1

GENERAL OUTLOOK Outlook and Expectations for September:

Global markets and especially emerging markets are generally positively affected by the rate cut and the decision to purchase asset backed securities of the European Central Bank (ECB). Although the volume of the purchase and the details are not clear yet, the first result of the decision is observed at the USD/Euro parity which went down to below 1.30.

The new ceasefire between Ukraine, Russian-backed rebels and Russia also positively affected the markets decreasing the geopolitical risks at least temporarily. However, recent news indicates that the conflict is again rising.

The economic data from the US are mixed. The recent non-farm employment figure is disappointing, although there is a minor decline in the unemployment. However, the latest data did not change the expectation that the US Fed will hike the policy rate in the end of first half of 2015. In this respect, the Fed FOMC meeting of September 16-17 is crucial.

Japanese GDP contracted more than expectations and the Japanese Yen continued to depreciate against the US dollar.

The conflict and internal chaos in Iraq is continuing. The US and some Western powers try to form a coalition against the “Islamic State” terrorist organization which continues to expand in Iraq and Syria. The participation of Turkey is also discussed in the recent NATO meeting and US President Obama also said that he wanted Turkey to join such a coalition. However, Turkey may find it hard to play a public role in the coalition for fear the militant group might retaliate against dozens of Turks held hostage. “Islamic State” is holding some 46 Turkish citizens hostage, including diplomats seized from the Turkish consulate in Mosul.

Oil and gold prices decreased in the beginning of the month. The decline in oil prices can be attributed to the sluggish expectations about the global growth due to the lower than expected US economic data and recession anxieties in the Euro Region. Gold prices are decreasing due to the appreciation of the US dollar and the slightly decreasing geopolitical risks. The price of Brent oil hovers around USD 99.4 per barrel and the price of the US crude is around USD 92.8. The gold price is around USD 1260 per ounce as of the beginning of September.

The euro/USD parity is at the level of 1.294; while the USD/JPY parity is around 105.40. In Turkey, the smooth election of the new President and the formation of the new

government decreased the political risk at least for the medium-term until the general election of 2015. The rating agencies will start to affirm their rating evaluations after the beginning of October.

SEPTEMBER 2014

2

August inflation figures in Turkey are higher than expected and the year-end inflation is anticipated to exceed 9%. The Central Bank decreased the upper end of the interest rate corridor but did not change the policy rate in August. We believe that it will be difficult for the Bank to cut policy rates until the end of the year, with the high inflation rate and the uncertainty in global markets. However, the Bank can continue to contract the interest rate corridor after the recent move of the ECB which increased the risk appetite in emerging markets.

We expect that the second quarter growth rate of the economy will remain under 3% as the growth indicators were slower than the first quarter.

Now that the Presidential election is over and the new government is established, Turkish markets will focus on macro-economic and financial figures as the political risks are diminished at least for the medium-term. The major geopolitical risks are again the situation in Iraq and Ukraine, while markets will continue to closely follow the data of the Euro Region, the road map of the ECB after the recent rate decisions and the 16-17 September FOMC meeting in the US. As a result, we envisage that the USD/TL parity will oscillate around 2.15-2.18. On the other hand, the average compound benchmark rates can move within a band of 8.80-9.20% in September.

Economic Developments: The Turkish Central Bank left the policy rate unchanged, while cutting the overnight lending rate… The Central Bank maintained its repo rate which is the policy rate at 8.25 percent, as expected, but continued to narrow its overnight interest rate corridor and repeated its guidance from July that it would maintain a tight monetary policy stance by "keeping a flat yield curve until there is a significant improvement in the inflation outlook." The Central Bank cut the overnight rate on marginal funding, the ceiling of its interest rate corridor, by 75 basis points to 11.25 percent but maintained the borrowing rate, or the floor in the corridor, at 7.5 percent. The Bank also cut the borrowing rate for primary dealers via repo transactions by 75 basis points to 10.75 percent and the lending rate at its late liquidity window by 75 basis points to 12.75 percent while it kept the borrowing rate at zero percent. The Bank has cut its benchmark repo rate by 175 basis points since May after raising it by 550 points on January 28. In January the Central Bank also shifted its overnight rate corridor sharply upwards by raising the funding rate to 12.0 percent from 7.75 percent and the borrowing rate to 8.0 percent from 3.5 percent. In July, the Central Bank cut the borrowing rate to the current 7.50 percent and with the new cut in the funding rate to 11.25 percent, the central bank continues to shift the rate corridor downwards. It said the negative impact of exchange rate developments since mid-2013 year on inflation are gradually decreasing but high food prices continue to delay an improvement in the outlook for inflation. "In this respect, the Committee also evaluated the possible impact of the drought and the geopolitical risks on the inflation outlook," the Bank said, adding that loan growth continues at reasonable levels in response to its tight policy stance and private demand is modest.

