Wednesday, March 10, 2010

Special Roubini Column: The misleading political calm in Turkey

As I had mentioned before, I recently agreed with Roubini Global Economics to have some of my Forbes and Hurriyet Daily News articles appear on their web site. But as I had done quite a bit of research on my Forbes article on the political situation in Turkey, and as Forbes had specifically asked me not to go into the nitty gritty details, I wanted to do a separate, more detailed piece for their Europe Economonitor. Anyway, the article I submitted is below; you can also find it on their web site.

Coming to the article, I think the reaction of the markets to that melee was noteworthy, especially when compared to Indonesia, who went through a similar political crisis, but without having any effect on markets. RGE has a very nice summary on Indonesian asset markets (subscription-base), and FT looks at the big picture. I, being a narrow-focused Turkey economist, just see this as a warning sign for Turkey: If politics still matter, then maybe your fundamentals are not that strong after all...

BTW, if you want to read more on the Turkish situation, FT has a recent commentary: I liked this one much more than others, and the the idea of the EU process holding powers in Turkey in alignment is logical, but the article still makes the usual mistakes of the foreign media covering Turkey: Labeling the country as black and white (there are many shades of grey; I, for one, do not talk about God and family a lot, but I do tend to care about football a lot, especially after we beat the eziks) and denoting AKP's Anatolian voter base as conservative, pious folk, more or less like the Protestants/Lutherans/Calvinists. But I'd still recommend the article as a complement to mine.

Turkey suddenly came into the spotlight two weeks ago with the arrests of more than five dozen military officers, some of them still on active duty, for an alleged coup plot that would put even the most imaginative Hollywood screenwriters to shame.

The plan, codenamed sledgehammer, was alleged to include the bombing of a major mosque, planting of weapons at the headquarters of religious sects and the gunning down of a Turkish fighter jet (which would be blamed on Greece), all to create the necessary circumstances for a military takeover.

It came to light when Turkish newspaper Taraf published what it claimed were military documents from 2003 detailing the plans for the coup. The military claims that the documents were part of a routine war-game workshop, and its own internal investigations have yet to find any concrete evidence for a coup plot.

But the turn of events caught investors off guard and Turkish equities, nearly two thirds held by foreigners, fell sharply two weeks ago. The reaction of bonds was more muted thanks to their large holding by domestic banks, and foreign currency selling by domestic residents acted as a brake on significant lira depreciation.

To their credit, the key actors were quick to respond: President Abdullah Gul, Prime Minister Recep Tayyip Erdogan and General Ilker Basbug, chief of staff, met at the presidential palace on Feb. 25, helping to ease political tensions considerably. As a result, politics did not impact Turkish assets any further.

But while investors have calmed down for now, there could be more political discord to come. This most recent turn of events is the latest in a series in the long-running conflict between the ruling Justice and Development party (AKP) and the so-called secularist establishment, who see the former's Islamic roots as a threat to the secular nature of Turkey. This is a conflict that is unlikely to die down any time soon.

Some of the frictions are related to the "Ergenekon" organization, a clandestine, right-wing group, which is allegedly trying to topple the AKP by any means necessary, including terrorism. The arrests of not only retired army officers, but also several journalists and academics over the past year, on suspicion that they were part of the group, but often without formal charge, have left many Turks doubtful about the real motives behind their detentions, if not the existence of the Ergenekon conspiracy itself.

For example, the district attorney of the Eastern province Erzincan suddenly found himself behind bars last month after looking into the activities of a religious sect on the grounds that he was also part of the Ergenekon gang, by none other than the special prosecutor of neighboring Erzurum. The ensuing fight between Turkey's top administrative judicial body, the High Board of Judges and Prosecutors, and the local court hint at the deep polarization in the judiciary.

At around the same time, Prime Minister Erdogan disclosed that the AKP would submit a constitutional-reform bill that would focus on restructuring the judicial system. It is no secret that the current constitution, remnant of the 1980 coup, needs a major overhaul. The same can be said of the judiciary, as detailed in the latest E.U. Progress Report on Turkey. But the timing has made many suspect a plot by the AKP to emasculate the judiciary.

The opposition political parties are vehemently opposed to the reform, so the AKP doesn’t have the votes necessary to pass the amendments in parliament and will have hold a referendum 60 days after President Gul signs them into law. The risk is that the referendum will be based not on the constitutional changes, but public approval of the AKP, as latest polls hint that Turks are getting increasingly polarized.

The AKP's victory in the referendum would put a stamp on Erdogan's authority, but a loss would turn the government into a lame duck, forcing it to call early elections. But that is not necessarily a bad thing for the AKP.

Erdogan's party has been losing support in the polls thanks to its dithering on domestic, foreign and economic policy, so an early election might be the safest way to ensure he stays in government. Meanwhile, economic data are expected to turn out deceivingly positive over the next several months after last year's sharp contraction, so the AKP could tout an economic recovery. Therefore, Erdogan may opt for early elections even after a referendum victory despite his recent statement that he has no intention to do so.

On the other hand, it is also possible that a loss in the referendum could accelerate the party’s recent downward momentum in the polls and even result in the extremely investor-unfriendly result of a hung parliament.

But the AKP has other troubles to contend with. Turkey's chief prosecutor, who unsuccessfully tried closing down the party two years ago, is conducting a "routine" investigation into the AKP, and if he is looking for an excuse to prosecute, the same religious sect that cost the Erzincan district attorney his freedom might have handed one to him on a silver platter: two of the congregation's leaders recently admitted to the media that they had asked the AKP to get rid of the district attorney.

This, along with a couple of earlier ongoing investigations, could be sufficient for the chief prosecutor to turn the investigation into one for "breach of securality." The AKP's top brass have already declared that they will call elections if charges are filed. Playing the oppressed and wronged has served the party well in the past, and a recent poll finds that it would again this time.

To sum up, investors may yet be prone to more nasty surprises over the course of next several months. It’ll pay to be wary of any signs of political tension until the clouds over the possibility of early elections, a closure case against AKP and the results of the referendum dissipate.

In the case of more political turmoil, equities will probably get hit most again, with bonds and the currency likely to show more resilience. But the real disaster would be waning of real sector and consumer confidence. Then, the country’s fragile economic recovery could be seriously hampered as well.

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