August 18 - 25, 2008

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Economic Developments:

Great Idea, Bad Show. The first Turkish-African Summit was held in Istanbul last week with six of heads of state and senior officials from 50 countries in attendance. What started as a lobbying effort to secure a UN Security Council seat has been turning into deeper relations with several African countries, allowing better trade opportunities for both parties. While the Minister of Trade Tuzmen got carried away with statements like “Our exports to Africa will reach $130 billion” which is the current level of Turkey’s exports, it is a good beginning and EPA hopes that efforts to deepen relations will not wane after the October elections for the Security Council. What was bad about the summit is the invitation to and the presence of Omar Al-Bashir, the Sudanese leader, for whom there is a request for an arrest warrant by the chief prosecutor of The Hague-based International Criminal Court (ICC) on suspicion of genocide, war crimes and crimes against humanity over the conflict in Darfur. It was al-Bashir's first trip abroad since the ICC prosecutor accused him of directing genocide in Darfur. The ICC will make a decision in weeks on whether to issue an arrest warrant. Al-Bashir, in an interview with the Al-Arabiya television from Istanbul, said that “Sharia law reigns in Sudan and he cannot accept any court that doesn't follow its rules. We are ready to go through war with the great power to protect the Sudanese citizen." He added that his government would ask international peacekeepers to leave if a warrant is issued. ICC was created by the Rome Statute of the International Criminal Court to which Turkey is not a signatory, to a large part, because of the pressure from the U.S. Turkey, however, has come under pressure recently from the EU, as part of the accession negotiations, to sign and ratify the Rome Statute that has so far 108 signatories. Ironically, Al-Bashir’s and George W. Bush’s views on the ICC are almost identical. Although Bill Clinton signed the Rome Statue in 2000, Bush unsigned it on May 6, 2006. In 2002, the U.S. Congress passed the American Servicemembers' Protection Act (ASPA) that included prohibitions on the United States providing military aid to countries which had ratified the treaty establishing the court. In addition, ASPA has provisions prohibiting U.S. co-operation with the Court, and permitting the President to authorize military force to free any U.S. military personnel held by the court, sometimes dubbed as "The Hague Invasion Act."

Pestling water in a mortar. While Georgia and Russia seem to have diplomatically welcomed Turkey's proposal for creating a Caucasian platform, they rejected to sit at the same table, Georgia refuses to sit at the negotiating table with Russia while under occupation, and Russia and a Russian diplomat, speaking on condition of anonymity, said Moscow had not yet given an official response and was still discussing the Turkey’s proposal, Turkish Daily News reported. Erdogan was in Baku for a day last week trying to soften Aliyev’s reactions for Turkish overtures with Armenia. While engaging Russia rather than isolating it as in the cold war days makes sense, Turkey will need to tread a delicate balance between injecting itself into Russia’s dealings with what Putin sees has his backyard and legitimate concerns of a country bordering with and has economic interests in the region. In an environment where Bush (now Sarkozy in the tow) and Putin are fanning the flames and ramping up polarization, it would make sense to have a saner approach by others (in the EU and elsewhere) as a group. Erdogan’s self-appointed mediator role, however, looks more like a home-made effort rather than a strategically well anchored approach. It may also result in hurting Turkish interests in the region in the short run (see below for the difficulties exporters to Russia are facing) and potential loss of credibility.

A reprieve for Erbakan. President Gul commuted, on health grounds, the remaining sentence of Necmeddin Erbakan who had been serving an 11-month term out of a 28-month jail sentence at his seaside home near Edremit. Erbakan was found guilty for embezzling about TL 1 trillion (around $11.5 million with interest) from the Treasury assistance to Refah Party – AKP’s predecessor- that was closed down by the Constitution Court for anti-secular activities in 1998. Erbakan was the chairperson and Gul, one of the deputy chairpersons of the party at the time of closure. A case against Gul for the same charges was dropped a few months before he was elected as president.

Green Erdogan. During a speech in Rize, Erdogan criticized protesters who believe that the hydroelectric projects planned to be built in the Ikizdere Valley would ruin the delicate ecosystem of the pristine nature reserve, by calling them “an unemployed bunch who has nothing better to do”. He added that he is the best environmentalist and his record as the mayor of Istanbul would attest to it. He gave bringing water from the Melen Creek to Istanbul as an example of his environmental work. Melen, however, is about dry up and its water has toxic contamination. EPA knew that Erdogan liked things green but had no idea about its extent.

Economic Developments:

Oil prices that spiked over $120 a barrel on Thursday closed the week at $114.59 on resumption of flow over BTC pipeline and the reports of reduced demand for oil in the US. Bernanke's speech at the Fed event in Jackson Hole calmed down otherwise volatile markets. ISE-100 lost all its gain from the previous week under a heavy sell off much of the week despite the Friday’s rally when stock prices closed with 3.3 percent gain. Lira remained around the 1.185-1.195 band against the dollar.

