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Graft scandal exposes Turkish economic vulnerability | ASHARQ AL-AWSAT English Archive 2005 -2017
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File photo of Turkish lira banknotes. (Reuters/Murad Sezer)

Turkish lira banknotes are seen in. (Reuters/Murad Sezer)

Turkish lira banknotes are seen in this file picture illustration taken in Istanbul on October 18, 2011. (Reuters/Murad Sezer)

Ankara, AP— For the last decade, an idea has prevailed that Turkey might provide a model for modernizing Muslim countries, combining Islam, democracy and market economics.

By 2012 the country’s economy had grown 64 percent from 10 years previous, making it the 15th largest in the world. Foreign cash was flowing in readily, Erdoğan’s policies were garnering praise from the World Bank, and even global powerhouses like Microsoft and Coca-Cola had come to set up shop on the Bosphorous.

But as Erdoğan enters the last week of 2013, marking almost 11 years of his premiership, a bitter quarrel between him and his former allies continues to escalate which, coupled with the Taksim square protests and their aftermath earlier this year, have left financial markets running scared, punishing the country’s stocks and currency.

Now global investors are rethinking the country, and its risk profile.

Erdoğan took the defense of his administration to the road over the weekend, addressing supporters at six election rallies and lashing out at prosecutors heading the graft investigation, which his Finance Minister Mehmet Simsek called a “soft coup.” Flyers for the ruling Justice and Development, or AK Party, say it’s in a “struggle for liberation” as it seeks a fourth term in power.

Graft allegations led to the removal last week of four cabinet ministers and undermined two of Erdoğan’s strongest arguments for continued leadership: his Islamic-rooted party’s claim to purity and its stewardship of the 822 billion US dollar economy. While Erdoğan led Turkey, a NATO member and European Union candidate, to triple its nominal gross domestic product over the past 11 years, an explosion in private debt over that period pushed the current account deficit to records, increasing susceptibility to capital outflows when risk perception rises.

High domestic interest rates have pulled in short-term capital from abroad, pushing up the value of the Turkish lira. But with cash inflows thus so dependent on foreign money, and with the lira now plummeting to a historic low of 2.1035 against the dollar on Thursday in light of recent events, the future is perhaps a little more worrying.

“The Turkish economy is vulnerable due to its dependency on borrowed money from abroad and the size of the current account deficit,” Anthony Skinner, head of analysis at Maplecroft, a global risk and strategic forecasting consultancy in Bath, Britain, said by email. “There is little to suggest that this crisis will be resolved quickly,” he said. “Investors will continue to seek to sell the Turkish lira.”

The currency strengthened 0.7 percent to 2.1390 against the dollar at 11:08 am in Istanbul today, trimming losses to 5.5 percent since a wave of detentions on December 17 targeted businessmen, the sons of three ministers, and the chief executive of a state-run bank. That brought the lira’s decline this year, which heated up in May with expectations of the Federal Reserve tapering that hit emerging markets as a whole, to 17 percent.

“We didn’t build an economy that can be razed with a gentle wind,” Erdoğan said in a speech in the western town of Salihli in Manisa province Sunday. “We are building an economy for 2023, for 2071,” he said, referring first to the centenary of the republic’s founding in 1923 and second to the 1,000th anniversary of the Turkish victory over the Byzantine Empire in the Battle of Manzikert.

Finance Minister Simsek sought to reassure investors, writing to his 736,000 followers on Twitter on December 28 that markets had largely priced in risk and “when the environment calms, the recovery will be quick.” He also said public support for the ruling party remained strong, so “political stability isn’t at stake.”

But even global ratings agency Fitch Ratings, which affirmed Turkey’s long-term debt vulnerability as “stable” with a BBB- rating, admitted that the country’s heavy reliance on net capital inflows compared to its domestic savings left the country “vulnerable to swings in global investor sentiment.”

Turkey’s large current account deficit, standing at 7.4 percent of GDP in 2013, according to Fitch, is funded almost wholly by this short-term foreign cash, and by portfolio capital inflows. And with an exodus now in full swing, some analysts are predicting trouble.

Earlier this year, and following the Taksim square protests, analysts at global investment powerhouse Goldman Sachs deemed Turkey the most debt-laden of all the emerging market economies.

Since the scandal broke, Erdoğan has exchanged verbal barbs with Fethullah Gülen, a US-based cleric with millions of followers in Turkey, some in powerful positions in the judiciary and police. Before the two men split over issues including Erdoğan ‘s foreign policy and his decision to shut schools run by Gülen followers, the Gülen movement backed the government as it sought to reduce the influence of the military and promote the country’s Islamic faith in the constitutionally secular republic.

Erdoğan now says the Gülen movement has created a “gang” inside the state, and has vowed to destroy it, raising the prospect that parts of the judiciary and executive are effectively declaring war on each other. Interior Minister Efkan Ala, appointed on December 25 when Erdoğan replaced 10 cabinet ministers, said yesterday that a gang within the state “wants to design politics by setting a trap.”

Erdoğan said he would put the high board of prosecutors and judges, which makes appointments to those positions, on trial if he could. The government has removed hundreds of police chiefs from key positions and replaced them. A prosecutor leading a separate corruption investigation said on December 26 that police had refused to carry out orders to detain and arrest people in that investigation. One of the people he sought to question was Necmettin Bilal Erdoğan, the prime minister’s son, according to a document leaked by Radikal newspaper and other local media last week.

“With elections looming, this is political risk galore,” Nicholas Spiro, managing director at Spiro Sovereign Strategy, said in an emailed report Sunday. “One of Turkey’s prized commodities over the past decade—political stability—has been severely undermined at a particularly inopportune time for emerging markets.”