A New Dawn: Turkey post July 2008

Now that the highly dramatic month of July has finally come to an end, the people of Istanbul can collectively turn a page and look to an immediate future, which appears considerably more certain, if not banal, in comparison to the recent past. The city's bourgeoisie will head to their summer houses in the greater Istanbul region, while the upper classes augment their social status and darker skin tones at exclusive seaside ghettos such as mythic Bodrum.


By mid-September, Istanbul and Turkish current affairs in general will most likely return to their more traditional frenetic cadence. The school year will have commenced, Istanbul traffic jams will be in full-force and the "deep state" Ergenekon trial will steadily gain momentum in the headlines. On the heels of the Turkish national team's truly remarkable and extremely lucky showing in the UEFA Euro 2008 tournament, one must also not forget the beginning of the new domestic football season; more Brazilians playing for Fenerbahce and greater promise for the eternal underdog and this observer's favorite team, Trabzonspor.

While all of the above is well-established on the country's active radar over the next three to four months, this observer is surprised by the relative lack of consideration being given to basic economic variables, which arguably hold the greatest potential to disrupt. It has been quite remarkable to observe how Turkish equities analysts, often quoted in the Western media, have been very quick point out that all of the political intrigue surrounding the country's economy has been "already priced into the market" with apparently great efficiency.

To their credit, the Istanbul Stock Exchange undertook an aggresive ascent during the hours leading up to the court's decision and barely flinched in reaction to the American Consulate shooting at the beginning of July and the more recent "double bombing" at the end of July. While both events were indeed tragic due to the loss of human life involved, both were also quite bewildering in terms of identifying a likely motivation or intended political message. Furthermore, the Turkish state's decisions to attribute the consulate bombing to "Al-Qaeda" and the Istanbul double bombing to the "PKK" were both predictable and unconvincing. The unfazed reactions of equities investors were a testament of the relative insignificance of both incidents.

The financial markets greeted the Turkish Constitutional Court's decision to not close the ruling AK Party with predictable enthusiasm. It was a highly pro-business decision, which this observer accurately predicted in April 2008. The recent sale of Akpet to Lukoil and the Istanbul Stock Exchange's rise from this year's doldrums, which have earned it the distinction of the world's worst performing emerging market exchange in 2008, will remain sparkling examples of Turkey's "new dawn" during the next few months. Nonetheless, certain extremely fundamental concerns, in addition to the slowing Eurozone economy, remain. They consequently demand adequate consideration in order to clearly assess the country's short and medium-term future.

The following are a series of economic issues, some new and others ongoing, that this observer has picked from the headlines over the past few weeks. It is highly likely that some combination of these issues will influence country's political and economic landscape through 2009.

Deutsche Bank AG, the world's biggest currency trader, raised its forecast for the lira against the dollar after Prime Minister Recep Tayyip Erdogan's Justice and Development Party escaped a constitutional ban. The currency will end the year at 1.20 per dollar, Arend Kapteyn, chief economist for Europe, Africa and the Middle East at Deutsche Bank in London, wrote in a report dated today. The bank's previous estimate was 1.41 per dollar.

Source: Bloomberg

Turkey's prime minister, defense minister and military commanders are meeting to appoint a new military chief of staff. The four-day gathering began Friday at the armed forces headquarters in Ankara...Gen. Ilker Basbug, the current commander of Turkey's army, is expected to succeed chief of staff Gen. Yasar Buyukanit, who retires this month.

Source: IHT

"Once the euphoria dies down, attention will again turn to run-of-the-mill issues, like global markets, oil prices, and the domestic macro situation," says economist Banu Tokali of Istanbul brokerage FinansInvest, citing "inflation and monetary policy, in particular, coupled with the still-gaping current account deficit."

Turkey's central bank raised rates a further 50 basis points in July, repeating identical hikes it made in May and June. The latest increase brings the overnight borrowing rate to 16.75%, with the lending rate unchanged at 20.25%. The bank has been cagey about projecting its future monetary course, given the uncertain outcome of the AKP case and the unknown duration of the recent drop in oil prices. But in its July inflation report, the bank hinted at a slowdown in rate hikes. The bank also revised upward its projected inflation rate for 2008, from 9.7% to 10.6%, and pegged next year's rate at 7.9%.

