndustialProduction (3mMA, %y/y)

 On the monetary policy front, while there was little scope to cut rates to support the
economy – thanks a weakening exchange rate and headline inflation running well above
the Central Bank of Turkey’s (CBRT) target of around 5% – this did not prevent the CBRT
from providing unlimited liquidity to the banking system. Additionally, macro-prudential rules
have been relaxed so that, among other things, those borrowing in the form of unsecured
credit have seen their repayment periods extended.
While it’s difficult to disaggregate the impact of these measures on Turkey’s recent growth
performance, it’s fair to say that, taken together, they’ve played a vital role in reviving
confidence in the Turkish economy. Indeed, on the back of such measures, key industrial
activity indicators have rebounded after the failed coup attempt (see Chart 3). Additionally, by
standing behind the banking system through the provision of unlimited liquidity, there was no
run on the Turkish banking system, while at the same time a potential “credit crunch” scenario
was avoided. Indeed, since H2-2016 credit flows to the “real economy” have picked noticeably
and presently stand at 20% plus in annual terms even on a foreign currency-adjusted basis
(see Chart 4). While this is indicative of the buoyancy of Turkey’s current credit-fuelled
recovery, the downside of all this is that by boosting domestic demand – and hence imports – it
will serve to perpetuate the underlying structural imbalances in the Turkish economy,
particularly in terms of its much talked-about current account deficit. Also, of note here is the
fact that the government’s efforts to engineer strong growth has come at the expense of higher
inflation. Indeed, at 11.9%, the latest CPI reading is well above the CBRT’s 5% target and
appears to be driven by higher food and fuel costs. More worryingly, at 11.8%, core CPI –
which strips out volatile items such as food and fuel – has reached the highest point since
2004, suggesting more broad-based inflationary pressures (see Chart 5). This, along with
ongoing downward pressure on the lira, in our minds warrants the need for higher interest
rates which – while they appear to be high on a nominal basis – in inflation-adjusted terms are
barely in positive territory2
. That said, our sense is that with the ongoing pressure on the CBRT
from the governing AKP party – including Mr. Erdogan himself – to, in fact, loosen monetary
this is likely to constrain its room to raise rates much further from current levels.
2
For the sake of simplicity, if we take the CBRT’s weighted average interest rate in nominal terms it stands at 12.25% but in real terms it only
amounts to 0.35%.

…But questions about sustainability continue to linger…
In essence, the measures taken by the Turkish authorities in the aftermath of the attempted
coup have worked in terms of supporting growth. But, despite this, there are still questions
about both the sustainability and quality of growth. This is based on the following reasoning:
 For one thing, over 85% of the TRY250bn CGF – which was an important driver of growth
through the course of this year – has now been used up. As a result, credit growth,
particularly to the corporate sector is set to slow going forward. This, in turn, is likely to be a
drag on investment spending looking ahead.
 While we welcome the fact that net exports have made a positive contribution to growth
recently, this can perhaps be attributed to temporary factors, such as the declining value of
(Source) Macrobond, BTMU *Adjustment made on the basis that 90% of CGF related lending is in TRY, while 10%
in FX. (Source) Macrobond, BTMU
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Chart 3: Industrial activity indicators have rebounded
sharply after the failed coup attempt...
Capacity utilisation rate (RHS, %) PMI (LHS)
(Total loan growth, % y/y)
0
10
20
30
40
50
Jan/12
Jan/13
Jan/14
Jan/15
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Jan/17
Chart4: Thanks in large part to the strong creditimpulse
FX denominated Total (FX adjusted)* Total (TRY)
(Loan growth, % y/y)
(Source) Macrobond, BTMU
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4
6
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Jan/12
Jan/13
Jan/14
Jan/15
Jan/16
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Chart 5: Inflationary pressure have itensified and not just at the
headline level
CPI Core CPI
(%, y/y)
CBRT target

