1. IKV Meeting, Istanbul: February 24, 2012 EZ’s ‘Identity’ Crisis and Its Impact on the Turkish Economy Murat Üçer

2. Slide # 2 Main Points  With LTRO and Greek PSI, EZ got some more breathing space.  But real adjustment issues are daunting.  Turkey is tightly wired to the EU/EZ.  It should make contingency plans taking into account the fact that deepening of EZ problems would not hit Turkey through external demand (trade/growth) alone, but also through availability of external financing.  We saw this happen last year.

3. Slide # 3 EZ Adjustment Economics 101  Financing does not solve problems, it buys time…  At a real level, EZ has simultaneously:  a public debt sustainability problem. So it’s premature to call the end of the Greek problem and further contagion.  an external imbalances problem. So competitiveness gaps between north and south have to be mended  Neither of these is easy to resolve…  An extra complication: Monetary financing the ECB is doing these days comes with no ‘conditionality’ to EZ as a whole, which may remove incentives to formulate a tighter fiscal framework (Fiscal Union?) in the long run.

4. Slide # 4 The Debt Sustainability Problem: Figures Source: IMF, Fiscal Monitor

5. Slide # 5 The Debt Sustainability Problem: Basic Math Change in Debt/GDP [∆(D/Y)] < 0 ∆ in Debt = Primary Deficit + Interest Payments ∆ in GDP = Growth + Inflation So ∆ in Debt < ∆ in GDP after a little math we get: (Interest Rate–Growth) x D/Y < Primary Balance For this equation to work Greece has to:  Reduce D/Y to some negligible level  Reduce r, increase g and move pb>0 permanently… Even after a painful PSI, we are nowhere there yet…

6. Slide # 6 The External Imbalances Problem: Figures Source: WEO, our calculations Source: Krugman blog, NYT

7. Slide # 7 The External Imbalances Problem: Basic Math Remember Y = C+I+G+X-M? Y = Domestic Demand (A or C+I+G) + Foreign Demand (X–M) When A > Y  Current Account Deficit  Financing/Change in Net External Position When this is no longer feasible, the country has to: 1) Cut A through tighter policies notably fiscal adjustment (G↓) (‘internal devaluation’); and/or 2) Depreciate the currency to reduce wages in foreign currency terms and hence, switch the composition of demand (‘rebalance’) from A to NX (‘external devaluation’)

8. Slide # 8 External Imbalances Problem: Basic Math Recall that for a country to gain ‘competitiveness’, the following has to hold: ΔP*/P* ≥ ΔW/W - Δ[Y/L]/[Y/L] - ΔE/E whereP* = Foreign price of the commodity W = Nominal wage in local currency Y/L = Productivity (output per labor) E = Local currency price of a unit of foreign currency Since ΔE/E = 0; we need wage deflation and productivity increase…. Both take time and are politically very, very difficult...

9. Slide # 9 Competitiveness Problem: Figures Source: http://www.voxeu.org/index.php?q=node/7536http://www.voxeu.org/index.php?q=node/7536 Unit labour costs in selected EU nations

10. Slide # 10 Turkey and the EU/EZ  We have very strong links  In trade and tourism  Despite the recent diversification, some 45% of Turkish exports still go to EU  In finance  Some 80% of our MLT debt is to European Banks  Some 80% of FDI has come from EU  More broadly, negative confidence and bank implosion effects -- if EZ problems deepen -- would be very significant because for growth, we need others’ savings.

11. Slide # 11 Some export diversification, but still…

12. Slide # 12 Likewise with FDI…

13. Slide # 13 Bank deleveraging has started in Q3 Source: BIS; BIS banks assets and liabilities vis-à-vis Turkish residents.

14. Slide # 14 Turkey’s growing CAD is a challenge…

15. Slide # 15 Growth and inflows are highly correlated

16. Slide # 16 What Should We Do?  I don’t know…  But at least:  Be prepared, avoid complacency, do not assume that problems are gone…  Conduct a detailed scenario analysis and formulate a Plan B…  Try to diversify (exports, FDI, etc.) as much as possible through public-private partnerships…  Save (fiscally) for the rainy days…

17. Copyright 2009 GlobalSource Partners. All rights reserved. This presentation and its corresponding research reports are prepared for the use of GlobalSource Partners clients and may not be redistributed, reproduced, stored in a retrieval system, retransmitted or disclosed, in whole or in part, or in any form or manner, without the express written consent of GlobalSource Partners. The research report is distributed via email and simultaneously posted to this website and other portals by GlobalSource Partners. The information herein was obtained from various sources and is believed to be reliable but GlobalSource Partners does not warrant its completeness or accuracy. Neither GlobalSource Partners nor any officer or employee accepts any liability whatsoever for any direct, indirect or consequential damages or losses rising from any use of this report or its contents. 708 Third Avenue 18 th Floor, Suite 1801 New York, NY 10017 info@globalsourcepartners.com www.globalsourcepartners.com + 1 (212) 317.8015 Phone + 1 (212) 317.8318 Fax GlobalSource Partners Tepecik Yolu, Devran Apt. 1/18, Etiler Istanbul, Turkey Murat Üçer murat@turkeydatamonitor.com murat@istanbulanalytics.com 90 212 352-1270 Phone 90 212 352-4520 Ucer-Mizrahi Info Systems