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Political risk still high in Turkey following Erdoğan’s victory according to Fitch… Global ratings agency Fitch has claimed political risks to Turkey’s economy are still high following Prime Minister Recep Tayyip Erdoğan’s presidency win, warning tensions are likely to dominate the country’s agenda ahead of the parliamentary elections. “Erdoğan’s outright victory of August 10 vote, in the first round of Turkey’s first popular presidential election, does little to ameliorate the political risk to Turkey’s sovereign credit profile,” Fitch Ratings said in a statement released August 11. “Political risk will weigh on Turkey’s ratings through its potential effects to discourage capital inflows and reduce policy predictability,” the agency said. The agency suggests the parliamentary elections, which will be held by June 2015, will likely keep the political tension high, “as Erdoğan seeks to extend the power of the presidency.” According to Fitch, the anti-government Gezi Park protests last summer that were a response to Erdoğan’s perceived authoritarian tendencies is a fresh reminder of a potential new wave of political and social unrest in the country. “Political continuity does not eliminate political and social unrest, which has been elevated since last year’s Gezi park protests and the 2013 corruption scandal,” the agency warned, saying how political and social shocks can damage a country’s credit rating and international reputation. “Turkey has been remarkably resilient to recent external shocks and banks and corporates continue to enjoy high roll-over rates, but we expect political risk to remain a credit weakness that could lead to a negative rating if it adversely affects government effectiveness and policy predictability,” Fitch stressed. The agency also warns the president elect’s public criticism of the Central Bank’s policy on interest rates could undermine the Bank’s “tenuous credibility.” It also says “a rapid unwinding of these hikes would make Turkey more vulnerable to a sudden change in investor sentiment towards emerging markets.” On the other hand, year-end growth estimations for Turkey have been upgraded to 2.7 percent, Fitch Ratings Senior Director Janine Row said, pointing to the country's robust banking system and strong first-quarter growth performance. Row said that many international institutes – including the World Bank, Standard & Poor's and the OECD – have upgraded their growth estimations for Turkey. "Fitch expectations were revised up as well, but very modestly from 2.4 percent to 2.7 percent. Other agencies and other international financial institutions have increased the forecasts for growth for Turkey. And we saw that Q1 growth was very strong at 4.3 percent," Row said. Row said that Turkey has a strong banking system, which can cope up with financial shocks. Claiming that geopolitical strains in Turkey's region will continue to pose problems, Row said that an increase in savings and foreign direct investments could cushion volatility in economy. Meanwhile the rating agency said that Turkish banks' rapid credit growth and higher external debt increase downside risks in case of extremely stressed market conditions. The agency affirmed that foreign liabilities have increased, particularly at the short-end, as loan demand has outpaced deposit growth. Increased short-term borrowings and uncertainty over the ability to monetise foreign-currency assets in a stress scenario leave banks more vulnerable to downside risks. The banks have limited foreign currency cash and unencumbered foreign securities, so they would have to draw down on central bank reserves to service external debt. Fitch believes that total loan growth will be around 15%-20% for the year, below its recent historical pace. The agency expects that sharp interest rate changes and a fluctuating lira against major currencies are likely to persist in Turkey. The credit profiles of the four large private banks are sensitive to the volatile operating environment. The banks' broad and diversified franchises are a source of credit strength. The agency said that growth, tougher

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regulatory demands and the impact of lira depreciation on foreign currency assets have pushed down regulatory capital ratios. Weaker and volatile capital markets also depressed capital in 2013 where securities are marked-to-market through equity. Moody’s expects political uncertainty to persist until 2015 elections… International ratings agency Moody’s has warned that Prime Minister Recep Tayyip Erdoğan’s victory in Turkey’s recent presidential elections might not abate political tension, stressing that economic risks remain. “We caution that the conclusion of the presidential election is unlikely to resolve Turkey’s key economic and institutional credit challenges because of ongoing domestic political tension and uncertainty that will prevail at least through the next parliamentary elections,” the agency said in a statement released on August 15. Detailing the referred weaknesses, the agency named slower growth, high inflation, material external vulnerabilities, and the weakening independence of key institutions such as the Central Bank as being among the key challenges. The ratings agency further said the credit implications of August 10 presidential election would not be clear until a new prime minister is appointed in late August and general elections, which are due by next June, have been held. No change to Turkey's rating after election according to S&P… Turkey’s current sovereign credit rating of BB+ will not be affected by the outcome of August 10 presidential elections, the agency S&P said in a statement. Because Prime Minister Recep Tayyip Erdogan was elected in first round and his successor as premier would be from the ruling Justice and Development Party, S&P said a change in macroeconomic policy is not expected. Turkey’s BB+ credit note was confirmed in the statement. Political Developments: Erdogan sworn in as new Turkish President… Turkey's High Electoral Board confirmed Prime Minister Recep Tayyip Erdogan as the country's first popularly elected president. The board confirmed that Erdogan received 51.79 percent of the vote in the elections held August 10. Ekmeleddin Ihsanoglu, the former head of the Organization of Islamic Cooperation received 38.44 percent and Kurdish politician Selahattin Demirtas came third with 9.76 percent, the Board said. Although largely a ceremonial position, Erdogan has said he wants to strengthen the presidency and would make use of its seldom-used powers, such as presiding over Cabinet meetings. Erdogan has been sworn in as Turkey's 12th President on August 28. Reading the oath of office in a ceremony in parliament, Erdogan vowed to protect Turkey's independence and integrity, to abide by the constitution and by the principles of Mustafa Kemal Ataturk, founder of the modern secular republic. Moments after being sworn in, Erdogan appointed outgoing foreign minister as acting prime minister. Senior representatives of some 90 countries from Asia, Africa, the Middle East and Europe attended ceremonies. New Prime Minister Davutoğlu formed the cabinet… Turkey’s ruling Justice and Development Party (AKP) has elected Foreign Minister Ahmet Davutoğlu as its new chair during its extraordinary congress on August 27. Outgoing Prime

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Minister Recep Tayyip Erdoğan, elected president in August 10, announced moments before the convention that the new government will be formed August 29. Consequently, after his nomination as Prime Minister on August 28 by the new President Erdoğan, Davutoğlu established the 62nd government of the Republic of Turkey and submitted the list of his cabinet members for presidential endorsement to Erdoğan on August 29. President Erdogan has approved Prime Minister Ahmet Davutoglu’s cabinet. Turkey's newly appointed Prime Minister Ahmet Davutoglu announced his Cabinet on Agust 29, a day after President Erdogan assigned him to form a new government. There are four new names on the list for ministries of EU relations, customs and trade, and two deputy prime minister posts. Davutoglu, foreign minister in the previous Cabinet, is replaced by Mevlut Cavusoglu, who formerly served as the EU affairs minister. Yalcin Akdogan -- former Prime Minister Erdogan's former top political adviser -- and Numan Kurtulmus are the new deputy prime ministers. Volkan Bozkir, the former head of the Turkish parliament's Foreign Affairs Committee, replaced Mevlut Cavusoglu to fill in the position of top EU-affairs official. Nurettin Canikli, former deputy head of ruling Justice and Development Party's parliamentary group, is the new minister of customs and trade, replacing Hayati Yazici. Despite questions over his future, Ali Babacan remained as Deputy Prime Minister responsible from the economy within the cabinet. The government of Prime Minister Davutoğlu won a vote of confidence in Parliament on September 6. Turkey's 62nd Cabinet, formed by Davutoğlu, received backing from 306 MPs with 133 voting against in the 550-seat Parliament where the ruling AKP has 312 seats. Davutoğlu said his government was keen to realize the 2023 targets to build a "new Turkey" based on a new constitution, peace with Kurds and a booming economy. Davutoğlu, had reaffirmed ambitious goals to make Turkey a top 10 global economy and member of the EU by 2023 as he presented the programme of his new government on September 1.

