When an international news agency described Prime Minister Recep Tayyip Erdogan as “the strongest man in Turkey” last month, it was merely stating the obvious.
In June, Erdogan and his Justice and Development Party (AK Party) were returned to power for a third successive term, mopping up the remaining support of other Islamist and centre-right parties, and coming within a whisker of 50% of the popular vote.
Erdogan overhauled the judiciary through constitutional changes approved by referendum in 2010 and has progressively increased his authority over the once-powerful armed forces – so much so that the force commanders retired en masse in early August, while dozens of generals (not to mention civilians, including journalists) are behind bars in connection with coup allegations.
Now the prime minister is promising a brand new constitution. In the media and the universities, willingness to criticize him is on the decline. His appeal for aid to Somalia raised $200 million in a matter of days as industrialists of all persuasions scrambled for their wallets. And he is widely assumed to have the last word on everything from football match-rigging investigations to incentives for a national automotive trade mark.
Like many commentators and diplomats, Bilal Cetin, Ankara bureau chief for the mainstream daily Vatan, believes that Erdogan is aiming to become president of the Republic by popular vote in 2012 – or, more likely, for two consecutive terms between 2014 and 2024. Significantly, 2023 is the 100th anniversary of the Republic, and the former mayor of Istanbul has promised to make Turkey the world’s 10th-largest economy by then, from 17th at present.
He has also announced a series of mega projects including more high-speed rail links, new satellite cities and a 45-kilometre waterway – a kind of artificial, parallel Bosphorus – linking the Black Sea to the Mediterranean. Given the AK Party’s dominant position, well-organized supporters and popularity among conservative voters, its 57-year-old leader could well be at the helm when the first ship enters the canal.
TROUBLED WATERS
But in the meantime, Erdogan must steer the country through choppy straits. The Cyprus issue is unresolved and membership talks with the EU are spluttering. Before moving to the presidential palace, the prime minister will want to secure a substantial increase in presidential powers, yet he lacks the parliamentary majority needed to change the constitution single-handed – with or without a referendum. “If he cannot get these authorities from parliament by 2014, and if politics follows its normal course and conditions are right, then they may hold an early general election before 2014, in an effort to increase their majority,” Cetin predicts. Local government elections are also due in 2014.
The Kurdish issue presents a more urgent challenge. Newly-elected Kurdish nationalist Peace and Democracy Party (BDP) members of parliament have boycotted the assembly over the disqualification of a fellow candidate, while in the troubled, underdeveloped, mainly Kurdish-populated south-east, Kurdish nationalist PKK terrorists have been killing members of the security forces – mainly conscript soldiers – at the rate of one a day.
Erdogan, who attempted dialogue in 2009/10, has reverted to a hard-line stance, and authorized operations against PKK bases in northern Iraq. “There is talk of civil disobedience. Instead of coming to parliament, the BDP MPs may go and meet in Diyarbakir. Last year they tried not sending their children to school, to claim mother-tongue education. There are many more tactics like this which can be tried. Not even a government with 80% of the vote could solve this issue on its own,” warns Cetin.
OFF BALANCE
Meanwhile, the renewed global downturn has caught the Turkish economy heavily off balance. Year-on-year GDP growth of 8.9% in 2010 and 11.0% in the first quarter of 2011 was accompanied by a surge in the import bill, lifting the current account deficit to 7.5% of GDP last year and a possible 9–10% this year.
The deficit has been covered mainly by short-term capital inflows to bank deposits and the bond market. Not surprisingly, Turkey was one of the emerging markets worst affected by the global sell-off in late July and early August. The main Istanbul Stock Exchange index shed 17% of its value in two weeks, while the lira, which had already weakened substantially since late 2010, shed a further ten cents to test the TL1.80 mark against the dollar for the first time since March 2009. The weakness of the lira has added to concerns about above-target inflation and the external indebtedness of the corporate sector.
Policymakers have come in for criticism. In September 2010, the central bank adopted an unorthodox policy mix of high reserve requirements and low interest rates in a bid to cool the economy without attracting further speculative short-term capital. In July, Governor Erdem Basci dashed expectations that the bank might raise rates once the general election was over by highlighting the danger of an externally-induced recession. Taking its cue from Basci, the Monetary Policy Committee (MPC) cut the weekly repo lending rate from 6.25% to a sub-inflation 5.75% on August 4.
Faik Oztrak, a former Treasury undersecretary who is now one of the deputy leaders of the main opposition Republican People’s Party (CHP), accuses the authorities of exacerbating the current account deficit by permitting short-term capital inflows to fuel rapid pre-election credit growth. He also deplores the mixed signals emitted by the administration more recently.
“When the latest turbulence started in the world economy,” he recalls, “the deputy prime minister and the deputy chairman of the party warned that there was a crisis approaching, but other ministers and the prime minister said that Turkey would not be affected. The central bank governor followed the prime minister’s line, but only a week later the bank moved onto a sort of crisis-management strategy. As a result, our risk premium, reflected in the CDSs [credit default swaps], rose more rapidly than similar economies.”
