Turkey has a metronomic relationship with Europe and the EU on one side, Russia on the other. President Recep Tayyip Erdogan’s heavy-handed response to an attempted coup in July brought gales of criticism from the west, encouraging him to patch up a previously tense relationship with his eastern neighbour. Better relations with Russia might improve its current account deficit. They will not remedy its lack of competitiveness.

Russian trade matters to Turkey, in particular through its dependence on Russia for energy. Tourism is important too, providing a fifth of Turkey’s current income overall. In 2014 more visitors came from Russia than anywhere else, but after Turkey downed a Russian warplane, a breakdown in relations between the two countries staunched the flow of arrivals. By June tourist receipts had collapsed more than 40 per cent year on year. By the end of 2016, visitors from Russia will have collapsed by 90 per cent, while those from countries such as Germany and the UK have fallen too, as a result of security fears.

Markets had largely looked the other way since the crackdown. Not now. Last week, Moody’s downgraded the country’s debt to Baa2, below investment grade, sparking a sell-off on Monday. The Turkish lira has steadily depreciated for years. It is a trend that has done nothing to help Turkey’s current account, generating neither more exports nor more foreign investment. Turkey received the same proportion of foreign direct investment to GDP as Russia did in 2014, about 20 per cent, and about half as much as Poland. Turkish workers look expensive, in terms of unit labour cost, compared with other emerging economies with similar credit ratings such as India, South Africa and Indonesia.

Turkey has definitely lost whatever rhythm it may have had. The stock market fell 4 per cent on the day of the downgrade. Local listed banks, vulnerable to any threatened rise in borrowing costs, suffered even more. JPMorgan’s decision on Monday to remove Turkey from its investment grade bond indices will not make matters any better. While some Russian tourists may well return next year if relations improve, Turkey’s security issues coupled with its lack of competitiveness will not be fixed any time soon.

Email the Lex team at lex@ft.com



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