Confidence up. Consumer confidence index, published by the Central and Turkstat, for the first time in a year, reversed its declining trend in July. Index stood at 77, up from 75 a month earlier. The consumer expectations survey showed a decline, from 56.9 percent to 54.5 percent, in the percentage of people surveyed who thought that their economic situation in the next six months would be worse than the previous six months. Central Bank's latest business expectations survey showed no significant changes compared the previous survey carried out in early August.

Banks on a roll. According to a report by the Banking Supervision Agency, assets of the banks in Turkey reached YTL 634 billion at end-March 2008, accounting for 71 percent of GDP. Bank profits rose 14.4 percent, totaling YTL 3.9 billion. Figures for the profits for the first half of 2008 showed a 25 percent increase in profits over the same period in 2007, mostly derived from interest income, reflecting high real interest rates. Also interesting is the higher rate of increase in the profits of smaller banks that are trying to increase their market shares.

Limits to bravery? Minister of Energy Guler said that he would visit Iran, together with Babacan, to discuss the gas deal that was not signed during Ahmedinejad’s visit to Turkey and hoped to conclude the deal within a month. Guler denied that the gas deal that would allow Turkey to invest in the South Pars field was not signed because of the U.S. and said that “We are an independent country that knows what it is doing and looking after our national interests.” It is not clear how the intensified diplomatic efforts to convince the U.S. will result. It is unlikely that the AKP administration can go ahead and sign the Iranian deal if the U.S does not drop its opposition. “Turkey will not sign a plannednatural gas accord with Iran unless changes acceptable to global investors are made to its proposed buyback system”, a senior Turkish energy ministry source told Reuters on Friday.

Business not as usual. Turkish exporters have complained that shipments to Russia are being subjected to “full inspections”, causing delays and the waiting time for TIR trucks now exceeds 10 days, costing more than €180 a day. Milliyet reported that there were 200 Turkish TIRs, 70 percent of which loaded with textiles, were waiting at the customs offices in Moscow as of last Wednesday. This sounds like a typical politically motivated intimidation effort by the Russian authorities and require appropriate reaction from the Turkish side, not just Tuzmen raising it with the Russian chargè d’affairs in Ankara.

Wrong Incentives. MInister of Industry Caglayan announced that interest free credits would be provided to exporting SMEs as part of a $650 million program. There is little sense in subsidizing interest rates to prop of exporters while running monetary and fiscal policies that erodes the competitiveness of the economy. It will only to lead to more distortions.

Briefly:

• Turkey’s top administrative court decided to halt government plans to sell the rights to operate highways and bridges for the lack of a legal framework.
• Zurich Financial Services is the leading candidate to buy insurance company, Yapı Kredi Sigorta which has a market value of about $1 billion (€700 million) according to Thursday's closing price on the Istanbul Stock Exchange Vatan newspaper reported Friday.
• GSD Holding has received initial bids to buy a stake in its Tekstilbank. Textile group GSD Holding that has a 75 percent stake in the bank said in March it was working on a possible sale or partnership for Tekstilbank and media reports have said Lebanese businessman Adnan Kassar was interested in buying it.
• Turkcell said that it had signed an agreement with Apple Inc to sell the third-generation iPhone in Turkey.

Global Developments:

Taking their time. Although Medvedev promised that the Russian troops would withdraw from the Georgian territory by the end of the week, they do not seem to be in a great hurry to pull back. Observes reported that troops from the 56th Army were seen leaving Gori on Friday, but Russian forces set up a security buffer zone about seven kilometers (4.4 miles) inside Georgian territory from the South Ossetian administrative border. Russia insists on leaving “peacekeeping forces” behind after the pull out and has made it clear that it will not withdraw from the breakaway territories of Abkhazia and South Ossetia. While Russia claims that it has met the obligations under the Sarkozy-Medvedev agreement, Georgia, as well as the U.S, demand a full withdrawal of troops that entered Georgia on August 8. Russia also reciprocated to NATO’s decision that there could be no “business as usual” with Russia so long as its troops remain in Georgia agreed during an emergency meeting last week. On Saturday, angry Georgians protested against about 20 Russian soldiers who wore peacekeeper badges at a post just outside the port of Poti which is outside the buffer zone that Russia wants to establish at the border with Abkhazia.

Not quite true. Referans, a Turkish daily, reported on Thursday that Kazakhstan was considering pumping its oil through Russia as an alternative to the Baku-Tbilisi-Ceyhan (BTC) pipeline due to increased security concerns over the clashes in the Caucasus. Erlan Idrissov, Kazakhstan’s ambassador to the U.S., has written to WSJ to say that his country plans to continue with the pipeline project. About the Baku-Tbilisi-Ceyhan project, Idrisov wrote that "we have signed a whole set of mutually binding agreements with Azerbaijan and other participants on creating the Caspian transportation system. And let me assure you that Kazakhstan does not even mull the idea of stepping back and leaving the project."

Oooppps! FT reported that Georgia did not believe Russia would respond to its offensive in South Ossetia and was completely unprepared for the counter-attack, the deputy defense minister Batu Kutelia has admitted.

