Market In Flux, But Growth To Be Maintained

BMI View: We forecast 5.3% real growth in the construction sector over 2014 and growth should remain buoyant over the short-term thanks to projects already under construction fuelling industry value. However, we highlight the downside risks this quarter with allegations of corruption within the construction industry adding to the financing headwinds the industry is facing in light of a major depreciation in the lira. As such investor confidence in the Turkish construction sector will deteriorate posing a threat to our longer-term forecasts, as this 'perfect storm' of social, political and macroeconomic headwinds is certainly going to keep international investors in the sidelines.

A corruption probe of unprecedented scale is underway in Turkey, which has seen the detention of dozens of bureaucrats and businessmen within or related to the construction industry with regards to accusations of corrupt practices during the tendering of contracts and the violation of zoning laws. The government's position on the scandal is that outside forces have orchestrated the corruption investigation in an attempt to weaken Prime Minister Erdogan ahead of elections in March and August and prevent progress on his flagship infrastructure projects.

Projects caught up in the probe are wide-ranging; from residential developments with the private owners of real estate firms involved with the country's public housing administration Toki, to the developers of both the third bridge over the Bosphorus and the planned third airport in Istanbul receiving judicial summons with regards to the awarding of contracts.

Market Risks Hit Score
Turkey Infrastructure Risk/Reward Ratings

Market In Flux, But Growth To Be Maintained

BMI View: We forecast 5.3% real growth in the construction sector over 2014 and growth should remain buoyant over the short-term thanks to projects already under construction fuelling industry value. However, we highlight the downside risks this quarter with allegations of corruption within the construction industry adding to the financing headwinds the industry is facing in light of a major depreciation in the lira. As such investor confidence in the Turkish construction sector will deteriorate posing a threat to our longer-term forecasts, as this 'perfect storm' of social, political and macroeconomic headwinds is certainly going to keep international investors in the sidelines.

A corruption probe of unprecedented scale is underway in Turkey, which has seen the detention of dozens of bureaucrats and businessmen within or related to the construction industry with regards to accusations of corrupt practices during the tendering of contracts and the violation of zoning laws. The government's position on the scandal is that outside forces have orchestrated the corruption investigation in an attempt to weaken Prime Minister Erdogan ahead of elections in March and August and prevent progress on his flagship infrastructure projects.

Projects caught up in the probe are wide-ranging; from residential developments with the private owners of real estate firms involved with the country's public housing administration Toki, to the developers of both the third bridge over the Bosphorus and the planned third airport in Istanbul receiving judicial summons with regards to the awarding of contracts.

While the ramifications of the scandal are still developing, what it does bring to the fore are the close ties between construction and politics in Turkey. This renewed emphasis on opacity within the industry will raise serious questions over the value of exposure to such risks for those international investors and construction players who had begun to see Turkish infrastructure assets as an attractive source of revenue since the country gained investment grade status in May 2013.

Indeed, in light of the allegations of illegitimate practices when tendering contracts, we have moved to reduce Turkey's Industry Risks score in our Infrastructure Risk Reward Ratings. Now scoring 5 out of 10 for the indicator "transparency of the tendering process", putting it on an equal footing with Russia, the downgrade represents serious doubts about the openness of the awarding of contracts in Turkey.

Market Risks Hit Score
Turkey Infrastructure Risk/Reward Ratings

We note that the judicial process surrounding the allegations of corruption remains in a state of flux, with hundreds of judges and prosecutors, as well as thousands of police officers, having been removed or reassigned since December, and local media widely reporting that newly installed police chiefs have refused to carry out a second wave of detentions despite formal judicial orders. The response of Prime Minister Recep Tayyip Erdogan has echoed his response to the Gezi Park protests in June 2013, furthering his image as a non-compromising leader with increasingly autocratic tendencies. Instead of addressing the issue of corruption, Erdogan has ramped up populist rhetoric, implicating a foreign-backed conspiracy, while portraying the investigations as a judicial coup against his government.