MACRO ECONOMIC DEVELOPMENTS

CPI rose by 0.09% in August: yearly CPI inflation is 9.54%... Despite expectations of decline, the CPI (consumer price index) rose by 0.09% on a monthly basis in August and the annual increase rose to 9.54% due to the base effects. On the other hand, the DPPI (domestic producer price index) increased by 0.42% on a monthly basis and the yearly DPPI increase rose to 9.88%. The increases in food and service prices were the main factors affecting the CPI inflation, while the decreasing prices in the clothing sector due to seasonal sales had a downward effect.

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MONTHLY INFLATION (%)

-4

-3

-2

-1

0

1

2

3

4

5

07

1 5 9

08

1 5 9

09

1

5 9

10

1 5 9

11

1 5 9

12

1 5 9

13

1 5 9

14

1 5

DPPI CPI

ANNUAL INFLATION RATES (%)

-5

0

5

10

15

20

07

1 4 7 10

08

1 4 7 10

09

01 4 7 10

10

01 4 7

10

11

01 4 7

10

12

01 4 7

10

13

01 4 7

10

14

01 4 7

PPI CPI

SELECTED CPI INDICATORS*

1%

3%

5%

7%

9%

11%

13%

15%

08

4 7 10

09

1 4 7 10

10

1

4 7

10

11

1 4 7 10

12

1 4 7 10

13

1 4 7 10

14

1 4 7

H: Energy, unprocessed food, alcoholic beverages, tobacco and gold excluded

I: Energy and all food, and oth. excluded

* Percentage change with respect respect to same month in the previous year.

In this light, the highest price increase within the CPI index was in the prices of restaurant-hotels sector which rose by 1.64%. The contribution to inflation was 0.11 percentage points. This was followed by the food and non-alcoholic beverages sector prices which rose by 0.89% which contributed by 0.22 points to inflation. While the prices of education rose by 0.75%, the rise was 0.65% for the prices of miscellaneous good and services. On the other hand, prices in the clothing and shoes sector fell by 4.92% and had a 0.36 points negative contribution to inflation. While the prices of tobacco and alcoholic beverages decreased also by 0.46%; the decline was 0.06% in transportation prices. In annual terms, the largest price increase was in restaurants-hotels with 14.73%, which was followed by the food and non-alcoholic beverages group with 14.44% and the transportation sector with 9.45%. The core inflation indicators fell slightly on monthly basis and yearly basis. The favourite core inflation index I (excluding all food and beverages, energy, and tobacco products) fell by 0.09%, with a yearly increase of 9.68%. On the other hand, the second favourite H index rose by 0.12% on monthly basis, causing an increase of 10.36% on yearly basis.

The DPPI inflation which comprises the industrial producer prices rose by 0.42%% in August; the yearly increase was 9.88%. Prices rose by 0.59% in the manufacturing sector and by 0.39% in the water sector; however, they fell by 0.80% in the electricity and gas sector and by 0.68% in the mining sector. On yearly basis, the prices in the manufacturing sector rose by 10.99%.

As a result, August CPI inflation was higher than expected due to the increases in the prices of food and services sectors. The drought and negative weather conditions negatively affected the agricultural prices and the price adjustments were instrumental in the rise of the prices of this sector. There could be a slightly fall in the CPI inflation for the following months due to the base effect. However, the launching of the educational season in September, the possible rises in the clothing, transportation and housing equipment prices in the autumn months and the volatile structure of the food prices can limit this decline in inflation. In sum, we estimate that

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-25,0

-20,0

-15,0

-10,0

-5,0

0,0

5,0

10,0

15,0

20,0

25,0

2007 1 4 7 10

2008 1 4 7 10

2009 1 4 7 10

2010 1 4 7 10

2011 1 4 7 10

2012 1 4 7 10

2013 1 4 7 10

2014 1 4

Yearly Monthly

Monthly Industrial Production*

* Calculated from the 2010-based industrial production index. Yearly growth is calendar adjusted, monthly growth

seasonally and calendar adjusted,

CPI Components

% change Weights 2014

August

2014

Aug./

2013 Aug.

TURKEY 100,00 0,09 9,54

Food and non-

alco. beverages24,45 0,89 14,44

Alco. beverages

and tobacco5,29 -0,46 4,56

Clothing and

footwear7,17 -4,92 8,62

Housing, water,

electricity, gas and

other fuels

16,41 0,31 5,39

Household

equipment7,52 0,31 9,64

Health 2,44 0,16 9,08

Transport 15,54 -0,06 9,45

Communications 4,70 0,14 1,53

Recreation and

culture3,36 0,59 8,95

Education 2,26 0,75 8,56

Hotels, cafes and

rest.6,58 1,64 14,73

Miscell. goods

and services4,28 0,65 8,13

Special (core) CPI Aggregates

% change 2014

August

2014

Aug./

2013

Aug.

