2012-04-12

Turkey's investment incentive package gets mixed reviews

Economists say the government's much-awaited investment incentive package will only yield results in the medium term.

By Erisa Senerdem Dautaj for SES Türkiye in Istanbul -- 12/04/12

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The new investment incentive package -- announced last week by Prime Minister Recep Tayyip Erdogan -- has sparked optimism among businesses. However, economists argue the extent to which it will attract investment to underdeveloped regions is ambiguous, and that it might cause unfair competition and budgetary imbalances in the short-term.

The investment incentive package aims to reduce the country's current account deficit -- which hit a dangerous level of 10% of GDP in 2011 -- and increase investment in underdeveloped areas in order to lower income disparities between regions.

It plans to achieve these goals by strengthening the investment-production-employment and export chains, encouraging production of intermediary goods for import-dependent sectors and transforming the export sector from labour-intensive to technology-intensive product groups.

According to Gizem Oztok Altinsac, an economist at Garanti Yatirim, the government is trying to compensate for the lack of investment by the private sector and low savings rates and FDI inflows.

"Turkey's potential growth rate could increase from the average 5% to higher levels, should the package's goals be achieved -- especially if it gets realised in sectors that cause the current account deficit," she told SES Türkiye, adding that the effects would appear only in the medium term.

However, Erinc Yeldan, a professor at Bilkent University in Ankara, criticised the new approach, noting that the package was a reproduction of previous ones presenting new definitions of regions.

"A broad strategy of regional development that is a well-organised effort led by public investment will provide the basis for [developing] social capital and turn underdeveloped regions into potential production centres of excellence, rather than directing private investors under public money," he said.

The investment incentives package includes four major categories: general incentives, regional incentives, large investment incentives and strategic investment incentives.

The government has determined six regions in accordance with their socio-economic development, with the first region including the most developed provinces and the sixth group underdeveloped regions mainly in the southeast and east.

The main incentives will be value added tax (VAT) rebates, VAT exemptions of investment expenditures up to 60%, custom duty exemptions, and social security premium support up to 12 years.

Depending on the region, free land, tax deductions up to 8% from the current effective rate of 20%, and loan rate support of 3 to 7 percentage points are also included. Incentives vary in quality and amount according to different regions, with the sixth region being subject to most attractive incentives.

Ozgur Altug, chief economist at BGC Partners, notes that attracting foreign investment to the eastern and southeastern parts of the country could be difficult, despite the incentives.

Noting that foreign investors look for certain criteria such as security, infrastructure, climate conditions, transportation alternatives and availability of human capital, he says many of these are missing.

"Security is not available due to [Kurdistan Workers' Party] PKK terrorism, and the availability and quality of human capital is also a question mark," he said. Nonetheless, he says any increase in investment in these regions would be beneficial.

The main advantage of the investment package -- compared to previous ones -- is that investors who make a strategic investment will be able to deduct some portion of their investment expenditures from their taxable income, according to Altug.

He says another advantage is that tax cuts would begin with the initial investment. Previous packages allowed the cuts to occur only after the investment was made.

This investment package also defines strategic sectors such as mining, iron and steel, chemicals, textile, automobile and agriculture. Other strategic sectors are defence, aviation, space, pharmaceuticals, education, maritime, railway and tourism.

Although the energy sector will not be directly supported -- which is forbidden by EU regulations -- energy usage in strategic investments will be supported and investments in iron, lignite and any other mining sectors will have incentives.

Providing incentives to these strategic sectors aims to encourage production of heavily-imported intermediary goods that widen the current account deficit, but the need for technology and research and development to invest in these areas could still cause an increase in imported goods and services, according to Zumrut Imamoglu, an economist at Bahcesehir University's Economic and Social Research Centre (BETAM).

"There is a reason why there is [not enough or] no previous investment in such areas in Turkey," Imamoğlu told SES Türkiye.

Noting that serious tax cuts were planned for investments, especially in the fifth and sixth regions, Imamoglu says this could lead to a serious decrease in marginal costs of production for new entrants, thus causing unfair competition against already existing firms.

"This might cause instabilities [at the micro-economic level]," she added.

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