Source: Business Week

Turkey, which could find funding from global markets more easily in the past, had to increase its interest rates to cope with the squeeze. The credit crunch process in the global markets has created a dramatic change in the financing of Turkey's current account deficit.

In the first five months of the year, current account deficit rose 33.3% from $16.16bn to $21.54bn while the total of foreign direct investments and portfolio investments dipped 73.3% from $18.87bn to $5.0bn. Meanwhile, foreign borrowing of banks and companies surged 116.2% from $10.39bn to $22.46bn, an indication that there may be a problem in financing the current account deficit.

Normally, the distress in financing the current account deficit results in a narrowing of imports for investments and production. Therefore, while the current account deficit is moderated, the economy starts to shrink. When companies are unable to find resources from abroad, they are obliged to knock at the door of banks for loans. This increase in loan demand results in the further increase of loan interests.

Source: Referans

Turkey raised its natural gas prices by nearly 20% on Friday in line with a new cost-based pricing mechanism, state pipeline company Botas said, announcing a move likely to increase already high inflation.

The gas price rise was fixed at 16.88% for residential properties and 18.77% for industry, Botas said. The cost-based pricing mechanism, introduced by the High Planning Board from the start of July, applies to all state energy companies and is seen as an important step before further privatisations of power distribution and production facilities.

Before the new system was introduced, electricity prices for industry were raised by 22% effective from July. Electricity companies have not applied to set new power tariffs this month. Rises in energy prices generally have been a major component in Turkey's double-digit inflation. The central bank, which has raised interest rates this year and said it could tighten further, has repeatedly cited energy prices as an inflation risk.

Source: Reuters

Considering the Likely Fate of the AKP

The drama surrounding the potential closure of the ruling AKP party acquired a significant nuance with the decision of Standard & Poor's to cut Turkey's credit rating to three increments below investment grade (BB-) last week. The credit agency attributed its sudden decision to "the increasingly challenging political and global environment that Turkey faces in the near term". Moody's, on the contrary, has decided to keep its rating unchanged, choosing to focus on more fiscal factors for its credit appraisal.

While S&P's credit rating cut was probably a bit rash, its verdict on the Turkish economy was nevertheless inevitable at some point in 2008. After multiple years of robust growth, it has become increasingly clear over the last nine months that the country's economic pendulum has begun to swing away from good fortune. Only the very brave, or ignorant, have argued that the Turkish economy could easily navigate the brewing global downturn. In this regard, S&P's announcement can be taken as the symbolic beginning of a new era of Turkish political-economic history; the good times will no longer roll like they once did.

The current economic situation is not particularly dreary for most segments of the Turkish population other than inflationary pressures on food prices. However, as growth projections are revised due to the impending slowdown in foreign direct investment (FDI), the economy will increasingly experience more unpleasant realities. The mechanics of this impending economic malfunction are largely related to the Turkish economy's need to attract FDI in order to stave off the symptoms of its looming account deficit. In addition to the usual threat posed by cheap imports from China, one of the main causes of Turkey's robust account deficit has been the AKP's legacy of generous public spending. It should also be noted that this spending has made a significant contribution to the party's popularity in certain parts of the country.

Economic issues are perhaps of highest importance to Turkish voters and may have in fact been responsible for the AKP's resounding victory in the July 2007 referendum. It is therefore the opinion of this observer that any attempt to predict how the AKP will weather the current legal storm must be considered in the context of economic factors.

If Turkey's constitutional court decides to advocate the closure of the AKP on grounds of anti-secular activities, members of every single part of the Turkish political and religious spectrum will face a great economic punishment. The reasons for such a forecast are in fact quite simple.

1.) Any legitimate sympathy Turkey in fact has in the EU political universe vis a vis its EU candidacy will vanish over night. Without even the lingering possibility of EU membership, Turkey will become a much less attractive place to a certain breed of foreign investor. Whether Turkey truly needs the EU from an economic standpoint is separate question. What is certain is that "perceptions" of Turkey among investors will be damaged if the EU has reason to distance itself.