the Turkish lira, which is likely to have made the country’s exports more price competitive
abroad. Also, on the external front, our sense is that import growth is likely to accelerate in
H2 on the back of strong domestic demand, so the positive contribution of net exports –
which reached 1.7pp in Q2 – is set to fade. In terms of 2018, our sense is that this negative
bias on net exports may lessen somewhat because of the likely deceleration of domestic
demand, which could crimp demand for imported goods. This is based on two key factors: i)
the expiry of some of the stimulus measures alluded to above; and ii) the lagged impact of
the Turkish lira’s recent depreciation, which will make the cost of imported goods coming
into the country more expensive.
 Even though Turkey’s public debt stock is low, at under 30% of GDP, the current pace of
fiscal stimulus – which pushed the budget deficit from 1.1% of GDP in December 2016 to
2.1% of GDP in August (see Chart 6) – needs to be closely monitored. Adding to these
worries is the fact that investors in Turkish debt have become unnerved recently as result of
the country’s deteriorating relations with its key allies, namely the US and EU. This, in turn,
has had the effect of putting pressure on the lira, while yields on the country’s benchmark
10-year government bonds have risen by more than 100bps since early October, to a post-
crises high of over 12% (see Chart 7). If sustained, this could likely add to country’s
borrowing costs and, ultimately, undermine its fiscal flexibility, at least, at the margin.
…As a myriad of challenges still confront the country
External vulnerability
The most obvious challenge that Turkey faces today is its gapping current account deficit.
While this has fallen from a peak of around 10% of GDP at the start of this decade to a figure
in the region of 4% today, it still remains an area of concern. This is especially true given the
fact that it is largely being financed by volatile portfolio flows rather than foreign direct
investment (FDI), which tends to be more durable in nature. Central to this problem is the fact
that Turkey’s saving rate is too low relative to its investment outlays (see Chart 8). Thus, to
(Source) Macrobond, BTMU (Source) Macrobond, BTMU
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Chart 6:Turkey's fiscal metrics remain respectable...
Public debt(% of GDP, LHS) Budget balance (% of GDP, RHS)
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Jan/13
Jul/13
Jan/14
Jul/14
Jan/15
Jul/15
Jan/16
Jul/16
Jan/17
Jul/17
Chart 7:...But the uptick in bond yields suggest that the
markets remain wary
(10-year govt. bond yields, %)

plug this gap, the country resorts to borrowing from abroad. While in principle this should not
be a problem, the point to note is that such borrowing makes the country vulnerable to the
vagaries of changing market sentiment. Indeed, when the US Fed signalled in 2013 that it was
looking to pare down its quantitative easing or asset purchase programme, bond yields in the
US rose sharply and portfolio capital started to flow out of emerging markets. The currencies of
most EMs came under downward pressure at the time, but the lira came under particular line
of fire due to the country’s outsized current account deficit. Between May 2013 – when this so-
called “taper tantrum” saga started – to the end of 2015, the currency lost around 40% of its
value vis-a-vis the US dollar. The lira came in for another bout of punishment after the failed
coup attempt last July and is down some 50% or so since May 2013.
Against this backdrop, our sense is that Turkey needs to do a number of things to reduce its
external vulnerability:
 The country needs to reduce its reliance on imported fuel and energy, which accounts for
something like two thirds of the country’s current account deficit. To this end, it needs to
instigate measures that would aid the development of alternative or renewable energy
sources, including nuclear and solar power projects. While there’s a lot of interest on the
part of the Turkish authorities in such projects, it is important to highlight they’re very
capital-intensive in nature and, for this reason, have been rather slow to take-off.
Notwithstanding this, the role of alternative energy as a whole is set to rise in Turkey over
time – and if the consultation document entitled “National Renewable Energy Action Plan
for Turkey”3
is any guide it’s expected to jump from around 17% presently to around 20% in
2020. Also, of note here is that with economic growth – which is one of the key drivers of
energy demand – set to continue at a decent pace over the next three years (3.5% on
average according to the IMF) energy consumption is expected to closely following suit.
Indeed, we are of the view that on this assumption Turkey’s energy demand is expected to
jump from an estimated figure of 100.6m tonnes of oil equivalent (toe) presently to ~112m
toe in 2020.
3
This was published in December 2014.
(Source) World Bank, BTMU
0
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32
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
Chart 8: The mismatch between Turkey's investment &
savings position is central to it's external vulnerabilities
Gap (RHS) Gross investment Gross savings
(% of GDP)(% of GDP)

