Spectre of change

Feature | 29 November 2016

Turkey has found itself at the centre of an international
effort to contain violence and aggression across Syria and Iraq, and the refugee crisis it has created, while resisting a coup d'état at home. Where has all this disruption left trade?
Anastazia Clouting investigates


From the establishment of the Republic of Turkey in 1923 until 2002, Turkey's government endorsed a unitary, secular model for the state, with the support of the military. Following the victory of the centrist Islamist Justice and Development Party (AKP) in 2002, tensions between the government, the military and elements of the judiciary have complicated domestic politics, with implications for regulatory stability and business operations.

Recep Tayyip Erdogan, the president, was prime minister from March 2003 through August 2014. He became the first directly elected president of Turkey in August 2014, and named Ahmet Davutoglu as the next prime minister.

Suspicion and separatism

Since taking office, the AKP government has curtailed the power of the military substantially. The military fears that Turkey's strict separation of religion and state will be undermined by the AKP following amendments made to the constitution in 2010. The government, on the other hand, believes that some of its critics represent a conspiratorial "deep state" committed to its overthrow.

The AKP lost its majority in the 2015 elections but retained the largest share of seats, prompting the formation of an interim government in advance of polls held early in November that year. On 1 November 2015 the AKP exceeded its previous majority, although it fell short of the threshold for implementing constitutional amendments unilaterally. The Kurdish left-leaning People's Democratic Party (HDP) also gained legislative representation for the first time; its members had previously campaigned as independents.

Regional politics are affected by the status of Turkey's Kurds. The imprisoned leader of separatist Kurdistan Workers' Party (PKK), Abdullah Oslan, endorsed a comprehensive ceasefire in March 2015 following months of negotiations, but the process collapsed in mid-2015 amid ongoing Turkish air campaigns that hit Kurdish as well as Islamic State (IS) targets. The south-east of the country is expected to suffer instability over the intermediate term, and remains under periodic military curfews. The government launched an investigation of 1,200 academics in January 2016 (before the failed coup) after they signed a petition critical of official policy towards the Kurds.

Despite on-going social tensions, Erdogan is expected to dominate the political system over the next decade. His government's aggressive stance towards protesters is expected to bolster his standing with conservative middle class voters, many of whom are small business owners keen to preserve public order. Erdogan may stand for the presidency again in 2019, after which he could make another bid for the prime minister's office. The rotation between roles has drawn comparisons to Russia's Vladimir Putin, whose state-directed growth policies have also sustained popular support.

Failed coup attempt

Erdogan's power was augmented by the failure of a hastily organised coup attempt on the evening of 15 July 2016. A minority of military officers aimed to secure key institutions and arms supplies, but were not supported by the balance of the security forces. Crucially, they also failed to secure major media outlets, enabling the president to communicate directly with the population via Facetime, confirming his physical safety and will to remain in office. Although executive power has grown in recent years, the bid to oust the government, which has a popular mandate, was largely seen as undermining Turkish democracy.

In the aftermath of the unrest, the government blamed the attempt on followers of Fethullah Gulen, an erstwhile ally of the government who denied any involvement from his self-imposed exile in the US. Nevertheless, officials authorised mass arrests. Over 100,000 workers in the civil service, military, academia and media were accused of sympathising with Gulen and lost their jobs. In short, the coup attempt provided a pretext for neutralising remaining critics of the Erdogan government. A three-month state of emergency was imposed in July 2016 and was extended by another 90 days in October. An additional 13,000 members of the police also were suspended in the same month.

Nevertheless, investors have displayed a muted reaction to recent developments, balancing the stabilising effect of growing executive power against underwhelming growth prospects in alternative markets.

Migrant crisis

From 2015, the focus of the international community moved from jihadi travel and supply lines through Turkey to outward migration, as migrants from Syria, Iraq and beyond fled to Europe from increasingly harrowing conditions. Facing a public backlash centred on security concerns and strained entitlement programmes, most countries on the northern and eastern routes into the EU enforced stricter border controls in early 2016, increasing the backlog of migrants stranded in Turkey.

In March 2016, the EU agreed to a direct exchange of asylum seekers, returning migrants to Turkey in exchange for approved Syrian and Iraqi refugees. The EU was also expected to increase aid for migrants in Turkey by 100%, to €6bn (US$6.52bn), and loosen visa restrictions on Turkish passports ahead of schedule, by late 2017. Separately, some educated Syrians complained of being prevented from travelling to Europe and the US after their asylum applications were approved due to their perceived value to the Turkish government.

New borders, new business?