Whether or not Erdogan's characterisation of the probe holds any merit, his success in stifling the investigation via mass purges of state institutions and attempts to place the judiciary under direct control of the executive branch of government imply a worrying centralisation of power, damaging perceptions of Turkish institutions in the eyes of investors.

As such we expect short-term political risk to weigh heavily on the investment climate, and that Erdogan's latest moves will have negative long-term implications for foreign direct investment in Turkey's infrastructure market.

Given that the graft scandal is ongoing, we highlight important questions for the infrastructure market over 2014 and 2015:

  • Which contracts are to be investigated and how far will authorities look back when searching for instances of graft?

  • Will all contracts be put on hold or will certain companies be frozen out of bidding on new contracts?

  • To what extent will investors keep Turkish construction projects at arm's length and for how long?

Impact On Forecasts

We have upgraded our estimated forecasts for how much the industry grew over 2013. Data released by the Turkish Statistics office reinforces our view that the Turkish construction industry performed well over 2013 after growing by just 0.6% in 2012. Further supporting our view is general construction confidence increased over the year in comparison to 2012, according to data from the Turkish statistics authorities. Full year data for real growth in 2013 is not publically available at the time of writing, but over the first three quarters of the year real growth averaged 7.8% on the previous year.

Growth Over 2013 Despite Elevated Political Risks
Turkey Real Construction Growth, % change y-o-y

In light of the political tension over 2013 we moved to downgrade our forecasts last quarter, although it seems that Erdogan navigated the widespread protests, keeping their direct impact on construction activity limited. Nonetheless we expect that fourth quarter growth will have suffered as contractors postponed work to see how the protests played out and as such we expect final year real growth to fall more into line with our new 2013 estimated real growth rate of 6.5% y-o-y.

However, looking at the confidence in construction employment over the next three months and confidence in the size of order books indicators, it is evident that the market is worried over the coming impact of the combined effect of a summer of popular protest and now the corruption scandal - with a downturn in confidence witnessed in December 2013.

We currently forecast that 2014 will see real growth of 5.3% y-o-y. We do however highlight the downside risks to that forecast and indeed growth over the longer term as well. We do not expect that foreign investor confidence will return to the market until at least after the elections in March and August this year, and potentially even until after the general elections scheduled in 2015. This is especially true considering it is unlikely that the tendering process itself will not receive any attention in terms of review or reform until after the elections.

Dip In Confidence To Dent Growth
Turkish Construction Confidence

Macroeconomic conditions will also continue to drag on growth. The Turkish lira has suffered a major depreciation, and risks to the unit remain firmly weighted to the downside, as we believe the worst of the political infighting in the country has not yet passed, implying a further deterioration of the investment climate ahead. In the face of mounting policy uncertainty and rising US yields, project financing from domestic banks, who have been the main drivers of investment in construction projects to date, will subsequently become more expensive as Turkish banks are heavily reliant on international credit. Coupled with this financing picture, the government of Turkey forecasts a sharp decrease in capital expenditures beginning in 2014. As BMI's Country Risk team has highlighted for over 2013, private sector investment activity has been in contraction for much of the last half a year. Given higher funding costs and elevated financial and macroeconomic uncertainty, we do not expect stronger construction growth in 2014 than the previous year.

Buoyant Growth With Scandal Downsides
Construction Industry Value (US$bn), Real Growth (% Change year-on-year)

In terms of our longer-term forecasts, we are holding off from altering our view until the dust from the corruption scandal begins to settle. We highlight that 2015-2018 should still manage to maintain growth above 5% per annum, although most at risk will be the projects under Turkey's push towards greater privatisation, including the extensive use of the public-private partnership (PPP) model. With little confidence in whether contracts are being awarded openly, we highlight the downside risks for appetite for these long-commitment contracts.

Growth Across Construction
Residential and Non Residential Building, Transport Infrastructure and Energy and Utilities Infrastructure Industry Values (U$bn)
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