 Second, Turkey needs to improve the quality of the financing of its current account deficit.
In this regard, the country needs to improve its business environment as well as its
infrastructure base, both of which are often cited as vital in helping the country to attract
greater FDI inflows. In fact, the country has made reasonable strides in terms of the former,
with its latest ranking with respect to the World Bank’s Ease of Doing Business Index
climbing some nine places. However, at 60 (out of total of 190 countries), the country’s
current ranking still lags that of comparable EMs within Central and Eastern Europe, such
as, Poland and the Czech Republic, which rank 27 and 30 respectively.
 Third, the country needs to boost its savings rate which, at under 25% of GDP, is rather low
by EM standards4
. We expected this figure to remain broadly the same through to 2020 in
part thanks to Turkey’s young and growing population and its high propensity to consume.
While measures to encourage private individuals to save more is perhaps the most obvious
way to deal with this problem, another would be for the Turkish government to run a smaller
budget deficit, if not, a surplus. However, we don’t see this happening, for the time being at
least, given the fact that in the run-up to the 2019 presidential election the government will
be under pressure to ensure that growth remains robust. Elsewhere, measures could also
be taken to, for example, further develop the country’s capital markets which, over time,
would make it more attractive for Turkish companies borrow domestically rather than from
abroad.
While the priority areas we have identified above are not exactly new and – if anything –
amount to long-standing challenges, markets will be expecting to see much greater focus on
implementing such reforms, especially now that the political uncertainty associated with
constitutional referendum vote that was held earlier this April is out of the way. Additionally, it is
also worth pointing out that given the above measures are essentially structural in nature and
are accorded a high weighting by the rating agencies, some progress would need to be seen in
these areas for the country’s sovereign rating – which was downgraded to “junk” status in the
aftermath of attempted coup – to be upgraded back to investment grade territory (See Table 1).
Banking/Corporate sector risk
The Turkish banking system remains sound, as banks are liquid and well capitalised (see
Chart 9), while non-performing loans are generally low (about 3%). However, as noted above,
government policy aimed at stimulating credit growth is somewhat worrying, as there has been
a reversal of tighter regulations, which were originally put in place to prevent run-away credit
4
The top tier EMs, i.e. BRIC economies, average closer to 30% of GDP.
Current rating Previous rating Date of downgrade Current outlook
S&P BB BBB- 20-Jul-16 Negative
Moody's Ba1 Baa3 23-Sep-16 Negative
Fitch BB+ BBB- 27-Jan-17 Stable
(Source) Bloomberg, BTMU
Table 1: Turkey's recent sovereign rating action

growth. The loan to value ratio has been relaxed from 75% to 80% and government applies
suasion on banks to keep mortgage rates low despite rising funding costs. Against such a
backdrop, credit growth has exceeded the 15% ceiling previously considered by the CBRT to
healthy. The danger is that with loan growth as a whole currently running in excess of 20% it
could push up NPLs of the Turkish banking system going forward.
Also, of note here is the fact by lending to the corporate sector in the form of foreign currency
debt, banks are also indirectly vulnerable to currency risk. Total corporate debt at the end of
2016 stood at over 65% of GDP, a more than two-fold increase on the level seen in 2007 (see
Chart 10). This is particularly worrying given the fact that about 45% of this debt is
denominated in foreign currency. Turkish companies – particularly in the energy, construction
materials, steel, transport (airlines) and chemicals sectors – have extensively borrowed in
foreign currency from local banks. While there are mitigating factors at play, such as the fact
that two thirds of the loans are in sectors with natural hedges (e.g. via export revenues), the
point to note is that as foreign exchange assets only cover 40% of liabilities corporates run a
substantial currency risk. Most at risk are smaller firms with earnings mostly in local currency
that are not sufficiently hedged.
Labour market challenges
Elsewhere on the domestic front, productivity growth – which averaged 5% over the 2000-2007
period – slowed sharply to 1.4% over 2008-2015 according to OECD data. There have been
no meaningful education or labour market reforms in recent years. As result, Turkey continues
to register one of the highest youth unemployment rates among Central and Eastern European
countries, while in terms of female participation rates it does not fare much better either (see
Chart 11). While the latter issue is, in part, influenced by cultural factors, it is also important to
*This is indicative of whether banks have adequate high quality liquid assets (Source) BIS, BTMU
(HQLA) to survive stressed liquidity conditions over a 30-day period. This ratio
is calculated as follows: LCR = HQLAs/ Net cash outflows.**This is the
amount of ownership an individual or company has in an asset. Formula:
Total assets - total liabilities. (Source) BRSA, BTMU
0
5
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25
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120
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180
2009
2010
2011
2012
2013
2014
2015
2016
Sep-17
Chart 9: Key fundamentals of the Turkish banking
system remain sound...
Liquidity Coverage Ratio (%, LHS)* Owners Equity (US$bn,LHS)**
CAR(%,RHS)
11.3 18.2 17.7
29.9
44.8
67.9
39.9
35.8
28.6
0
20
40
60
80
100
120
2007 2012 2016
Chart 10:...But growing exposure to the
corporate sector could be troublesome going
forward
Credit to Govt. Credit to Firms Credit to Houselholds
(% of GDP)