Oztrak believes that the government is gambling on a positive impact from further monetary stimulus in the global economy. “It appears that they have based their strategy on the assumption that global money will pour in and that this will make the current account deficit a less important target than growth,” he argues. “But we will continue to witness fluctuations in the global economy, and emerging markets including Turkey must be ready to face those fluctuations.”
SMOOTHING THE GROWTH PATH
Professor Guven Sak, director of the leading policy think-tank TEPAV and a former MPC member himself, agrees that the central bank has not communicated well, and has suffered a loss of credibility. But he notes that its unorthodox policies did succeed in creating some “constructive ambiguity”, which was useful in sapping the strength of the lira gradually in late 2009 and early 2010.
Sengul Dagdeviren, chief economist with ING Bank in Istanbul, sees logic in the central bank’s current approach. “ It’s an open-ended question whether Turkey can maintain growth even in very bad global conditions, but they are trying to do everything to make it less severe... [But], if there is a significant change in global liquidity, I don’t think the bank will hesitate to change its overall stance.”
Slower economic activity is expected to cause the current account deficit to peak in the coming months – especially in the event of a lower global oil price – and some analysts see scope for a partial recovery in the lira, which has recently enjoyed some central bank support. Dagdeviren expects the pass-through from the weak lira to push headline consumer price inflation (CPI) up to 7.4% by the end of the year, compared to 6.3% at the end of July and an official target of 5.5%. By the end of 2012, she believes that weaker demand will bring CPI down to 6% compared to the 5% official target.
Official foreign exchange reserves of around $90 billion are “technically not very adequate”, the ING Bank economist admits, and the net short position of the non-bank corporate sector is “huge” at around $112 billion. “However,” she points out, “the corporate sector’s foreign assets are overwhelmingly short term while the liabilities are long term. The short-term net position is only $9 billion. This gives firms the ability to cope.” Dagdeviren also underlines Turkey’s undeniable strengths: a solid banking sector, a healthy budget and a relatively low public debt level of about 40% of GDP.
FISCAL FRONT
The central administration budget was in surplus in the first half of 2010, albeit partly due to ongoing windfall revenues from a tax restructuring scheme. Analysts are hoping that the government will try to preserve its fiscal record when it announces its Medium-Term Programme (MTP) and 2011 budget in October. “We might even get a credit rating upgrade if we do,” suggests Dagdeviren.
Ibrahim Ozturk, professor of economics at Marmara University, Istanbul, believes that the financial sector should have confidence in the ability of the AK Party government and its bureaucrats to manage the economy. “At the beginning of the previous global crisis, there was also a deep loss of confidence between the government and the finance sector,” he explains. “Representatives of the banks were urging the government to sign an IMF stabilization agreement. But the government believed that the finance industry was robust enough, and the performance of Turkey’s banking industry during and after the crisis shows that government was right.”
Today, the professor says, strong public finances give policymakers space to manoeuvre. But Sak points out that non-interest expenditure has been growing in real terms and that a structural fiscal deficit persists. He rues Erdogan’s refusal to accept a fiscal rule in mid-2010 in spite of detailed preparations. “It is true that our government debt is low, but it only takes a few months for debt to increase if perceptions change,” he remarks.
The current account deficit too requires public expenditure to be reined in. “It is public-sector dissavings which are creating this current account deficit and wasteful boom-bust pattern of growth,” says Sak, citing figures showing that the government invested TL43.6 billion more than it saved in 2010, while the private sector invested only TL13.2 billion more.
Deputy Prime Minister Ali Babacan has said that most of the windfall budget revenues will be saved, and that the MTP will take the current account deficit into account. More recently, however, he indicated that the need to support economic activity would also be a factor. “I don’t think there will be a tightening signal in the government’s MTP in October,” comments opposition spokesman Oztrak, citing the upcoming election calendar and the possibility of another constitutional referendum. “I think they want to keep economic activity at a certain level.”
Oztrak’s distrust of the government has been deepened by a decree law published on August 17 which places institutions like the competition, banking, energy, telecommunications and public procurements watchdogs under the direct supervision of government ministers.
“The problem with the AK Party is that they think that once you are elected you should be the only decision-maker and there should be no checks and balances,” he says. “They don’t like those institutions, including the central bank, acting without their consent. This step will signal that the government wants to interfere more and more in the day-to-day operation of the economy and that the degree of discretion in decision making will increase. This is bad news for investors, who would like to see longer horizons.”
THE LONG RUN
“All daily decisions are going to be more politicized,” agrees Sak. At the same time, however, he gives a cautious welcome to the new government’s interest in a new round of reforms in areas like labour markets, tax, industrial policy, judicial procedures and the education system.
“If you want to become the 10th-largest economy, you have to increase the productivity of Turkish labour, and you can no longer rely on rural-urban migration, because 75% of the population is already in urban areas,” he stresses. “And that means you need those second-generation reforms. Either we can be a high-income country or we can get caught in the middle-income trap. Turkey is now right there.”
Even Oztrak has an optimistic bottom line. “The Turkish economy may perform worse than her competitors in the short run,” he forecasts, “but the built-in resilience of the economy is quite high... and in the long run – given the young educated population, the vibrant domestic market and the expertise of businessmen and the labour force in undertaking complex investments and trade relations – the prospects are quite bright.”