Navigating Geopolitical and Economic Risks in Turkey's Defense-Driven Economy: Implications for FDI and Emerging Market Exposure

Turkey's evolving defense policy and geopolitical ambitions have created a complex landscape for foreign direct investment (FDI) and emerging market exposure. As the country prioritizes self-sufficiency in defense production and expands its global military footprint, investors must weigh the opportunities and risks associated with its strategic realignments.

Defense Spending and Economic Implications

Turkey's defense budget has surged to $47 billion in 2025, accounting for 10.9% of its central government budget-a 17.5% increase from 2024, according to a Nordic Monitor report. While that report also notes the spending supports a domestic defense industry with localization rates exceeding 80% and defense exports reaching $5.5 billion in 2023, it also raises concerns about resource allocation. Critics argue that diverting funds from social sectors like education and healthcare could undermine long-term economic growth, particularly amid high inflation (58.5% in 2024) and a depreciating lira, according to the Prisme Initiative. A 2023 analysis found that a one-point increase in defense spending as a share of GDP reduced overall economic growth by more than one point in Turkey, as reported in a Turkish Minute analysis, underscoring the trade-offs inherent in this strategy.

Geopolitical Shifts and FDI Dynamics

Turkey's assertive foreign policy, including military interventions in Syria and Libya, has bolstered its defense industry but strained relations with NATO allies. The 2019 acquisition of Russia's S-400 air defense system triggered U.S. sanctions under CAATSA, disrupting collaborations like the Turkish Utility Helicopter Program (TUHP) with Lockheed Martin and expelling Turkey from the F-35 fighter jet program, according to Nordic Monitor. These sanctions have forced Ankara to diversify defense partnerships, seeking alternatives in Europe and BRICS nations. Despite these challenges, Turkey attracted $11.3 billion in FDI in 2024-a 5.6% increase from 2023-driven by its strategic location and competitive investment environment, according to a Turkiye Today report. However, the Netherlands (23.6% of inflows) and Germany (11.5%) remain key contributors, reflecting the country's reliance on European capital amid shifting alliances (Turkiye Today).

Sanctions and the Defense-Export Nexus

The ripple effects of U.S. sanctions extend beyond defense collaborations. The TUHP's suspension and delays in F-16 procurement have cast uncertainty over Turkey's ability to secure export contracts, potentially dampening FDI in the sector, as reported by Nordic Monitor. Yet, the government's push for indigenous projects-such as the Kaan fighter jet and Kemankeş loitering munitions-highlights its ambition to become a global defense supplier, a point explored in an Atlantic Council brief. These efforts align with the National Artificial Intelligence Strategy (2021–2025) and NATO's Defence Innovation Accelerator for the North Atlantic, signaling Turkey's intent to leverage technology-driven exports (Atlantic Council).

Investor Behavior and Risk Mitigation

Emerging market investors are increasingly hedging against geopolitical risks by shifting portfolios toward real estate and gold. A 2025 ScienceDirect study found that Turkey's housing market and gold prices demonstrated resilience during periods of heightened geopolitical tension, while fixed-income instruments failed to act as safe havens. This trend suggests that investors view Turkey's economy as volatile but are drawn to its strategic assets, such as its geographic position and growing defense sector.

Conclusion: Balancing Ambition and Vulnerability

Turkey's defense-driven economic strategy presents a paradox: while it enhances technological capabilities and export potential, it also exacerbates fiscal and geopolitical vulnerabilities. For emerging market investors, the key lies in assessing whether Turkey's defense sector can sustain growth without compromising social welfare or deepening reliance on volatile capital flows. As the country navigates sanctions, inflationary pressures, and shifting alliances, its ability to balance military ambition with economic stability will determine its attractiveness to foreign investors.