LONDON, ENGLAND — Friction between Turkey and Russia has been escalating after a recent military incident, putting pressure on economic ties between the two countries, the European Bank for Reconstruction and Development (EBRD) said on Dec 7.

Following last month’s downing of a Russian military jet by the Turkish air force, Russia has imposed a set of economic and other sanctions against Turkey. Some measures are being put into effect immediately, while others will apply from January 2016, EBRD said.

According to an assessment by EBRD economists of the impact of the measures on economic ties between Russia and Turkey and on the short-term growth and inflation outlook, the sanctions may reduce Turkey’s GDP growth in 2016 by around 0.3 - 0.7 percentage points, if they persist over the next year and are fully applied, with most of the impact related to tourism and occurring around the mid-year.

The impact on Russia’s GDP will be limited, with some moderate pressure on import prices and inflation.
Since the incident on Nov. 24 , the Russian government has issued a decree and a resolution imposing the following measures:

-A ban on imports of certain foodstuffs (mainly fruits, vegetables and poultry) from Turkey, as well as certain works and services (to be further clarified on  Dec. 10);

-A curb on future economic activities of Turkish firms in Russia, although these measures appear to be carefully chosen not to affect current construction activities;

-A ban on new employment of Turkish nationals in Russia (existing employees are not affected and their contracts can be rolled over);

-A major reduction in the number of international road transport permits for Turkish companies (from 8,000 in 2015 to 2,000 in 2016), and the introduction of tighter safety controls in Russian waters and seaports;

-The suspension of bilateral economic cooperation programs and commissions between the two countries;

Turkey’s economy is linked to Russia through several major channels:

-Russia is Turkey’s main energy supplier. Turkey imports 98.8% of its natural gas consumption, with Russia accounting for 56% of these. Turkey’s energy imports from Russia, including oil and natural gas, amounted to US$ 16.5 billion in 2014, which was around 30% of Turkey’s total energy bill, 65% of total imports from Russia, and 2.1% of Turkey’s GDP. Besides energy, other major imports from Russia include metals and grains.

-Russia is the seventh largest exports market for Turkey. In 2014 Turkey’s exports to Russia accounted for 3.8% of total exports and 0.7% of Turkey’s GDP. Foodstuffs made up 20% of total exports to Russia, with other major items including textiles, vehicles and machinery.

-Turkish contractors, especially in the construction industry, have large operations in Russia. The total value of new contracts signed by Turkish construction contractors in Russia in the three years to September 2015 is estimated at around $10-12 billion or 1.2%-1.4% of Turkey’s GDP.

-Russia was the fourth largest foreign direct investor in Turkey in 2014. Russian foreign direct investments in Turkey were around $730 million or 0.1% of Turkey’s GDP in 2014. These exclude property-related investments of Russian nationals, which are estimated at around $400-450 million annually.

Deteriorating economic ties are likely to have a non-negligible, but not major, impact on Turkey’s GDP. If the sanctions imposed so far persist and are fully applied through 2016, they may have a negative impact of around 0.3-0.7 percentage points on Turkey’s GDP in 2016, mainly through lower tourism revenues and food exports, and reduced new business for Turkish contractors in Russia. The bulk of the impact related to seasonal tourism revenues may come around the mid-year.

However, a further escalation of the sanctions cannot be ruled out, in which case Turkey’s country risk premium and cost of funding could rise, causing a larger than estimated impact.
While the macroeconomic impact on Turkey may be moderate, the impact on individual companies with close ties to Russia is likely to be larger. Tourism companies that rely on revenues from Russian tourists and exporters of banned foodstuffs (such as producers of tomatoes, onions, grapes, cucumbers, and chicken and turkey meat by-products) will be affected disproportionately by the sanctions, as will regions that host many of these companies, such as Antalya. Similarly, Turkish contractors with a significant share of their business in Russia may come under pressure.

The effect of current sanctions on Russia’s GDP is likely to be limited. There may be some positive GDP impact in the short term from increased domestic production of foodstuffs and/or higher revenues from domestic tourism.

But the limited capacity in both food production and domestic tourism suggests that any benefits will be largely offset, first, by the increasing production cost in food processing industries as the price of food imports edges up, and second, by a fall in real disposable income, as food and travel services become more expensive.

If the situation escalates to the point of disrupting energy exports, the effect on Russia’s GDP will likely be negative. Turkey is the second biggest export market for Russian gas, with an $8.3 billion volume in 2014 (around 0.6% of Russia’s GDP), providing 18.8% of Gazprom’s revenues. Any disruption to this supply in 2016, which appears very unlikely at this stage, would harm Russia’s exports and GDP.