highlight that it’s reflective of the failure of the education system to perhaps adequately equip
new entrants into the labour market with the requisite skills to succeed. Also, of note here is
the fact that labour market rigidities – for example in the form of strictness of employment
protectionism – remain at elevated levels in Turkey (see Chart 12).
Finally, Turkey’s slide in a number of governance indicators compiled by the World Bank
recently (including in the areas of voice and accountability, political instability, government
effectiveness, rule of law and control of corruption) suggest that the pace of institutional
reforms has also slowed.
Political concerns
Turkey has had to navigate many political challenges over the past year or so, not least the
failed coup attempt and the constitutional referendum vote on the creation of an executive
presidency. Notwithstanding this, political risk in the country still remains at an elevated level
thanks to following factors:
 For one thing, the purge Mr. Erdogan instigated in the aftermath of the coup attempt
against the followers of the exiled religious cleric Fethullah Gulen – who he and his
supporters claim were behind the putsch – continues to this day, leading some, to rightly
question, whether this may have gone too far.
 Related to the above point, Mr. Erdogan retains the power to rule by decree, which he
initially amassed following the aborted coup attempt. While such emergency powers served
a useful purpose in stemming the immediate crisis, their continuation leads us to the
inevitable conclusion that the checks and balances within the Turkish political system are
being eroded.
(Source) HDI, World Bank, BTMU *0-6 scale where 6 is the most restrictive. (Source) OECD, BTMU
0
10
20
30
40
50
60
Bulgaria Hungary Poland Czech
Rep.
Romania Turkey
Chart 11: Turkey's labour market indicators compare
poorly with its CEE peers...
Female participation rate (%) Youth unemployment (%)
0
0.5
1
1.5
2
2.5
3
3.5
Turkey Czech Rep. Poland Hungary
Chart 12:...Whilethe strictnessofits employment
protectionlegislation isalsomoreworrisome
(0‐6 scale)*

 Although the political noise associated with the constitutional referendum vote held this
Spring has abated, this by no means the end of the story as far as the proposed
constitutional changes are concerned. Indeed, the country is due to hold presidential
elections in 2019 which Mr. Erdogan will need to convincingly win in order to push ahead
with his aim to move towards an executive presidency. This, in turn, is likely to add to
continuing political uncertainty up to 2019 and perhaps even beyond if the outcome of this
election proves to be inconclusive. Aside from the political uncertainty associated with the
aforementioned presidential election, the fact that Turkey’s fragile Kurdish peace process
has broken down recently – with the separatist PKK declaring an end to its unilateral
ceasefire – will continue make the security situation in Turkey rather precarious as we
approach the end of this decade. This – along with Turkish army’s recent incursion into
northern parts of Syria that border Turkey to attack Kurdish separatist strongholds there –
we feel will also make the prospect of reprisal attacks on Turkish soil a potential likelihood
over this period.
 Finally, on the external front, the country also needs to reset relations with the EU and the
US, which have suffered a serious setback recently. With respect to the former group,
failure to do so could mean it could lose a vital anchor which, until recently, has helped the
country to benchmark its policies against EU member states. US-Turkish relations
meanwhile appear to have worsened since the arrival of Donald Trump at the helm of the
US presidency and we expect this tendency to persist going forward as the two countries
appear to be taking a differing stance on regional issues including Syria.
Concluding thoughts/look ahead
Turkey finds itself at a key juncture at the moment. While the economy has rebounded sharply
in the aftermath of the failed coup attempt, it’s not fully out of the woods yet. For one thing,
there are still lingering doubts about the sustainability of the current recovery, which has been
propped up by the government’s various stimulus measures, some of which are set to expire
as the year-end approaches. Elsewhere, measures to address the country’s external
vulnerabilities are still pending while, on the political front, a key event risk in the form of the
2019 presidential election still looms large. Against this backdrop, while we welcome the fact
that Turkey’s economy didn’t tank in the aftermath of the attempted coup, going forward our –
and – indeed the market’s – focus will very much be on whether the Turkish authorities will be
able to push through some of the key macro and structural reforms, which we’ve highlighted in
this report including, for example, boosting human capital, strengthening the business
environment, and improving the functioning of the labour market. Such measures, despite
being seen as of vital importance in helping the country to transition towards a more value-
added growth model over time, will in our minds struggle to gain traction thanks, in large part,
to the fact that forthcoming presidential elections are due to take place in Turkey in 2019 and
in the run-up to this event it’s highly unlikely that Mr. Erdogan will be willing to embrace painful
structural reforms which in the short-term at least are likely to temper growth and hence his
electoral popularity.
Set against this rather bleak backdrop for structural reforms and an economy which is currently
running beyond its current growth potential5
, while we expect Turkey to continue to “muddle
5
IMF’s estimate of Turkey potential GDP growth stands at slightly above 3%.

