Economically, Turkey had a flying start this century and that is largely down to one man, Recep Tayyip Erdogan. Mr. Erdogan began his political career as capable mayor of Istanbul and became Turkey’s prime minister in 2003 after he founded a new party, the Justice and Development (AK) Party, two years earlier and won elections in a landslide victory in 2002. Since 2014, Mr. Erdogan is Turkey’s president, hitherto a ceremonial role but one that he desperately wants to change. Erdogan rebuilt Turkey’s economy after a financial crash in 2001. He supported sound macro-economic policies with the aim to attract foreign investments and lifted many government regulations, unleashing the economic power of Anatolia, the long-neglected hinterland of Turkey where most of his pious and industrious voters live. Gross national income per capital grew threefold from USD 3,800 in 2003 to USD 10,830 in 2014, according to the World Bank, whereas poverty declined to 1.6%. Turkey’s public debt pile, meanwhile, shriveled from 75% in 2002 to 35% as did the budget deficit, which since 2011 is below 3% (down from 10% in 2002).

Turkey’s economy has continued to defy gravity and is expected to grow by 3% to 4% this year, despite the negative geopolitical environment. Growth largely has been consumption-driven. For example, the government increased minimum wages (affecting about one-third of the working population) by 30% (!) in early 2016, whereas the influx of about 2.5 million Syrian refugees also stimulated demand. Furthermore, since 2008, fiscal and monetary policies have been accommodative. However, exports were hurt by armed conflicts in the region even though a depreciation of the lira against euro of 15% since early 2015 increased Turkey’s competitiveness (although this is partially undone by the increase in wages and despite wasteful use of international reserves to support the lira). This year, exports to Russia declined substantially after Russia imposed an import embargo pursuant a fall-out between Messrs. Erdogan and Putin. Tourism (Russians and others) is also falling due to terrorist attacks. Thus, Turkey’s current account balance remains in deficit by more than 4% this year, despite lower oil prices. This foreign-funded consumption-driven growth model is rather risky, as illustrated by the financial turmoil in mid-2013 when the Federal Reserve announced the end of QE and investors (wrongly) believed a rate hike to be imminent. Turkey needs to rebalance its economy and reduce its reliance on short-term foreign funding (running at about 22% of GDP). As is the case for most Emerging Markets, Turkey should implement structural reforms (cutting red tape being one of them) to improve productivity and competitiveness of its business sector (helping to boost exports) and actions to boost private savings (e.g. bolstering private pensions; Turkey’s savings rate is a very low 12.5%) and attract FDI. Further, the country should invest more in education, improving labour skills. Monetary policy should be tightened, as inflation is uncomfortably high (8%-ish), and the fiscal deficit should be reined in.

Although the Turkish economy has serious challenges, we believe these can be overcome. The main impediment is Mr. Erdogan himself. He has become autocratic over the last couple of years, increasingly using Islamic and nationalist rhetoric to rally his troops. In a push to transfer power to the presidency, Mr. Erdogan removed his prime minister, Ahmet Davutoglu, for a more compliant person. He reversed peace talks with the Kurds (PKK) and ratcheted up military actions against Kurdish groups in the south-east of the country with, at least in our view, the sole aim to win parliamentary elections in 2015 (the Kurds did themselves no favour by subsequently engaging in terrorist attacks, predictably pushing the electorate AK Party’s way). Erdogan regularly interferes with the rule of law and sets the agenda for the country’s central bank. It now seems that Erdogan only has his party’s and his own (family included) interests in sight, overturning his sensible policies when he came to power in the early 2000s.

The EU is partly to blame for the decaying political situation in Turkey. It should have embraced Turkey when Erdogan came to power but instead turned away when another self-interested politician, Nicolas Sarkozy, found it more convenient to play the anti-immigration card. Turks should immediately and unconditionally be granted visa-free travel (as is already the case for Albanians, Venezuelans and inhabitants from Vanuatu, amongst others); this should not be used as a bargaining chip. Instead of focusing on the Balkan or Ukraine, the EU should restart accession talks with Turkey in earnest. Yes, Turkey should strengthen its (independence of) institutions and the rule of law as a prerequisite to join the EU. When the Turkish electorate understand that they have a fair chance of joining the EU, they will ditch their Sultan…