2.) While the AKP has probably been partly responsible for the considerable amount of Arab investment from Gulf sources that has poured into Turkey over the course of its political tenure, its actual skill for "economic management" can be isolated to a single issue: stability. As an emerging market prone to natural disasters, military coups, terrorism activity, and domestic turmoil of many kinds, the AKP has been very adept at keeping a lid on Turkey's eternally boiling pot. By Turkish standards, the political scene has progressed quite smoothly over the past couple of years and this has emboldened investors to make greater financial commitments.

3.) Closure of the AKP would require new elections and the creation of a new government. Assuming economic conditions slide as a result of the political turmoil and the EU chooses to take a step back from Turkey, it is quite likely that the Turkish public would turn inward. An introverted Turkish public might very likely gravitate towards the right-wing nationalist arms of one Devlet Bahçeli, the head of the MHP or Nationalist Movement Party. Having won 14.3% of the electorate in the July 2007 vote, MHP might prove to be the biggest beneficiary of a court ruling against the AKP. The social turmoil that this gravitation to the right would entail could become extremely unpleasant and would further stall the country's economic progress.

It is unlikely that the AKP will face closure or that any of these doomsday scenarios will see the light of day. Turkey can nonetheless grasp this moment in its political history as an opportunity to evolve its democratic institution to its next possible level of development.

It may indeed be true that the AKP is at fault for transgressions against secularism. However, Turkish proponents of secularism and other supposed "pro-Western" elements of society would be remiss for decisively terminating the life of a democratically elected political party. While Turkey is a democracy in practice, it remains reluctant to emotionally embrace the kind of pluralism that characterizes the world's strongest democracies. Very few people in Turkey seem to sufficiently trust their government in order to hold the expectation that government will protect the rights of individuals on any end of the political spectrum. It is for this reason that most secular Turks consider it unthinkable for the AKP to protect the rights of women who chose not to wear the headscarf. Conversely, religiously-observant Turks continue to fight for equality in Turkish society, as evidenced by the removal of the law against women wearing head scarves on the grounds of Turkish universities. It is quite unclear whether this particular reality concerning head scarves in universities will endure beyond the era of the AKP.

If the country's constitutional court were to decide to reprimand as opposed to ban the AKP, democracy in Turkey will have taken a giant step forward. By allowing the AKP to persist, albeit under certain constrictions that force it to better "respect" the secularist framework of society, Turkish politics would have gained an important new dynamic. Such a decision would help establish an environment in which the country's emerging religiously-minded values can coexist with its traditionally secular mores and legal framework. In the long term, this is something for which both the EU and foreign investors would enthusiastically cheer.

Head Scarves and Socio-Economic Mobility in Turkey

Few individuals in Turkey or beyond lack an opinion about the AKP's proposal to give young women attending university the legal right to wear head scarves in university facilities. The mere political progress made by this reform convinces many of the country's secular citizens that their country is five years away from resembling Iran - a type of doomsday "back to the future" scenario considering the last great Islamic revolution was in 1979. Western voices, which laud the democratic or Western aspects of these impending reforms, are chastised by the secular elites for not understanding the critical threat of "politicizing" religion in such an important public sphere of Turkey's legally secular society. These elites furthermore derive a feeling of abandonment and perhaps betrayal from the West’s tendency to cite Turkey as an example of the potential for democracy to cohabit with Islam.

In addition to the rhetoric of politicians, Turkey’s secular community has made most of the headlines with flag-waving political demonstrations. There nevertheless exists a less publicly assertive portion of Turkish society, which is a less-widely reported, but is nonetheless growing in importance for the Turkish social landscape. This segment is composed of individuals who are less concerned with issues such as secularism or political symbolism. They desire equal opportunities for religiously observant woman, who want to remain faithful to the commandments of their religion while in the act of receiving a Western-style education in Turkey's universities.

Arguments concerning the validity of religious symbols have enveloped the domestic and international discussion of head scarf reform in Turkey, obscuring other extremely important and equally symbolic aspects of the political initiative. Not simply an issue of religious political symbolism clashing with the original secular values of the Turkish Republic, the crisis over the head scarf is perhaps more importantly symbolic of frictions related to the socio-economic evolution that defines modern Turkey.