through”, our sense is that there will be a number of implications for the country looking ahead
over the short to medium-term:
 Current account implications – Turkey’s current deficit, which is viewed as its main Achilles
heel, will remain at an elevated levels of greater than 3% of GDP over the next couple of
years. While, in theory, this gap should improve somewhat through the course of next year
and, perhaps, beyond on the back of the predicted moderation in domestic demand, this in
our minds will be offset by the recent rebound in international oil and energy prices whose
imports, as we’ve alluded to above, account for around two-thirds of the country’s total
current account deficit. Going forward, our sense is that with oil prices expected to remain
within the US$60-70/barrel range or beyond in the period to 2020 this will not be helpful in
aiding the Turkish authorities desire to bring down the country’s underlying current account
deficit.
 Sovereign rating implications – Concerns over the financing of Turkey’s sizeable external
deficit, coupled with the reluctance on the part of the authorities there to tighten fiscal policy
in the run-up to the 2019 presidential election, will continue to weigh on Turkey’s sovereign
rating. Indeed, we expect its rating to remain in “junk” territory for the time being at least.
While our central view is that this rating will not be downgraded further, in the event that it
does it could certainly have the potential to negatively affect the value of its local currency
unit and/or bonds. This in turn could make the task of financing its current account deficit
even more difficult than it already is.
 Political developments & their likely implications – A final point worth noting here is that we
expect the recent political uncertainty in Turkey to persist going forward over the next two
years or so not only because of domestic political factors, such the forthcoming presidential
elections, but also due to the country’s strained relations with its key western allies, such as
the US. This, in our mind, will have a negative bearing on the country’s financial markets
and will, in particular, continue to undermine the performance of its local currency unit over
the short to medium-term. Also, should Mr. Erdogan win the 2019 presidential election with
a landslide majority – an outcome which will allow him to continue to go down the road of
an executive presidency with little checks and balances – there is a danger that this could
further undermine the quality as well as investors’ perception of Turkey’s institutional
strength.
The Bank of Tokyo-Mitsubishi UFJ, Ltd. (“BTMU”) is a limited liability stock company incorporated in Japan and registered in the Tokyo
Legal Affairs Bureau (company no. 0100-01-008846). BTMU’s head office is at 7-1 Marunouchi 2-Chome, Chiyoda-Ku, Tokyo 100-8388,
Japan. BTMU’s London branch is registered as a UK establishment in the UK register of companies (registered no. BR002013). BTMU is
authorised and regulated by the Japanese Financial Services Agency. BTMU’s London branch is authorised by the Prudential Regulation
Authority (FCA/PRA no. 139189) and subject to regulation by the Financial Conduct Authority and limited regulation by the Prudential
Regulation Authority. Details about the extent of BTMU London branch’s regulation by the Prudential Regulation Authority are available
from us on request.
This report shall not be construed as solicitation to take any action such as purchasing/selling/investing in financial market products. In
taking any action, each reader is requested to act on the basis of his or her own judgment. This report is based on information believed to
be reliable, but we do not guarantee, and do not accept any liability whatsoever for, its accuracy and we accept no liability whatsoever for
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