A. CPI excl. seasonal

prod.0,49 9,54

B. CPI excl. unprocessed

food0,01 8,74

C. CPI excl. energy 0,18 10,64

D.(B) and (C) 0,08 9,87

E. (C) and alcoholic bev.

And tobacco prod.0,21 11,07

F. (E) and admins. prod,

other prod., indirect taxes0,21 10,89

G. (F) and (B) 0,13 10,13

H. (D) and alcoholic bev.,

tobacco and gold 0,12 10,36

I. (C) and excl. food and

non-alco. bev., alco. bev.

and tobacco

-0,09 9,68

the year-end CPI inflation will be around 9.34%. Meanwhile, there are upward risks to this expectation; considering a possible hike in the natural gas and electricity prices and/or administrated prices in the remaining months of the year which can raise the inflation rate.

Industrial production rose by 1.4% in June…

Growth in industrial production decelerated in June. Industrial production rose by 1.4% compared to the same month of the previous year according to the calendar-adjusted production index. Production increased at a rate of 1.7% according to the non-adjusted figure. Growth in production was more than 5% in the first quarter of the year, while it went down to near 3% in the second quarter. The rise was 4.2 % in the capital adjusted index in the first half of the year, whereas it was 3.8% according to the non-adjusted index. Finally, production rose by 0.1% in June compared to the month before according to the seasonally

and calendar-adjusted index. The strongest production increase in June compared to the same month of the previous year according to the calendar-adjusted index was in the durable consumer goods with 6.7%. This was followed by the non-durable goods sector with a rise of 2.2% and by 1.9% in the capital goods sector. The production growth was 1.3% in the energy sector. However, there was no change in the intermediate goods sector. The rise in production in June was 1.5% in the manufacturing sector, 2.6% in the electricity, gas and water and whereas production fell by 2.3% in the mining sector.

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Unemployment

7,0

9,0

11,0

13,0

15,0

20

06 1 4 7 10

20

07 1 4 7 10

20

08 1 4 7 10

20

09 1 4 7 10

20

10 1 4 7 10

20

11 1 4 7 10

20

12 1 4 7 10

20

13 1 4 7 10

20

14-1 4

Unemployment Rate (%) Seasonally Adjusted

Consequently, June figures indicated that growth slowed down in the industrial production. This is also bad news for the GDP figures for the second quarter, which we expect to follow the same trend.

Turkey's unemployment was 8.2% in the second quarter of 2014...

The unemployment rate slightly rose in the May period (April-May-June) of 2014 compared to the same period of the previous year; however, it fell compared the previous April period. The slow growth in the economy can be an explanation for this rise. The unemployment rate was 8.8% and the non-agricultural unemployment was 10.70% in the second quarter of 2014. The unemployment rate was 8.2% in the same period of 2013, whereas the non-agricultural unemployment rate stood at 10%. The unemployment rate of the previous period was 9.0%. Meanwhile, the seasonally

adjusted unemployment rate was 9.5%; rising both compared to the rate of 8.9% in the same period of the previous year and 9.2% in the April period.

The number of unemployed persons rose to 2,551,000 with an increase of 288,000 persons compared to the same period of the previous year. The number of employed persons rose by 1,352,000 to reach 26,538,000. While the agricultural employment rose by 374,000; service employment increased by 288 thousand. In parallel, the employment rose by 164,000 in the industry and 109,000 in the construction sector.

Labour force participation rate was realized as 51.2%, increasing by 2 percentage points over the same period of 2013. This rate was realized as 71.8% for male and 31% for female labour. The youth unemployment rate was 15.8% in the second quarter of the year. Of those who were employed in this period; 21.9% was employed in agriculture, 20.2% was employed in industry, 7.4% was employed in construction and 50.5% was employed in services.

In sum, while unemployment fell compared to the previous period, it rose compared to last year which indicates that the economic growth slowed down in the same period. In addition, the high seasonally adjusted figure shows that the drop is mostly seasonal and is related to the rise in agricultural and services sectors. Furthermore, the rise in the labour force participation rate is a positive factor; however, the rate is still too small compared to other OECD and emerging countries. We expect that unemployment rate can stay around these levels in the summer months but it will rise in the fall-winter season both due to seasonal factors and the moderate economic growth.

Foreign trade deficit was USD 46.1 billion in January-July 2014... The improvement in the foreign trade has continued in July and the trade deficit fell compared to the same period of the previous year. While the imports fell in July, the rise of the exports has also stagnated. The gold exports were higher than exports in this month. The foreign trade deficit in July was USD 6.5 billion with 35% decrease compared to the same month of the

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MONTHLY FOREIGN TRADE

(USD BILLION)

0

5

10

15

20

25

2007 1 5 9

2008 1 5 9

2009 1 5 9

2010 1 5 9

2011 1 5 9

2012 1 5 9

201

3 1 5 9

2014 1 5

Exports Imports

50

75

100

125

150

175

200

225

250

275

2007 1 4 7 10

2008 1 4 7 10

2009 1 4 7 10

2010 1 4 7 10

2011 1 4 7 10

2012 1 4 7 10

2013 1 4 7 10

2014 1 4 7

Exports Imports

ANNUAL EXPORTS AND IMPORTS

(USD BILLION)*

* 12-months moving sums

previous year. Exports rose by 2.6% to USD 13.4 billion while imports decreased by 13.5% to USD 19.9 billion. According to the calendar and seasonally adjusted index, exports increased by 8%, while imports rose by 0.4% compared to the previous month.

Exports rose by 6.1% in the January-July period to reach USD 93.5 billion from USD 88.27 billion; while imports fell by 6.2% to 139.6 billion from USD 148.8 billion in the same period of the previous year. The foreign trade deficit also fell by 24% to USD 46.1 billion from USD 60.6 billion. The foreign trade deficit dropped to USD 85.3 billion as well, in yearly cumulative terms. The share of both the exports and imports towards the EU countries increased in January-July 2014 compared to January-July 2013. The exports to the EU countries rose by 13.3% to USD 40.8 billion. Imports from these countries fell by 4% to USD 37 billion. The share of the EU countries within the total exports was 43.6%, whereas the same share was 37% for imports. Exports towards the Middle East and Africa fell in this period. The share of the exports towards Middle Eastern countries which was 23.9% in January-July 2013 fell to 21.9% in January-July 2014. Exports towards these countries also fell by 3.1%. Exports towards African countries fell by 4.4%, while their share dropped to 8.8% from 9.8% within the total exports. On the other hand, the first destination of exports was Germany with USD 9 billion, United Kingdom was the second country of destination and Iraq was the third. Exports to Iraq fell by 45% in July due to the civil war at that country. The first country for imports was Russia with USD 15.2 billion, followed by China and Germany in the first seven months of the year.

