Tuesday, March 9, 2010

Weekly Forbes column: Turkey’s still-ignored political risks

Below is the unedited version of my column for this week. You can read the final version at the Forbes website. As usual, the unedited and final versions are a lot different. The editors always do a very tedious job over there, so I'd always recommend you to read the final version; the drafts are for my archiving purposes only. Feel free to comment or rate the article over there; remember that bad ratings are even more appreciated than good ones, provided they come with an explanation on why you don't like the article.

One surprise is that this article did not get attacked like the previous ones. I guess the loyal readers who were constantly accusing me of being a hired pen for Dogan finally gave up. All for the better:). Not that I am not fond of criticism, but debating my personality and motives rather than ideas was starting to be a bit tiresome...

HED: Turkish Trials And Tribulations

DEK: More political troubles on top of reports of an attempted military coup could lead to a wild ride for investors.

By Emre Deliveli

ISTANBUL - 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.

The turn of events caught investors off guard and Turkish equities, nearly two thirds held by foreigners, fell sharply during the last week of February. Turkish bonds were 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 not a lone incident, but 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.

For example, the frictions have also spread to the judiciary, as a prosecutor going after religious sects close to the AKP found himself behind bars thanks to a colleague. The ensuing fight between the country’s top judicial body, part of the secularist establishment, and the local court behind the prosecutor’s arrests is continuing.

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. While the judiciary needs a major overhaul, as detailed in the latest E.U. Progress Report on Turkey, the timing has made many suspect a plot by the AKP to emasculate the judiciary.

As the AKP doesn’t have the necessary votes to pass the amendments in parliament, it will have to hold a referendum sixty days after President Gul signs them into law. But the referendum could be perceived by the public as not on the amendments, but on public approval of the AKP, as latest polls hint that Turks are getting increasingly polarized.

The AKP's victory in the referendum would then put a stamp on Erdogan's authority, but a loss would turn the government into a lame duck, forcing it to call early elections. The AKP has also vowed to call early elections if the Chief Prosecutor, currently conducting a routine investigation into the party, decides to pursue closure on grounds of “breach of secularity”.

But that is not necessarily a bad thing for Erdogan. His 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. And if there is a closure case, let’s not forget that the AKP has gained from playing the wronged and the oppressed in the past.

Interestingly, while the road to early elections is bound to be bumpy, an AKP victory would be investor-friendly, at least relatively, as the opposition’s economic agenda is anything but liberal and free-market. But the possibility of a hung parliament and ensuing instability, while not a base-case scenario, should not be taken for granted.

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, a repeat of the end-February melee would be the most likely outcome: Equities would get hit the most, with bonds and the currency showing more resilience. Turks are used to political tension, so the real sector and the consumer will be resilient, but significant negative political shocks have affected their confidence in the past; if that were to happen again, Turkey’s economic recovery could be hampered as well.

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