Regional chaos has altered the Middle Eastern balance of power, providing more space for emerging leadership. This has challenged Turkey's status as a moderate linchpin among its neighbours. The outbreak of civil war in Iraq could also alter the region's borders. The Kurds have long lobbied for de facto independence within Iraq, and the fresh outbreak of war has increased the likelihood that they will gain greater autonomy. Turkey also has agreed to export oil directly from the Iraqi Kurds and conduct local exploration in Iraq's northern Qandil Mountains, circumventing the country's central government. The Turkish government continues to target anti-Islamist Kurdish militias active in Syria, however, including those allied to the US.

Turkey has also considered acting as a transit point for Central Asian gas pipelines supplying Europe without Russian assistance amid conflict in Ukraine. Proposals include the US$45bn Southern Gas Corridor project sourced from offshore Azerbaijani deposits in the Caspian Sea, as well as potential routes linking Europe to Iranian and Iraqi supplies via Turkey and Syria. Prior to the Syrian civil war, Syria's government reportedly deflected the proposals, citing the interests of its Russian patron.

Russia had become one of Turkey's major trading partners prior to bilateral tensions over the Syrian civil war. The two presidents each claim an outsized role in their respective political cultures, and have endorsed strong executives bolstered by the power of their public personalities. Following the cancellation of the proposed South Stream gas pipeline project linking Russia to the euro area via Bulgaria, citing EU objections, Russia announced its intention to circumvent Ukraine by supplying Europe via Turkey instead.

In February 2015, Turkey and Russia examined potential Black Sea routes for a successor Turk Stream pipeline, but this was cancelled in December 2015 after Turkey refused to apologise for shooting down a Russian warplane on 24 November near its border with Syria. Following a bilateral rapprochement in 2016, Turkey and Russia began coordinating operations in Syria, with both targeting anti-Assad forces perceived to be in opposition to their individual national interests.

Economic status

Turkey has had an open and mixed economy since the 1970s, but the state still plays a major role in infrastructure, some utilities, selected food-processing industries and banks. The economy has grown since 2010, supported by low interest rates, expanding credit and stronger exports, particularly of precious metals. Iran is a major market for Turkish gold, given the former's difficulties in accessing other external markets under the previous sanctions regime that loosened from January 2016.

Domestic consumption, the main driver of the economy, was bolstered by public investment during the recovery that began in 2010. The government has also encouraged growth through private sector construction in exchange for access to public contracts. Structural reforms to increase competitiveness, property rights and labour force participation are required for a more sustainable growth model, however.

Business and consumer confidence will be affected by periodic social unrest and a languid job market. The growing power of the executive and its response to the coup attempt in July 2016 have bolstered external expectations of political continuity, and the government introduced a range of stimulus initiatives in its aftermath, including mandated interest rate cuts on mortgages. The outlook for stability was offset, however, by renewed signs that the government aimed to direct monetary policy.

The state has lobbied consistently for interest rate cuts to spur consumption since 2002. Erdogan views high inflation as a product of high interest rates, contradicting the consensus of most economists. Any apparent weakening of institutional independence could exacerbate investors' wariness towards the country.

The central bank remains under pressure to boost activity by lowering rates below independent guidance levels, despite recent currency depreciation. In September 2016, public prosecutors accused the central bank of being loyal to exiled government critic Fethullah Gulen, apparently building a case for reduced autonomy.

The central bank announced a 0.25% cut in the benchmark rate to 8.25% that month, possibly in a bid to preclude greater government intervention. The cut followed a series of monthly reductions that began in April 2016. Rate decisions will also be affected by inflation, which was projected to average above the bank's 5.0% target in the immediate term, equalling 8.0% in 2016 and 7.2% in 2017.

Promise and peril ahead

Turkey is exposed to external shocks due to its heavy reliance on short-term capital inflows and demand for imports. Stable growth was expected through 2017, averaging 3.1% in 2016 and 3.3% in 2017, with downside risks presented by reduced exports and tourism. Turkey is the world's largest producer of dried fruits and hazelnuts, and its cities are popular with sun-seeking tourists and religious travelers alike. Tourism fell by 30% in the first seven months of 2016 however, following terrorist attacks in Ankara in October 2015 and Istanbul in January 2016, and the failed coup attempt in July 2016.

The nation also has a large mineral export sector, focusing on marble, chromium ore, copper and boron. Natural gas is an emerging sector, but its contribution depends on increased regional stability. Reduced trade with Europe could be offset by the opening Iranian market, with which Turkey has long-standing ties that endured during the latter's sanctions regime.

In July 2016 Standard & Poor's lowered Turkey's sovereign debt rating to "BB", citing a negative outlook due to weakened institutional checks and balances after the failed putsch. Turkey has an open foreign investment policy and there is no limitation on foreign ownership of property or business. The state has been heavily involved in the past, but intends to privatise most state-owned enterprises. Risks in the future are more likely to emanate from public intervention, rather than private unrest.

Anastazia Clouting is a consultant analyst, global risk intelligence and data, at Axco Insurance Information Services

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