Turkey Economy: Pre-election Year

In 2006, the Justice and Development Party (AKP) government hopes to witness a fourth successive year of financial and monetary stabilisation and economic growth. Since the 2001 financial crisis, tight fiscal policies and IMF-inspired reforms, coupled with Central Bank independence, have restored confidence, reduced debt ratios and slashed interest rates and inflation. In 2005 inflation fell below the 8% end-year target, notwithstanding high crude oil prices. Interest rates fell, credit expanded rapidly and the Istanbul Stock Exchange boomed. Growth, although not as spectacular as in 2004, is thought to have come close to the 5% target. The government is now counting on the latest IMF accord, privatisation and, above all, the EU accession process, which formally got under way in October, to maintain financial confidence and augment foreign direct investment. However, politics will be tense, and tighter international liquidity conditions may threaten the extraordinary strength of the one-year-old New Turkish Lira.

Watch for...

The EU accession process. The screening process that forms the preliminary phase of the EU membership negotiations is well underway. This will determine what changes Turkey needs to make in order to comply with EU legislation under each of the 35 headings around which the talks will be organised. The EU will continue to debate its own budget for 2007-2014, which is expected to include an increase in financial support for Turkey's membership preparations.

IMF policy continuity. The May 2005 standby accord alleviates the government's debt repayment schedule in return for another three years of IMF scrutiny--and healthy primary fiscal surpluses of 6.5% of GNP. The 2006 budget has been drawn up accordingly. Parliament is expected to debate long-term social security reforms, designed to halt runaway deficits, in February.

Privatisation and foreign investment. Although not all have been finalised, an unprecedented US$20bn worth of privatisation deals were done in 2005. The focus will now switch to electricity--starting with local distribution rights--as well as the national lottery, sugar refineries, state banks and more port, motorway and bridge operating rights. Further cross-border mergers and acquisitions involving Turkish banks and other companies could also help to make 2006 another relatively lively year for foreign direct investment.

Risk factors

External deficit. International financiers continued to buy Turkish stocks and bonds and lend generously to Turkish banks and companies in 2005. In real terms, the lira surged to its highest level for 25 years, contributing to lower interest rates, lower inflation and continuing growth but also stimulating imports. Despite record tourism receipts, the current account deficit soared to over US$20bn or around 6% of GDP. Now that interest rates are rising in the US and Europe, the threat of weaker capital inflows and a slide in the lira remains significant. In this event, interest rates and inflation could back up, growth could slow, public finances could worsen and debt problems could arise for companies and households.

EU hitches. Many in the EU oppose Turkish membership. Germany's new chancellor, Angela Merkel, is just one of the sceptics. The accession process is subject to innumerable conditions. In its annual "Progress Report" in November, the EU called on Turkey to exert greater efforts over the next year in areas like freedom of expression, Kurdish language rights, the prosecution of human rights abusers, military-civilian relations and religious minorities. A major potential stumbling block is Turkey's reluctance to open its ports to Greek Cypriot vessels--regarded in the EU as a breach of the existing Turkey-EU customs union.

Domestic politics: The AKP has a large majority and a general election is not due until November 2007--months after parliament is due to elect a new president, possibly the AKP leader and prime minister, Recep Tayyip Erdogan, himself. However, the opposition is demanding an early general election ahead of the presidential ballot. Secularist elements in the political opposition, civil society, judiciary, universities and armed forces accuse the AKP of creeping Islamism, and regard the presidential ballot as a watershed. In foreign policy, the various opposition parties accuse the government of conceding too much ground over EU membership conditions.

Kurdish issues: 2005 saw an upturn in Kurdish nationalist PKK guerilla attacks, government military operations and popular nationalist demonstrations in south-east Turkey. Mr Erdogan has promised to recognise the Kurdish identity and uphold human rights in the region, and is under pressure from the EU to take concrete steps. With Turkish army conscripts regularly losing their lives, to do so could cost him political support elsewhere. Not to do so might only increase the tensions.