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Russia’s full-scale invasion of Ukraine hit Türkiye at a time when it was battling market angst around President Erdogan’s then dalliance with unorthodox monetary and economic policies. Erdogan saw high interest rates as a scourge to both growth and inflation, and had kept policy rates artificially low for much of the prior decade. The result was an over-inflated economy, revealed in imbalances such as a wide current account deficit, a perennially weak lira, and high inflation.
The war accentuated the challenges faced by Türkiye’s policy makers as it pushed global oil and energy prices higher and increased Türkiye’s energy import bill to over $50 billion in 2022. Türkiye’s merchandise trade deficit with Russia, its main energy import partner, almost doubled in 2022 to close to $50 billion. Some of this growing trade imbalance was made up for with higher receipts from Russian tourists, who we no longer welcome in Europe. But the war made a weak macroeconomic backdrop much worse and perhaps fast-tracked an inevitable policy 180-degree turn, which came after elections in 2023 with the appointment of Mehmet Simsek and a more orthodox policy team.
An understanding of war-related risks, such as higher inflation, higher import costs, and the sanctions risks, encouraged a more defensive policy response at home. Ultimately, that might have been a positive, as the move to orthodoxy looks set to deliver more sustainable growth, and it may well have alleviated risks of a larger systemic crisis in Türkiye. But no doubt the combination of the war-related costs, such as higher energy import prices, and policy tightening since then, has been painful for Türkiye.
Much focus now, though, is on U.S.-brokered peace talks and hopes that there may be an early end to the war in Ukraine. Could this bring benefits to Türkiye?
To start with, a lasting peace and the lifting of sanctions on Russia would likely reduce the geopolitical premium on oil, energy, and commodity prices. This comes when there is already talk of a glut in global oil prices. Lower oil and energy prices, closer to $50 a barrel, would help improve Turkiye’s trade and current account positions, anchor the lira, and help reduce inflation. It should also allow for lower policy rates and give a boost to real gross domestic product (GDP) growth.
Türkiye should also benefit if peace in Ukraine leads to a major reconstruction effort there. Estimates suggest that the losses to Ukraine during the war are upwards of $1 trillion. Reconstruction efforts could total at least $50 billion per year for the next two decades.
Türkiye has developed strong strategic relations with Ukraine during the war, helped by the supply of key military kit, including Baykar drones. Turkish construction companies are well known and respected in Ukraine, and they should be well placed to benefit from inclusion in reconstruction contracts.
I am less hopeful that a meaningful and lasting peace can be secured by what appears to be a one-sided and pro-Russian approach from the Trump administration. And as a result, I think any peace deal is unlikely to ease European or Ukrainian angst over the continued military threat from Russia. As a result, and whatever the outcome, Europe and Ukraine look set to continue to rack up increased defense spending. NATO has committed to increasing defense spending from 2% of GDP to 5% over the longer term. For Europe, that suggests an annual $1 trillion a year defense spend, an enormous and lucrative new market. And for Ukraine, it is likely to sustain its defense spending at tens of billions of dollars for many years to come.
This represents a huge and growing market for military kit and defense technology. It is in a field that Türkiye has clear strengths, be that in the manufacture of state-of-the-art drones (such as Baykar), rockets (Roketsan), military vehicles, ships and munitions.
The Turkish military is respected both for its experience in conflict and its war-tested defense industrial complex. Again in Ukraine, there is a strategic partnership with common interests, particularly containing the Russian threat in the Black Sea, and a history of cooperation, from supplying engines to Türkiye to supplying drones and various military kit to Ukraine.
Türkish and Ukrainian companies are already cooperating in defense innovation, and this cooperation will likely continue after the war ends, giving Turkish companies an edge in defense and technology exports. For Europe, it needs to ramp up military production and capability quickly. Türkiye already has the manufacturing scale that Europe often lags behind.
Improved cooperation between Europe and Türkiye can help moonshot European defense production to fill the gap left by the U.S., while Türkiye can hope for the quid pro quo of technology exchange and transfer to further advance its own defense industrial sector. The opportunity is there, let’s hope that Europe can leave its past prejudices behind for the security and good of the entire continent. The recent cooperation between Piaggio and Baykar in Italy offers some room for hope.
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