As is the case in many fledgling nations, accumulating wealth, increasing one's standing in society or simply creating a sense of security have all been a function of a citizen's proximity to the state. For the first five or six decades of the Turkish Republic's economic history, the state was almost the exclusive orchestrator of economic development in Turkey. Foreign investment was non-existent, entering the economy only by way of various aid packages from the United States and other allies in the West.

The development of many of the substantial conglomerates, which currently rule Turkey's modern economy, accordingly followed this rule of proximity to the state. Vehbi Koç, the founder of Koç Holding, was a mere grocery owner in Ankara during the 1920s. Tapped by Atatürk to become one of Turkey's early captains of industry, his descendants now control an empire of 98 companies that ranks 358th in the Fortune Global 500 of 2006. While the Koç story is extraordinary, it is nonetheless indicative of an economy strongly influenced by the state. Successful participants in Turkey's private sector, in addition to generations of Turkey's armed forces and other state organizations, traditionally acquired great wealth or more moderate financial security due to their affiliation with the Turkish state. Such affiliation naturally included their adoption of state-sponsored social mores - unabashed secularism chief among them.

Free market reforms during the 1980s, which were implemented under the leadership of then Prime Minister Turgut Özal, would prove to have a dramatic, and perhaps unintended, influence on the socio-economic dynamics of Turkey. Privatization of state assets allowed the Turkish economy to develop in new ways and slowly increase its interaction with global markets. This in turn paved the way for a customs union with the European Union in the mid-1990s, greater foreign investment, and ultimately the economic conditions in which a non-state affiliated lower-middle and middle classes could emerge.

This phenomenon was marked by free market economic growth that was not restricted to the traditional Turkish industrial centers such as Istanbul, Bursa or Ankara. During the 1990s and most prominently since 2001, unprecedented levels of prosperity, which were still extremely low by European standards, were also felt in traditionally underdeveloped places like Gaziantep, Kayseri and Konya. Business Week-type clichés such as "Anatolian Tiger" were accordingly coined to describe a phenomenon that would not have been possible two decades earlier. Turkey's president and AKP leader, Abdullah Gül, started his political career in Kayseri. Much of the AKP's current domestic political punch is thanks to the influence of wealthy businessmen from Kayseri and other regions in Anatolia that had been neglected by economic development prior to the free market reforms.

From the perspective of social values, these traditionally poor areas of Anatolia had understandably not bought into the mores of Ataturk's republic quite as enthusiastically as the more economically developed centers. Moreover, the social values and political concerns that had always held sway in these areas did not necessarily evolve due to the greater levels of economic development. Rather, they gained a more prominent political voice since they no longer represented a strictly poor cross-section of society as had traditionally been the case. With the gradual economic development of a non-state affiliated middle class in interior Anatolia starting in the 1990s, values common to interior Anatolia would come to develop a stronger political voice at the national level.

The development of the poorer regions in Anatolia has been a priority of the Turkish Republic since Atatürk's time. While it is true that the state did invest in these regions, it was ultimately capitalist free market actors that would appear to have generated the greatest momentum for socio-economic mobility. While Atatürk no doubt hoped that such an "Anatolian Tiger" renaissance would some day occur in Anatolia, it is doubtful that he would have appreciated the interior Anatolian social values that it has assisted in bringing into the national political arena.

It is ultimately within this framework that one can further consider the great paranoia of the secular Turkish elites concerning the current head scarf crisis. In particular, the emergence of the head scarf issue serves as a reminder to Turkey's secular elites that conservative social-values no longer exclusively belong to the domain of the poor in interior Anatolia. Rather, these values are espoused by Turks, who are steadily growing into sizable middle classes, and who consequently have a much greater will and ability to realize their social interests through politics. While still solid, the secularist economic power base established by Atatürk maintains a weakening grip on the direction of the country.

"Made in Turkey" - but for how long?

During a flight from Istanbul to Europe, this observer had the great fortune to strike up a conversation with a gentleman named Mehmet. Mehmet and his wife, along with half of the economy section of the plane, were on their way to a two week tour of South America. All of the tour participants were of retirement age or older, wore gold watches and jewelery, and lived in some of the nicer residential areas of Istanbul. They collectively represent a sort of golden generation of Turks, who were born toward the beginning of the Turkish Republic. Ataturk's reforms have influenced the entirety of their personal and professional development. They are accordingly some of the staunchest defenders of secular and westernized Turkey, since it is they who largely realized Ataturk's vision and have been its greatest beneficiaries.

