Great transformation of Turkish industry: A profitability analysis

The Turkish economy has been passing through a process of great transformation. This overwhelming challenge started after 1996 with Turkey’s membership in the European customs union and was further intensified with deep structural reforms triggered by the crisis of 2001.
Turkish firms are struggling with several factors to overcome this challenge and survive in a domestic and external economic environment where openness, integration and competition are the rules of the game. There are, of course, many factors to be adjusted in the new era. These are the drastic reduction in consumer price inflation (CPI), a quite unstable exchange rate and real interest rates. One can easily add many other factors to this list depending on the goal of the analysis. But there is certainly a single factor to decide whether we are headed in the right or wrong direction. At the end of the day we must look at the trends in profitability. As it is known, the İstanbul Chamber of Industry (İSO) has announced the figures from its traditional İSO Top 500 Industrial Enterprises survey since the early 1980s. This year the İSO explained its 2006 survey last week. Today I will analyze these results to decide whether the current transformation of the firms is healthy or not. But before attempting to do that, I will focus briefly on the trends of the 1990s. The reason is that, on the one hand, there is consensus among the people that the 1990s was a lost decade in every sense of the word. But on the other hand, it seems that there is regret over the high profits of the period amongst big businessmen.

We can easily observe this psychology in the 2006 ISO survey, as they repeatedly compare their profitability figures with the figures of the “lost decade.” Therefore, the first message is that they may still not understand the nature of the current transformation or the irrationality of the “golden days” of high profitability that dominated throughout the 1990s, as this decade was just a race to the bottom.

Let me briefly remind you of the nature of that race to the bottom. One of the factors requiring rapid adjustment today is the ongoing disinflation program itself. Turkey’s CPI was approximately 70 percent around 2001. High-level double-digit inflation persisted for more than two decades and therefore created its own culture.

The CPI was reduced to below 10 percent within just two years and has stayed in the single digits since 2004. Obviously this underlines a great success for the government and provides a fertile surrounding for companies in the longer term. However, it creates short-term adjustment problems for domestic companies as they operated under semi-closed and distorted market conditions for several years.

During the inflationary era, especially before the customs union with Europe, companies operated in a restrictive competitive environment and the quality of regulation was not market friendly in terms of transparency and accountability criteria. In this environment, companies established a special lender-borrower relationship with deficit financing and debt accumulating public sector.

As this wrong economic fundamental continued for many years, the relationships between big business, the public sector and the bureaucracy were converted into rigid “crony capitalism.” The companies seemed very happy in the “golden ages” of this patrimonial state as they were getting the bulk of their profits (sometimes more than 70 percent) from non-operation profits, meaning interest income derived from their lending to the state.

Now let me return to the 2006 survey. The İSO Top 500 Industrial Enterprises survey is known as the equivalent of the Fortune 500 for Turkey and it shows generally that the economy is headed in the right direction. In fact, the results show that Turkey’s companies have reached unprecedented levels in almost all areas, from exports to employment and from production-based sales to profits. For instance,

the sales profitability of the 500 companies in total was 5.9 percent in 2006 while it was 4.6 percent in 2005. Although the profitability rate in 2006 was higher than in the previous year, it was still below 8.5 percent, the level 10 years ago. However, you all know the meaning of that high profitability of the 1990s, after my explanations above.

the asset profitability of the 500 top industrial firms increased to 7.3 percent last year from 5.4 percent.

and finally, equity profitability increased to 13.8 percent from 10.3 percent — its level in 2005.

Also, export performance should be seen as a good indication of a transformation under global competitive pressures. The automotive industry gets the highest share in the exports of the top 500 companies with a 28.1-percent stake. The metals industry ranked second with a 19.6 percent stake. The export of metal goods and machinery spares took third place with a 17.5 percent stake.

As a matter of fact, the same trends can also be observed from the Central Bank of Turkey’s Financial Stability Report (2007-I) released just before İSO 500 survey. The central bank’s data is quite reliable as it derived from balance sheet reports of the companies that appear on the Istanbul Stock Exchange Market (İMBK-100). As is seen in the table below, both equity and asset profitability of the companies for all firms, including manufacturing firms, have risen significantly since 2004. As we put all these figures together, it seems that big companies started doing quite well in the global environment and therefore at the moment there is no rationale for complaining about foreign exchange rates or the domestic interest rate. However, the situation should be drastically different for small firms.