Motor vehicles were the largest export items in the January-July period with USD 11.1 billion rising by 11.6% compared to same period of the previous year. Boilers-machinery and mechanical appliances, knitted goods and articles, iron-steel, and electrical machinery and

FOREIGN TRADE DEVELOPMENTS

(USD Million)

July 2013

(I)

July 2014 (II)

(%) Change

(II)/(I)

Jan.-July 2013 (III)

Jan-July 2014 (IV)

% Change (IV)/(III)

Export 13,060 13,403 2.6 88,194 93,543 6.1

Import 22,966 19,863 -13.5 148,806 139,612 -6.2

Trade Balance -9,906 -6,460 -34.8 -60,612 -46,068 -24,0

Export//Import (%)

56.9

67.5

-

59.3

67,0

-

10

equipment were the other large export items. Meanwhile, the largest import item was mineral oils and fuels with an import bill of USD 32.3 billion in the same period, with a decrease of 1.2% as compared to January-July 2013. Boilers-machinery and mechanical appliances, iron-steel, electrical machinery and equipment, plastics and motor vehicles were among other major import items. There was 67.5% decrease in the imports of precious metals. In this light, gold imports fell to USD 3.2 billion from USD 11.1 billion, while exports rose to USD 2.9 billion from USD 2.7 billion. On the other hand, imports of consumption goods fell by 5%; the drop was 6.9% in intermediate goods and 3% in capital goods imports. As a result, the contraction of the foreign trade deficit is positive as it will cause the current account deficit to fall as well. However, the fall of imports indicates that the economic growth is slowing down, while the export towards the Middle East and especially Iraq continues to drop. In addition, the growth outlook for the EU countries is disappointing; another risk issue for the fate of the Turkish exports. Current account deficit was USD 24.2 billion in the January-June period... The current account deficit fell to USD 4.1 billion in June 2014 from USD 4.8 billion in June 2014. The improvement in the current account deficit is due to the improvement in the foreign trade deficit and the fall in the total imports and surge in exports. However, the gold trade was in deficit again as of June. On the other hand, the current account deficit fell to USD 24.2 billion from USD 37.1 billion in the first half of the year. The cumulative deficit also fell to USD 52.2 billion from USD 52.91 billion registered in May. The foreign trade deficit and the outflow from the income balance were instrumental in the current account deficit in the January-June period. The tourism revenues slightly rose in this period. The trade deficit was USD 29.3 billion in January-April 2014; it was USD 40.6 billion in January-June 2013. The deficit in the gold trade turned was USD 355 million in this period; although it fell as compared to the same period of last year, gold imports reaccelerated in the recent months. The service surplus reached USD 9.3 billion, while net tourism revenues amounted to USD 9.2 billion increasing by 3.9% compared to the same period of the previous year. The balance of income was in deficit with an outflow of USD 4.5 billion. The inflow from the current transfers reached USD 364 million. On the financing side, the capital inflows which were USD 48.8 billion in January-June 2013 fell to USD 19 billion in the same period of 2014. There was an increase of 20% in the direct investments. The net direct investments which were USD 3.9 billion in January-June 2013 rose to USD 4.6 billion this year. On the other hand, the real estate investments of non-residents reached USD 2 billion. Portfolio investment, which had resulted in a net inflow of USD 18 billion in January-June 2013, showed a net inflow of USD 10.1 billion in January-June 2014. However, there was a significant rise in government bond purchases and the bond issues of the private sector in June. There was a fall of USD 1.1 billion in the assets of the portfolio account which comprise of the securities transactions abroad of the residents. There was a net purchase of USD 247 million in the government debt securities in January-June 2014, with the help of the net purchase of USD 3.3 billion in June. The bonds issued abroad by the government amounted to USD 2.28 billion in the first half of the year. On the other hand, there was a net purchase of

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USD 1.46 billion in the equity securities in the same period, despite the sale of USD 153 million registered in June. Meanwhile, while the bond issues abroad of the banks reached USD 5 billion, with the USD 2 billion bonds issued in June; the bond issues of the other sectors reached USD 2.25 billion in the first half of the year, with the help of the USD 1.8 billion bonds issued in June.

There was an inflow of only USD 4.3 billion in the form of other investments in January-June 2014 compared to an inflow of USD 26.9 billion in January-June 2013. While the inflow of the corporate sector reached USD 17 billion in the form of deposits and loans; the banking sector registered a capital inflow of USD 4.4 billion. In this respect, the foreign deposits of the other sectors fell by USD 82 million, while the loans used reached USD 2.6 billion. The government realized a USD 747 million net long-term loan repayment. Currency and deposits item, which is composed of the deposits of non-residents held with the resident banks, recorded a fall of USD 195 million. The banking sector cash loans utilizations amounted to USD 4.74 billion. The loans abroad of the banking sector rose by USD 72 million. On the other hand, banks’ currency and deposit placements abroad in the form of foreign exchange and Turkish Lira recorded an increase of USD 248 million. The roll-over ratio for long-term debt was 167% for banks and 125% for the non-bank sectors.

