Possible Implications of Russia's Sanctions on Turkish Economy

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1 Possible Implications of Russia's Sanctions on Turkish Economy December 2015 Eren Demir Assistant Economist Economic Research Division

2 1 After a Russian warplane violated Turkish airspace near the Syrian border on 24 November 2015, Turkey downed the Russian plane in line with the military rules of engagement. This development seems to have significant implications for the two countries bilateral economic relations. Indeed, Russia has announced a package of economic sanctions against Turkey. The sanctions are listed as follows: - Restricting imports of some Turkish agricultural products as of January 1, 2016, - Terminating chartered flights from Russia to Turkey, - Calling for Russian tourism companies to stop selling vacation packages that include a stay in Turkey, - Restricting Russian companies to hire Turkish staff starting January 1, 2016 and - Suspending the visa-free arrangement for Turkish nationals from January 1, Taking into consideration the ongoing weakness in Russian economy, the sanctions seem to contribute to a worsening of the already deteriorated economic relations between the two countries. According to the IMF estimates, Russian economy is expected to contract by 3.8% in 2015 and %0.6 in 2016 due to the plunge in oil prices and sanctions imposed by the US and EU over Ukraine crisis. The 12-month cumulative annual trade volume between Turkey and Russia dropped from 31 billion USD in 2014 to 25.5 billion USD as of October Energy trade has long been the largest component of overall trade. Turkey imports almost all of its natural gas needs from abroad, 60% of which is imported from Russia. Therefore, the volume of imports from Russia largely depends on the level of energy prices. Accordingly, as the amount of imports from Russia declined throughout 2015 in line with the sliding oil prices, Russia dropped from the first place in 2014 to the third place in October 1 in Turkey s total imports. Amounting to nearly 6 billion USD in 2014, the exports to Russia consisted mainly of fruits and vegetables, textile products and automobiles. Having ranked 7 th among the Turkey s top export markets in 2014, Russia was placed 11 th as of October owing to the slowdown in Russian economy. Despite the relatively low share received by Russia in Turkey s total exports, Russia has been a key market especially for agriculture and textile sectors. Foreign Trade (million USD) (million USD) Exports to Russia 5,943 3,992 Imports from Russia 25,289 21,521 % share % share Rank 7 11 Rank 1 3 Top 3 Export Items Top 3 Import Items Fruits and Vegetables 1,043 1,030 Oil and natural-gas 16,459 12,681 % share % share Textile Products Iron and Steel 1,651 2,138 % share % share Motor Vehicles Other Metals 1,450 1,174 % share % share Source: Turkstat The importance of Russian market for Turkish exporters increases when the shuttle trade revenues are taken into account. Particularly, shuttle trade has been a significant source of revenue for domestic leather, textile 1 12-month cumulative figures as of October 2015

3 2 and garment sectors. According to a research conducted by the Central Bank of Turkey, 49% of Turkey s shuttle trade revenues came from Russia during period. Given the 8.6 billion USD total shuttle trade revenues of Turkey in 2014, it is calculated that Russia accounted for 4.2 billion USD. However, shuttle trade revenues fell by 33.9% yoy in the first 9 months of 2015 in tandem with the economic downturn in countries like Russia and Ukraine. Tourism (thousand) Number of Foreign Tourists 33,827 35,850 35,832 Number of Russian Tourists 4,269 4,482 3,655 % share Tourism Revenues (million USD) 25,322 27,778 26,544 Tourism Revenues from Russian Visitors (mil. USD) 2,440 2,704 1,962 % share (1) 12-month cumulative figures as of October 2015 Source: Turkstat, Tourism Ministry, CBRT Turkey attracted nearly 36 million foreign tourists in 2014, 4.5 million (12.5%) of which were Russian. The share of Russia in tourism revenues, on the other hand, stood at 9.7%. Even though the number of Russian tourists dropped by 20.7% yoy in the first 9 months of 2015, Russia s ranking remained unchanged at second following Germany in terms of the number of visitors. Considering that 73% of Russian tourists arrived by chartered flights in 2013, bans on chartered flights may adversely affect the tourism sector. Should tourism companies in Antalya and nearby, which are highly preferred by Russian visitors, do not offset their losses by gains from other markets, they may face substantial financial risks. Russia has been historically the largest market for overseas construction sector. The volume of the projects that Turkish contractors undertook abroad since 1972 was totaled to 318 billion USD in which Russia has been the top market with a share of 19.4%. In the first eight months of 2015, Turkish firms have undertaken projects worth 2.3 billion USD in this country. Although Russia's share in total construction projects has been declining due to the economic crisis, Russia kept its significance for Turkish contractors during this period. From a short term perspective, sanctions against Turkey are expected to adversely affect chiefly construction and tourism sectors as well as agriculture, textile and automotive sectors. In the medium/long term, companies might offset some of the negative effects of sanctions by switching to new markets. On the other hand, problems with Russia may have some negative repercussions for the other countries that have close ties with Russia and, in turn, also have an unfavorable impact on activities of Turkish entrepreneurs in these countries. Foreign Direct Investment 2002-Sep.2015 Russia s FDI in Turkey Amount (million USD) 4,938 Share in total (%) 3.8 Turkey s FDI in Russia Amount (million USD) 828 Share in total (%) 2.6 Source: CBRT