Mehmet began his career in the navy as a cadet at Turkey's naval academy and ultimately served as a electronics technician. He spoke with great pride about the technical training he received from the US Navy and also boasted that his daughter completed a masters in electrical engineering from a major American university. When Mehmet left the Turkish Navy, he started a manufacturing business with the technical expertise, which he had acquired during his career. His factory, which is located on the Asian side of Istanbul, has a vibrant business producing electronic components used in televisions made by Turkey's largest household electronic goods manufacturer, Vestel.

Mehmet's manufacturing business serves as a microcosm of Turkey's economic renaissance, which has particularly bloomed during the past few years of the AKP leadership. No longer dominated by state-owned businesses, agriculture and textiles, Turkey's economy emerged from a politically tumultuous period in the 1990s with an aggressive approach and strong support from foreign investors. According to the president of the Turkish Confederation of Businessmen and Industrialists, Rızanur Meral, 60% of Turkey's exports are purchased by European Union members. Turkey's historically weak currency, lower wage levels, emerging domestic economy, long-time NATO membership and proximity to Europe have made it a logical location for manufacturing growth.

While the lure of these conditions continues to prevail for the most part, Mehmet's forecast for the future of his business would appear to have great relevance to the prospects of the Turkish economy in general. "In three years I will have to close my production line," Mehmet predicted. In order to compete with Chinese manufacturers vying for Vestel's supply contracts, Mehmet's business has been forced to cut the price of its electronic components. These cuts will eventually render his domestic production operations completely unprofitable - a phenomenon that is relevant to many of the world's emerging market economies including Turkey.

Mehmet's story exposes one of the many vulnerabilities of the Turkish economy, which this observer views as an increasingly visible theme for 2008. While Turkey's labor costs may be low compared to Western Europe or even most of Eastern Europe, it offers little advantage when compared to India or China. Moreover, raw material costs in India and China benefit from substantial state subsidization. Due to Turkey's considerable trade with Europe, local Turkish suppliers of raw materials have raised their prices to European levels and the Turkish market furthermore does not feature nearly the same level of raw material subsidization.

Throughout 2007 the great strength of the Turkish lira, buoyed by record levels of foreign investment covering Turkey's growing deficit as well as by substantial foreign exchange trading, kept pace with the rising price of oil. Unlike in the US economy, which has felt the effects of higher energy costs, the Turkish economy was relatively buffered. Despite this situation, the following analysis from a Bloomberg article references a chronic fault in Turkey's manufacturing system.

“The essential problem for Turkey is the fact that manufacturers rely on imported goods to make products,” said Şengül Dağdeviren, economist for Oyak Bank in Istanbul. “Whenever exports increase, imports go up accordingly.” Exports rose 30 percent to $11.3 billion in November, a record for a single month, the statistics agency said Monday. Imports increased 29 percent to $16.6 billion in November from the year-earlier period, the agency said.

The Turkish government has responded to this situation by calling for Turkish manufacturers to pursue more value-added products. However, this observer wonders how moving up the value chain for manufactured products will alleviate Turkey's troublesome import-export cycle. Value-added products will make the country's exports worth more, but they will still require Turkey to import the necessary inputs - perhaps even at greater levels of cost.

The Turkish economy thrives on political stability and it appears unlikely that the magicians in the AKP will be able to ensure such conditions for 2008. The political calendar in 2008 will be marked by the inevitably heated battle over the series of constitutional reforms desired by the AKP. In addition, Prime Minister Erdoğan has demonstrated considerable resolve to overhaul the country's social security system, which is a key sticking point for Turkey's relationship with the IMF and with the European Union to a certain extent. At the moment, roughly 8m Turks directly receive social security payments and "90 percent of the Turkish population is directly or indirectly a part of the social security system" according to this article in Today's Zaman.