In sum, while there was a deficit of USD 24.2 billion in the current account balance, the financial and capital account posted an inflow of USD 19 billion in January-June 2014. The net errors and omissions item registered a net inflow of USD 6.4 billion despite the outflow of USD 1.3 billion registered in June. The Central Bank reserves augmented by USD 1.3 billion in the first half of the year, with the help of a rise of USD 1.5 billion realized in June. As a result, the reserve assets which rose by USD 7.3 billion in January-June 2013; increased by USD 1.3 billion in January-June 2014. As a result, the balance of payment figures of the first half of the year indicated that there was a significant decline in the current account deficit. The improvement in the foreign trade deficit and the fall of gold imports compared to the same period of last year were the two main causes behind this development. However, the contraction in the trade deficit slowed down compared to the beginning of the year due to the decline in the rate of growth of exports and rate of fall in imports. In addition, gold imports reaccelerated in recent months. We think that there is a risk that the contraction in the current account deficit can come to an end due to various factors: the appreciation process in the Turkish Lira after the beginning of the year, the considerable drop of the exports towards Iraq, the deceleration possibility of exports towards the EU countries as a result of the recent recession signals and the rate cuts of the Central Bank which have the potential of triggering the domestic demand and growth. However, the recent sanctions of Russia to the EU countries banning imports of various food items can be beneficial for the Turkish food and consumer goods exports to this country, positively affecting the total exports. On the other hand, the financing difficulties of the current deficit seemed to be alleviated in recent months due to the favourable factors in the global markets; there was a rise in the portfolio inflows and the banking and private sector loans are recovering. There was also a slight increase in the direct investments; although still insufficient. Meanwhile, this trend can rapidly change if the risk appetite in the global markets decline as a result of the rising geopolitical conflicts which we are faced recently and the increasing signals of the Fed about a rate hike in the US.

12

Balance of Payments

*Minus sign indicates an increase in reserves The budget registered a deficit of TL 3.4 billion in January-June 2014…. The budget gave a deficit in June amounting to TL 613 million; compared to a deficit of TL 1.2 billion in the same month of 2013. The primary surplus increased to TL 959 million from a surplus of TL 335 million in June 2013. Although the deficit fell in June compared to the same month of the previous year, the decline in the tax revenues was also noticeable. However, the non-tax revenues significantly rose due to the privatization income amounting to TL 3 billion. The increase in non-interest expenditures continued; but the rise was moderate in interest expenditures. All of the expense items have considerably increased except for the current and capital transfers in this month. On the tax revenues side, the corporate tax revenues considerably fell. Domestic VAT revenues, VAT from imports and Special Consumption Tax revenues registered declines as well. This situation indicated that consumption and imports were rather stagnant in June. The budget figures for January-June 2014 indicated that the budget which gave a surplus in the same period of last year, registered a deficit this year. While the budget deficit was TL 3.4 billion; the primary surplus was TL 23.1 billion. The budget had registered a surplus of TL 3.1 billion, while the primary surplus was TL 26.4 billion in the same period of 2013. The budget deficit was mainly originated by the faster increase in budget expenditures in contrast of the limited rise in total revenues due to the sluggish growth in tax revenues. While there were increases in almost all non-expenditure items, there was also a rise in interest expenditures. On the other hand, the increases in the revenues were limited; the tax revenues fell on real prices compared the same period of the previous year, while the non-tax revenues considerably rose.

The total expenditures increased by 5.1% in real prices and they realized as TL 213.9 billion in January-June 2014. While the non-interest expenditures rose by 5.1% in real terms to reach TL 187.4 billion, the interest expenditures increased by 4.9% to TL 26.5 billion. The current transfers rose by 1.7% in real terms. The social security institutions and health payments

(USD Million) Jan.-June

2013

Jan.-June

2014

CURRENT ACCOUNT -37,085 -24,151

Foreign Trade Balance -40,590 -29,322

Balance of services 8,413 9,296

Tourism income 8,885 9,231

Balance of Income -5,445 -4,489

Current Transfers 537 364

FINANCIAL and CAPITAL ACCOUNT 48,822 19,036

Direct Investments 3,859 4,639

Portfolio Investments 18,036 10,139

Other Investments 26,979 4,274

Central Bank -580 -886

General Government -1,034 -945

Banks 22,430 4,367

Other Sectors 6,163 1,738

NET ERRORS AND OMISSIONS -4,397 6,370

RESERVE ASSETS* -7,340 -1,258

Official Reserves -6,488 -1,258

Use of Fund Credit and Loans -852 0

13

increased in real terms by 0.9% to TL 39.9 billion, whereas the funds allocated to local administrations amounted to TL 18.5 billion and agricultural supports attained TL 6.8 billion.

The budget revenues rose by 1.8% in real terms in January-June 2014 to reach TL 210.5 billion. There was 20.4% increase in non-tax revenues in real terms, while the tax revenues decreased by 2%. Accordingly, there was TL 5.3 billion transfer from privatization receipts to the Treasury. Tax revenues fell in real terms apart from the revenues banking and insurance tax, stamp duties and other tax revenue items. The slowdown in the revenues from the main tax items can be evaluated as a signal for the sluggishness in domestic consumption and imports in the first half of the year. As a result, the budget performance of the first half of the year is not very successful. Although there was a rise in expenditures, the trend of the revenues was not strong. When we exclude the strong performance registered in non-tax revenues which is related to the privatization income, the slowdown in the tax revenues is annoying in terms of the budget performance for the next months of the year. Furthermore, this situation also indicates that economic growth in the second quarter of the year is also slowing down compared to the first quarter. In sum, although there is no major risk in terms of attaining the budget targets this year, the performance of the budget is not as strong as it was in the same period of the previous years.