4 3 Analysis of the foreign direct investments of the two countries revealed that Russia s investments in Turkey are higher than that of Turkey s in Russia. Russian authorities stressed that they cautiously determined the scope of sanctions and aimed to contain the damage to Russian firms operating in Turkey. This created uncertainties for businesses about the extent and the intensity of sanctions. In brief, Russia's sanctions do not imply a complete halt to economic relations. In this sense, it is difficult to assess the net impact of sanctions on Turkish economy. 2 scenarios are developed on the basis of the following assumptions: - According to the announcement of Russian authorities, acquisition of fresh fruits and vegetables, white meat and salt will be terminated as of January 1, Under the first scenario, exports to Russia would be reduced by 25% while in the second scenario, assuming that the scope of the sanctions might be wider, the decline in exports to Russia would reach 50%. - The revenues from shuttle trade would be reduced by 40% in the first scenario and by 50% in the second scenario. - The tourism revenues from Russian tourists would be lowered by 50% under the first scenario while in the second scenario this drop would be 75% parallel to the portion of visitors arriving via charter flights. - In the first scenario construction revenues would be reduced by 50% whereas revenues would be negligible under the second scenario. Under these assumptions, a total of 4.4 billion USD annual revenues would be lost in the first scenario because of the Russian sanctions against Turkey. On the other hand, the revenue loss would reach 7.3 billion USD under the second scenario. Accordingly, current account deficit to GDP ratio would increase approximately pp in Possible Implications of Sanctions on Turkish Economy Expected revenue loss in the next (million USD) months Scenario 1 Scenario 2 Export Revenues 1 3, ,996 Shuttle Trade Revenues 2 3,101 1,240 1,551 Tourism Revenues 2 1, ,472 Construction Revenues 3 2,285 1,143 2,285 Total 11,340 4,362 7,304 (1) 12-month cumulative figures as of October 2015 (2) 12-month cumulative figures as of September 2015 (3) January-August period

5 LEGAL NOTICE This report has been prepared by Türkiye İş Bankası A.Ş. economists and analysts by using the information from publicly available sources believed to be reliable, solely for information purposes; and they are not intended to be construed as an offer or solicitation for the purchase or sale of any financial instrument or the provision of an offer to provide investment services. The views, opinions and analyses expressed do not represent the official standing of Türkiye İş Bankası A.Ş. and are personal views and opinions of the analysts and economists who prepare the report. No representation or warranty, express or implied, is made as to the accuracy or completeness of the information contained in this report. All information contained in this report is subject to change without notice, Türkiye İş Bankası A,Ş, accepts no liability whatsoever for any direct or consequential loss arising from any use of this report or its contents. This report is copyright-protected. Reproducing, publishing and/or distributing this report in whole or in part is therefore prohibited. All rights reserved.

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