Turkey Economy: Storm Clouds

A semi-Islamic society or a secular nation state? Presidential and parliamentary elections in 2007 will help to determine Turkey's future trajectory. President Ahmet Necdet Sezer's seven-year term of office expires on May 16th, and parliament looks set to replace the staunchly secularist head of state with the current prime minister, Recep Tayyip Erdogan, leader of the Justice and Development Party (AKP), a party with Islamist roots. However, secularist and nationalist public opinion, the armed forces and most opposition parties seem determined to prevent the election of Mr Erdogan or any other Islamist. If they do not get their way, the campaign for the general election, pencilled in for November 4th, will be a particularly bitter one.

Pregnant with surprises, the twin elections come at a nervous moment for the economy. Four years of political and macroeconomic stability, high growth and rising business confidence gave way to a murkier picture in 2006. In May, a shift in the international financial climate, following the mismanaged appointment of a new Central Bank governor, prompted volatility on the capital and currency markets. Interest rates rebounded, inflation flirted with double figures and third quarter GDP growth was only 3.4%--although annual figures are still likely to show a 5% rise. Meanwhile, the outsize current account deficit went on growing. The government enacted a long-awaited social security reform and maintained tight fiscal policy, in line with the IMF standby accord, but December ushered in fresh uncertainties as the EU part-shelved Turkey's infant membership talks--regarded as an important "anchor" of financial and business confidence--over Ankara's failure to open up its ports and airports to Greek Cypriot vessels.

Watch for...

*Presidential election. The AKP swept to power in 2002 in the wake of economic crisis, recession and widespread discontent with existing politicians. Thanks to the quirky electoral system, 34% of the national vote was enough to give it a big majority. Secularists believe a creeping Islamicisation of society is taking place through patronage, schoolbooks, tolerance of radical Islamists and similar channels. With Mr Sezer gone, they argue, there will be no check on the legislation the AKP can pass or the appointments it can make. Mr Erdogan is toeing a centrist line, and will not unveil his candidacy until April 15th. This leaves him free to pass over the presidency if the seat becomes too hot, at the risk of his party colleagues falling out over alternative presidential candidates. While talk of a coup is exaggerated, the military will not refrain from clear public statements, and the opposition can organise widespread campaigns and demonstrations. The AKP's Cyprus policies and enthusiasm for EU accession have backfired. Wary of financial uncertainty, big business and the mainstream media may pressure the premier to compromise.

*General election. If Mr Erdogan becomes president, the AKP will go to the polls under a new and less charismatic leader--possibly the current foreign minister, Abdullah Gul, a moderate. The ruling party will count on the energies of its activists and the multiplicity of opposition parties with uninspiring leaders in order to win a second term in office, albeit perhaps at the head of a coalition. Barring major setbacks, it will also seek to play up its economic policy record, although the trickle-down effect of recent growth has been limited.

Risk factors

*Economic policy: The outcome of the political contest may affect economic policy less than the contest itself. The private sector is bracing for months of political antagonism and government and bureaucratic inertia. Privatisation activity could pick up in 2007, after a lean year in 2006, with regional electricity distribution concessions and Halkbank on the block. At the same time the government may loosen fiscal policy in a bid to maintain the pace of growth and engineer a feel-good factor. Given a net public debt of over 50% of GDP, this would attract the opprobrium of the IMF and the financial markets--not to mention the Central Bank, which faces an uphill struggle to reduce inflation to the targeted 4%.

*External balances. The current-account deficit broke the US$30bn mark in 2006, reaching about 8% of GDP due to rapid growth, high oil prices and a still-strong lira. In an election year, the constant financial inflows needed to finance such a large deficit will prove difficult to attract. Foreign investments in private banks and companies helped to bolster capital inflows in 2006, but investor appetites may shrink after the EU move. The lira could weaken at almost any time, potentially driving interest rates and inflation higher, trimming back growth and wounding public and private sector finances.

*Kurdish issues. Violence is on the upsurge in the mainly Kurdish-populated Southeast and elsewhere, despite a partially-observed Kurdish nationalist PKK ceasefire, which is liable to inflame both Kurdish and Turkish nationalism.