Central Administration Budget

*Rate of change in 12 months moving averages (%)

Central Administration Budget January-June January-June Real* Budget 2014

(TL Thousand) 2013 2014 % change Realiz.(%) Budget Target

Expenses 187.870.197 213.856.719 5,1 49,0 436.432.901

1-Excluding Interest 164.569.725 187.393.675 5,1 48,7 384.432.901

Personnel 48.955.863 57.039.091 7,6 51,9 109.969.100

Govern. Premiums to Social Security Ag. 8.073.071 9.586.311 9,6 50,8 18.874.583

Good and Service Purchase 13.340.267 15.206.278 5,2 40,5 37.590.028

Current Transfers 75.332.004 82.962.177 1,7 50,7 163.553.913

Transfers to social security inst. 36.546.096 39.921.028 0,9 51,8 77.059.462

Capital Expenses 11.973.707 13.908.449 7,2 37,9 36.688.695

Capital Transfers 2.205.185 2.706.339 13,3 41,5 6.518.197

Liability 4.689.628 5.985.030 17,8 78,3 7.645.162

Reserve Appropriation 0 0 - - 3.593.223

2-Interest 23.300.472 26.463.044 4,9 50,9 52.000.000

Revenues 190.933.551 210.481.432 1,8 52,2 403.174.813

1-General Budget Revenues 184.523.827 202.203.459 1,2 51,5 392.967.693

Taxes 158.356.768 168.095.251 -2,0 48,3 348.352.781

Non-Tax Revenues 26.167.059 34.108.208 20,4 44.614.912

Enterprise and Ownership Revenues 7.453.499 8.772.042 8,7 107,8 8.140.485

Grants and Aids and Special Reven. 1.086.358 1.165.789 -0,9 74,9 1.556.477

Interest, Shares and Fines 12.187.967 17.047.808 29,1 65,5 26.025.984

Capital Revenues 5.387.077 6.373.470 9,2 72,8 8.749.559

Receivable Collections 52.158 749.099 1226,1 526,0 142.407

2-Special Budget İnstitutions 4.597.117 6.284.893 26,2 87,0 7.222.934

3-Regularity & Supervisory Institutions 1.812.607 1.993.080 1,5 66,8 2.984.186

Budget Balance 3.063.354 -3.375.287 -201,7 10,1 -33.258.088

Balance Exclusive Interest 26.363.826 23.087.757 -19,1 123,2 18.741.912

14

USD/TL

1,1

1,25

1,4

1,55

1,7

1,85

2

2,15

2,3

2,45

02.01.2006

10.03.2006

12.0

5.2

00

6

17.0

7.2

00

6

19.0

9.2

00

6

24.1

1.2

00

6

31.01.2007

04.04.2007

07.06.2007

09.0

8.2

00

7

16.1

0.2

00

7

24.1

2.2

00

7

26.02.2008

30.04.2008

03.07.2008

04.0

9.2

00

8

14.1

1.2

00

8

23.0

1.2

00

9

27.0

3.2

00

9

03.06.2009

05.08.2009

09.10.2009

18.1

2.2

00

9

22.0

2.2

01

0

27.0

4.2

01

0

30.0

6.2

01

0

02.09.2010

11.11.2010

20.0

1.2

01

1

24.0

3.2

01

1

27.0

5.2

01

1

27.0

7.2

01

1

04.10.2011

12.12.2011

10.02.2012

13.0

4.2

01

2

19.0

6.2

01

2

23.0

8.2

01

2

01.1

1.2

01

2

04.01.2013

08.03.2013

14.05.2013

16.0

7.2

01

3

23.0

9.2

01

3

03.1

2.2

01

3

05.02.2014

08.04.2014

13.06.2014

20.0

8.2

01

4

EUR/TL

1,5

1,6

1,7

1,8

1,9

2

2,1

2,2

2,3

2,4

2,5

2,6

2,7

2,8

2,9

3

3,1

3,2

3,3

02.0

1.2

006

10.0

3.2

006

12.0

5.2

006

17.0

7.2

006

19.0

9.2

006

24.1

1.2

006

31.0

1.2

007

04.0

4.2

007

07.0

6.2

007

09.0

8.2

007

16.1

0.2

007

24.1

2.2

007

26.0

2.2

008

30.0

4.2

008

03.0

7.2

008

04.0

9.2

008

14.1

1.2

008

23.0

1.2

009

27.0

3.2

009

03.0

6.2

009

05.0

8.2

009

09.1

0.2

009

18.1

2.2

009

22.0

2.2

010

27.0

4.2

010

30.0

6.2

010

01.0

9.2

010

10.1

1.2

010

19.0

1.2

011

23.0

3.2

011

26.0

5.2

011

28.0

7.2

011

05.1

0.2

011

13.1

2.2

011

13.0

2.2

012

16.0

4.2

012

20.0

6.2

012

24.0

8.2

012

01.1

1.2

012

04.0

1.2

013

08.0

3.2

013

14.0

5.2

013

16.0

7.2

013

23.0

9.2

013

03.1

2.2

013

05.0

2.2

014

08.0

4.2

014

13.0

6.2

014

20.0

8.2

014

FINANCIAL MARKETS

Markets in August… The US dollar continued to rise in the global markets in the beginning of August due to the positive news from the US economy, the escalating tension between Russia and Ukraine and the military conflicts in Iraq between the Islamic state guerrillas and the Iraqi and Kurdish government forces. Thus, the decreasing risk appetite in the markets increased the demand for US dollar seen as a safe heaven. The European Central Bank did not change the policy rates, while saying that it is ready to take further actions. Parallel to this, the Euro/USD parity fell to 1.34. The Turkish Lira also depreciated against the US dollar affected by the high inflation figures of July and the low global risk appetite. The USD/TL parity exceeded the level of 2.18 at the end of the week of August 8, but it soon went back to 2.17. The higher than expected July inflation data also caused the interest rates to rise in the beginning of August. The expected rating statement from Moody’s, the rising conflicts in Iraq and the situation in Ukraine were also sources of concern for the Turkish markets. Consequently the compound benchmark interest rates of the July 13, 2016 bond went up to 9.36%.

