Turkey: investment grade, peace and FDI?

May 21, 2013

Turkey’s elevation to investment grade last week may or may not be a game changer for its stock and bond markets, but the country is really hoping for a boost to FDI – bricks-and-mortar foreign direct investment  into manufacturing or power generation. Its peace process with Kurdish separatists should help.

Speaking last week at Mitsubishi-UFJ’s annual Turkey conference, Finance Minister Mehmet Simsek cited data showing an average 2 percentage-point pick-up in FDI in the two years immediately after a country moves into investment grade.

Sticky, job-creating and not prone to sudden flight, FDI is the kind of investment that Turkey, with a massive balance of payments deficit, desperately needs. Turkey does worse than most other countries on the FDI front.  Its combined deficit of the current account and net FDI is around 5 percent, Commerzbank analysts note —  wider than most emerging market peers.

By itself, an investment grade rating may not lead to a surge in FDI.  But Turkey has an ace up its sleeve. Having fought a deadly three-decade war against Kurdish separatists, Ankara has managed to negotiate a withdrawal of PKK militants from Turkey to bases in Iraqi Kurdistan. That peace gambit, if successful, has the potential to transform the impoverished Turkish provinces that border the Kurdish areas.

Simsek told the conference:

The reconciliation process has boosted morale and interest in investment in southern and eastern Turkey has gone up five- and 10-fold. The regional development gap is going to be one of the main engines of growth in the next decade of two. Convergence between the regions of Turkey will be key.

The Kurdish conflict has led to 40,000 deaths.  In material terms, the cost to Turkey has been $350 billion, Simsek estimates. Indirectly though, the cost is more like $1 trillion, he reckons, referring to lost investments and livelihoods in these regions.  That, according to Simsek, would have paid for 3 million classrooms or 10,000 km of high speed rail lines. It should also cut spending on the army — the second biggest within the NATO bloc after the United States.

While it is hard to quantify how much FDI may flow to Turkey as a result of the withdrawal, there is potential. Both labour and land costs in Turkey’s southeast are far cheaper than in the western provinces nearer to Europe.  The government plans to grant tax breaks to companies setting up business in the border provinces, with exports to oil-rich Iraq an inducement, Simsek said:

We export $11 billion worth of goods to Iraq and 80 percent of this  goes to Kurdish regions. When these regions develop there will a huge further advantage for Turkey…there will be an absolute boom in investment.

Part of the prize is cheaper oil and gas (Turkey’s biggest import). Turkey is a customer and a transportation outlet for oil exports from the Kurdish region but Ankara recently joined the Kurdistan regional government and Exxon Mobil to explore for oil in northern Iraq.  Most pipeline projects in the region are dogged by high insurance costs because of the ever-present risk of conflict. If that eases, Turkey could reap an investment bonanza.

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