The legacy of last year's drought, the potential for military activity related to the PKK and interruptions in energy cooperation with Iran and Russia could also contribute to the brewing storm, which will hamper Turkey's economy in 2008. With slower levels of growth predicted for the coming year, Turkey and its AKP-led government must be extremely sensitive to the social and ethnic tensions that will most likely rise as the general climate of economic prosperity dissipates. It is this potential for unrest in Turkish society, which ultimately represents the greatest threat to the near-term progress of the Turkish economy, in addition to the nation at large.

Abdullah Gül's Upcoming Constitution Proposals: Looking at the Glass Half-Full

Now that the Turkish upper classes have returned from their sacred beach holidays and cool winds have at last prevailed on the torturous summer temperatures, Turkey watchers are settling in to observe what should prove to be a rather protracted debate. Turkey's man of the hour, Abdullah Gül, will drop his first bomb shell during the next few weeks. The country's secular elite is more than ready to sound the alarm while the ever enigmatic Turkish military bides its time in the shadows prepared to pounce at any moment.

The substance of this impending commotion will be directly related to Gül's plans to reform the Anayasa, which is Turkey's constitutional document. The spirit in which he plans on carrying out these reforms, as well as some of the particulars of his plan, has been neatly outlined an article from this weeks Economist.

Yet the 56-year-old former economist [Gül] hinted at a looser interpretation of Turkey's unique brand of secularism. Until now this has been defined by Ataturk's renunciation of Islamic symbols and rigid state control over all aspects of religious life. Secularism, said Mr Gul, was a precondition for “social peace” but also offered a model “for different lifestyles”. Some seized on his words as proof that he will support loosening restrictions on the headscarf and religious education.

As Mr Gul approved a new pro-EU cabinet this week, another clash loomed over a “civilian” constitution that Mr Erdogan proposes to adopt next year to replace the current text, written by the generals after their last coup in 1980. Draft clauses leaked to the media are nothing short of revolutionary: senior officers will no longer be immune from prosecution in civilian courts, military appeals courts will be scrapped, Kurdish will be taught as a second language in government schools and the definition of Turkishness will be expanded to embrace citizens from different backgrounds and creeds.

Almost all of the issues above strike at the heart of the national psyche and generally define the way any given Turkish citizen perceives their country. The idea of "social peace for different lifestyles" , whether they be ethnic or religious, is an extremely sensitive one. Particularly among pro-secular and prosperous segments of society, there exists a very strong conviction that there is a single secular, Turkish model by which all citizens of Turkey should abide. When the point is made that certain segments of the country's society, such as the Kurds, might have a different orientation toward "their country", a commonly heard refrain is that, "We are all Turkish people and there is no reason why we shouldn't live together in harmony."

From the perspective of this observer, the idea of Gül's initiative to achieve legal tolerance for other lifestyles is extremely attractive in theory. Particularly in the realms of education and freedom for cultural expression (including language), there are many segments of Turkey's population, which are explicitly denied the types of opportunities that one takes for granted in Western Europe. Indeed, one could argue that if these segments of the population, which exercise alternative lifestyles or cultures, were not the victims of a political agenda, they would cease to represent such debilitating political issues.

For example, less than a decade ago it was legally forbidden to speak the Kurdish language in public. Did not the easing of this restriction help relations between Turkey and its largest ethnic minority? Would not the continuation of this trend as proposed by Gül further augment the level of content felt by Turkey's Kurds?

Similarly, scholars have often wondered whether there is a correlation between the traditional campaign waged by the Turkish government against head scarves and the increasing numbers of Turkish women, who choose to wear head scarves as a political statement. Perhaps an easing on this issue would actually diminish the use of the head scarf as a political issue over the longer term.

These would all be positive developments if it is indeed the case that Abdullah Gül's true intention is to make Turkey a more tolerant of its multiple cultures or "lifestyles". However, it remains to be seen whether his real agenda is in fact religious in nature; a near-term goal to make Ataturk's secular nation more tolerant of other persuasions in order to fulfill a long-term goal of becoming the next Iran.

Whatever the intentions of Turkey's new president, it is the sincere hope of this observer that the Turkish military gives Gül the benefit of the doubt in the near-term at the very least. Anything short of such restraint by the military would make a further mockery of the institution of democracy in Turkey.