The markets were again volatile in the mid-August. After the Presidential elections, there was a relief in the markets as the outcome of the elections signalled the continuation of political stability in the country and the USD/TL parity fell to 2.15. However, the negative comments of the rating agency Fitch again deteriorated the mood supported with the negative global risk appetite. The USD/TL parity rose to 2.16. The Central Bank started to squeeze the liquidity and thus there was a “disguised rate hike” in the markets, and the average rate of the Central Bank funds rose to 8.29%. However, the benchmark rates also rose to 9.4%. The markets were also anxious about the fate of Deputy Prime Minister Ali Babacan and economy management team in the newly establishing cabinet. Later the markets were positively affected by the improving climate in the global markets. The perception that the major central banks will continue to their monetary easing policies increased the risk appetite. Thus, the USD/TL parity went down to 2.14 while the interest rates declined. However, the statement from the rating agency Moody’s indicating that political risks are not surpassed after the Presidential elections again caused the USD/TL rate to rise to 2.16. The compound rate of the benchmark bond did not change much as it was 9.30% as of August 15.

15

Benchmark 13.07.16 Bond Yields (Compound interest rates)

%

4

7

10

13

16

19

22

25

04

.01

.20

07

01

.03

.20

07

27

.04

.20

07

25

.06

.20

07

20

.08

.20

07

17

.10

.20

07

13

.12

.20

07

12

.02

.20

08

08

.04

.20

08

05

.06

.20

08

31

.07

.20

08

25

.09

.20

08

26

.11

.20

08

28

.01

.20

09

25

.03

.20

09

25

.05

.20

09

20

.07

.20

09

14

.09

.20

09

12

.11

.20

09

11

.01

.20

10

08

.03

.20

10

30

.04

.20

10

28

.06

.20

10

20

.08

.20

10

20

.10

.20

10

22

.12

.20

10

16

.02

.20

11

13

.04

.20

11

08

.06

.20

11

03

.08

.20

11

03

.10

.20

11

01

.12

.20

11

26

.01

.20

12

23

.03

.20

12

22

.05

.20

12

17

.07

.20

12

14

.09

.20

12

14

.11

.20

12

10

.01

.20

13

07

.03

.20

13

06

.05

.20

13

01

.07

.20

13

29

.08

.20

13

01

.11

.20

13

27

.12

.20

13

24

.02

.20

14

21

.04

.20

14

26

.06

.20

14

26

.08

.20

14

The FX and interest rates fell with the rumours that Mr. Babacan will be also minister responsible from the economy in the new government and the relatively decreasing global geopolitical risks towards the edn of the month. While the USD/TL parity fell to under 2.16; the benchmark interest rates went down to 9.20. However, the higher than expected US economic data decreased the risk appetite worldwide as it signalled an early rate hike from the US Fed. Thus, the USD/TL parity again rose to the level of 2.18. A new report from Fitch saying that risks related to four large Turkish banks were increasing due to their credit expansion and foreign borrowings also deteriorated the outlook in the Turkish markets.

As the Turkish Central Bank did not change the policy rate, the USD/TL parity went down to 2.15 on August 27. On the other hand, the benchmark interest rates also fell to around 9% as the Bank cut the higher end of the interest corridor from 12% to 11.25%. However the escalation of the conflict between Russia and Ukraine and the rising geopolitical risks again deteriorated the risk appetite in the global markets causing the Turkish lira to depreciate against the US dollar. Therefore, the USD/TL parity closed the month above the level of 2.16; while the benchmark rates were around 9.10%.

The total domestic borrowings of the Treasury reached TL 9 billion, while it repaid TL 12.3 billion in August. Consequently, while the USD/TL rose to the level of 2.1623 in August from 2.1371 at the end of July; the EUR/TL parity decreased to the level of 2.8502 from 2.8611. On the other hand, the average compound interest rate of the benchmark bond rose to 9.06% at the end of August from 8.35% at the end of July.

The domestic borrowing program of the Treasury for September – November 2014 … The Treasury has disclosed its domestic borrowing program for the September – November period. In September, domestic debt redemption is projected as TL 13.1 billion, while domestic borrowing is projected as TL 10 billion. In October, domestic debt redemption is planned as TL 15 billion, while domestic borrowing is projected as TL 10.5 billion. In November, domestic debt redemption is envisaged as TL 5.6 billion, while domestic borrowing is projected as TL 5 billion.

FOREIGN EXCHANGE RATES (1)

31.12.13

(2) 31.07.14

(3) 29.08.14

(3)/(2) %change

(3)/(2) real % change

(3/(1) %

change

(3)/(1) % real change

USD/TL* 2,1343 2,1371 2,1623 1,2 1,1 1,3 -4,7 Euro/TL* 2,9397 2,8611 2,8502 -0,4 -0,5 -3,0 -8,8 FX basket** 2,5370 2,4991 2,5063 0,3 0,2 -1,2 -7,1 Euro/USD rate 1,3774 1,3388 1,3181 -1,5 - -4,3 - * CB’s selling rate. ** 0.5 USD + 0.5 euro. *** The real change has been calculated using the CPI.

16

DISCLAIMER: This document is prepared by the Economic Research Section of Turkland Bank A.Ş (T-Bank) solely for information purposes by using official data and is not in any way intended as a professional advice related to subject thereof. Although utmost care has been taken in their compilation and processing, no responsibility is assumed or no warranties, explicit or implicit, are made for the accuracy or completeness of the information provided in the document, no liability and/or indemnification obligation shall be borne by. T-Bank vis-à-vis any recipient of the present document or any third party as to the accuracy, completeness and/or correctness of any information covered in the document or as to the usage of the information for commercial purposes. T-Bank accepts no responsibility also for the damages or loss to be incurred as a consequence of an investment made relying on the information in the present document. There may also appear opinions, which are of non-factual nature and subject to change without notice for which T-Bank can in no circumstances be held responsible.

Economic Research Section: Dr. Veyis Fertekligil Chief Economist, E-mail:veyis.fertekligil@tbank.com.tr Phone: 90/212 – 368 35 20 Fax:90/212 – 368 34 35

mailto:veyis.fertekligil@tbank.com.tr