Istanbul's huge construction projects in severe jeopardy due to jolting interest rate rises

Here is a long report by Today’s Zaman:

The central bank’s bold decision to increase the benchmark policy rates pushed the overall interest rates in the markets up as expected, and mortgage loans were no exception.
The least expensive monthly cost of a mortgage for a five-year term rose from 0.91 percent to 0.94 percent, whereas the highest rate climbed from 1.19 percent to 1.35 percent within the day following the central bank’s decision. In mid-summer last year, it was possible to borrow from the banks for house purchases at levels around 0.6 percent.

Economist Deniz Gökçek noted that interest rate increases always have an effect on the industries as well as on households, and the construction sector is no exception. An increase in the interest rates naturally sends mortgage loan rates up, and hence the cost of housing, leading to a sharp fall in the demand for houses. Gökçek sees no problem with asserting that the central bank has already been deliberately trying to lower the mortgage loan rate in the face of rising domestic consumption. “What really matters here is that the higher interest rates will adversely affect investors, who generally work on loans,” he said.

For Gökçek, the major problem with the increased loan rates will be seen on the employment side. Construction is a labor-intensive sector, responsible for a considerable portion of the total employment in the country. If investors decide to slow down, even halt further investment, the initial consequence will be seen in a sharp increase in unemployment rates, he pointed out.

The construction sector has been one of the engines of growth in the Turkish economy, and this role has, especially during the last decade, been particularly salient. As usual, governments pay utmost attention to construction because of its direct and indirect mutual influence on other sectors in a way that fuels and accelerates them, creating a synergy that reinvigorates the economy as a whole. It also accounts for a large portion of a country’s employment.

Although its share in the gross national product (GNP) is not very strong, which is about 5 percent in Turkey, the construction sector’s effects are amplified due to its ability to employ large numbers of people and its direct and indirect impact on other sectors.

As State Planning Office (DPT) figures show, the sector performed at an average of over 11 percent during the six years before the global economic crisis of 2008, driving the economy’s growth performance upwards. In both 2008 and 2009, the sector suffered the sharpest deceleration among other sectors with 8.1 percent and 16.1 percent, respectively. In 2008, the economy came to a grinding halt and the next year it hurtled down by as much as 5 percent. The construction sector bounced back in 2010, registering a growth rate of 17.1 percent and, reflecting this, overall economic performance also moved upwards, achieving growth of over 8 percent. Expectations have it that the sector will enjoy expansion by twice as much as the economy’s growth rate in 2013. But sector representatives see the same achievement as an unlikely possibility this year.

The construction sector’s biggest concern is ambiguities. Both investors and consumers want to see the future clearly ahead of making decisions. Association of İstanbul Construction Companies (İNDER) President Nazmi Durbakayım maintained in a statement last week that the construction sector is worse off in any case but that they prefer an interest rate increase to uncertainties stemming from extremely volatile exchange rates. “Another reason that directs us to this option is our experiences in 2004, because the mortgage rates were much higher than present levels and our sector enjoyed a period of high sales despite monthly interest rates of 1.7 percent,” he said.

Relishing the chance of having large capital inflows from abroad after the economic crisis made developed countries no longer seductive enough for the capital managers of colossal portfolio investment funds, Turkey’s Justice and Development Party (AK Party) government didn’t hesitate to funnel this fortune into feeding the appetite of the construction sector. This seemed a rational decision to the government, since buildings are a type of fixed capital investment for the private sector.

Yet construction investments are a double-edged sword. If they consume scarce resources to the detriment of industrial investments, which have the potential of producing more wealth by adding to the production capacity of the country, the construction sector becomes a burden on the economy, which, in times of deterioration in liquidity conditions, hampers economic growth, especially when there is a stubborn current account deficit (CAD).

This is likely happening in Turkey now. The Turkish economy has a CAD of over 7 percent per year. Its exports have been on the rise for many years, but the rate of increase in exports was a lot higher and the exports were extremely contingent on intermediary good imports.

With the unexpectedly high interest rate hike, the central bank kept the economy from the gallows; however, this is only a palliative remedy. The Turkish economy has been saved from sudden death but now it seems to have been doomed to painful crucifixion.

The necessity of implementing extraordinary measures in extraordinary times may explain the central bank’s shocking step to raise the key rates by 112 percent. But when conditions are extremely unusual and the atmosphere is dangerous, these bizarre solutions don’t necessarily do the trick. Turkey’s struggle to cope with a global nemesis may compare to the fight of a sea bass against a shark and David’s victory against Goliath is a very rare exception. Similarly, the central bank’s decision, although it totally outstripped expectations, was unable to raise the value of the lira.

Construction is not the backbone of the Turkish economy but since it makes a vital contribution to employment, it is one of the most critical sectors for not only the overall wellbeing of the economy but for its political repercussions. There is no better opposition to a government than unemployment.

“It is the economy, stupid!” was an effective election message that gave former US President Bill Clinton an upper hand in his campaign to unseat former President George H.W. Bush and it has evolved into a piece of global political wisdom. Ahead of a critical election cycle, this motto seems to reign again as the economy is on the edge of an abyss of stagflation, a worst-case scenario in which an economy stagnates while inflation keeps rising. And a stumble in the construction sector will only add insult to injury.

The lira’s demise, along with reversed capital flows from emerging markets to developed economies, may hamper the government’s ambitious construction plans. The government has advanced plans for the Kanal İstanbul project, which aims to dig a channel to the city’s north as an alternative to the Bosporus Strait; the third bridge across the Bosporus is halfway complete; and officials have made great efforts toward the construction of a new airport in İstanbul, to be the largest in Europe with a capacity of 150 million passengers a year. The government has put forward many other grand projects, all in the construction area. These were doable in the recent past, but the deterioration of market conditions, the lira’s fall and difficulty raising funds to finance these projects will likely hinder their construction.

Economist Uğur Gürses said these projects may not be finished on schedule because of adverse funding conditions and surging costs. The governme
nt had ordered local banks to provide funds for and contribute to the construction of the third bridge, but may not be able to do so again, as the banks are in a difficult position these days, he asserted. On the cost side, Gürses said the government and the companies planning ambitious construction projects that require more than $100 billion in total will likely have to make new cost assessments as the exchange rate evolves. “The lenders that may put money in these projects will now think 50 times before taking any step,” he said.