Cute touch! Last week in Tskhinvali, Ossetian conductor Valery Gergiev conducted the Mariinsky orchestra performing Shostakovich’s Seventh Symphony dedicated to the city of Leningrad as condemnation of Nazi invasion of the Soviet Union. Both sides in the conflict accuse each other for using excessive power and the concert, performed in front of the bombed out parliament building and broadcast over satellite to Russia, was a tribute to the victims of recent fighting in South Ossetia.

Shanghai 6-7? The upcoming summit of the Shanghai Cooperation Organization (SCO), focusing on security, economics and cultural cooperation,. will be held in Dushanbe on August 28-29, 2008. The SCO, founded in 2001, groups China, Russia, Kazakhstan, Kyrgyzstan, Tajikistan and Uzbekistan. The SCO accepted Mongolia as an observer to the organization in 2004 and offered observer status to Pakistan, Iran and India in 2005. Iran is expecting to be a member of the group after the Dushanbe Summit. Turkmenistan and Afghanistan are also expected to attend the summit as observers.

Scary for investors. FT reported that investors pulled their money out of Russia in the wake of the Georgia conflict at the fastest rate since the 1998 ruble crisis. Russian financial markets have also suffered sharp falls since August 8, with yields on domestic ruble bonds increasing by up to 150 basis points in the past month. FT also reported that Ukraine's CDS have risen sharply since August 8 as the markets got nervous over potential conflicts with Russia stemming from disagreements about the use of the Sevastopol base, among other reasons.

Brought back bad memories. An earthquake registered 6.0 on a 12-level scale shook Tashkent on Friday, rocking buildings and forcing people on the streets with confusion, There were no immediate reports of casualties. Tashkent was leveled by a 7.5 earthquake when hundreds of thousands of people were left homeless in 1966.

Can’t sew, so he can’t leave. A court in Chita (Siberia) overruled the appeal for conditional release filed Mikhail Khodorkovsky who is serving an eight-year sentence in the colony near Krasnokamensk town of the Chita region. Khodorkovsky said, if freed, he would quit the oil business for good, and devote his life instead to humanitarian work and his family. Chief of Chita Detention Facility Vladimir Klyukin urged the court to reject the appeal as “Khodorkovsky should remain in the place of detention to reform.” Apparently he failed to reform because he has been refusing to attend sewing classes offered in jail.

Correction: In the last week’s review, the port for Russia’s Black Sea Fleet's base was referred to as Odessa in error. It should be corrected as Sevastopol.

What to expect this week:

Equity markets in Europe and Asia are likely to have a rough time, although CPI data from Germany, Italy and the United States as well as better than expected Q2 US GDP growth may ease anxieties later in the week. The latter would also strengthen the dollar against the euro further. EPA expects a much slower pace in the decline of crude oil prices than it has been the case in the last four weeks. Turkish markets will continue to reflect the global volatility.

August 24, 2008

August 11 - 17, 2008

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Political Developments:

A trip wasted? Iran’s President Ahmadinejad was in Istanbul for two days during which the traffic on the European side of Istanbul was pretty much paralyzed because of road closures. Even Ahmadinejad apologized for the inconvenience that zealous Turkish officials have caused for the Istanbulians . The Guardian reported that “Turkey delivered a humiliating snub to Iran's visiting president by backing out of a lucrative energy deal under pressure from the US government, which feared it would enhance Iranian nuclear ambitions.” Ahmadinejad’s trip, branded as a “working visit” for him to avoid visiting Ataturk’s mausoleum in Ankara, was intended to sign a major gas deal that would allow Turkey to invest in and purchase gas from South Pars fields. It was reported that Turkish officials had to agree not sign any gas deals under heavy US pressure. "Such a deal by Turkey with Iran would send the wrong message at a time when the Iranian regime has repeatedly failed to comply with its UN Security Council and IAEA obligations," said the state department. At a time when Russian intentions on the Caspian oil and gas are unmistakably clear and how Gazprom has been toying with gas prices for Ukraine is not a joking matter, it is difficult to understand why Turkey could be left overly dependent (close to 70 percent) on Russian gas supplies for at least another winter. W will be cutting wood in Crawford, TX if Gazprom decides to turn the tap off in a cold January in Turkey. On a separate note, at a press conference which was interrupted by a visit to Blue Mosque for Friday noon prayer, Ahmadinejad said that he supported Turkey’s EU bid and did not understand EU imposing conditions in an unacceptable manner. That may have sounded like music to his hosts’ ears who have had similar problems in understanding the accession process.

Ban Ki-Hu? Secretary-General Ban Ki-moon has so far been unable to contact Russian President Dmitry Medvedev by telephone to discuss the crisis in Georgia, a U.N. spokesman said on Friday. Ban has spoken to Georgian President Mikheil Saakashvili, who called him on Thursday.
He wasn’t alone. It turns out that the Secretary General was not the only one whose calls were not returned. Erdogan ended up flying to Moscow where he met Putin and Medvedev before flying off to Tblisi to comfort Saakashvili. It is not clear how the Russians took Erdogan’s offer to mediate. Russian press reported that Turkey was supporting Russia and the fact that US ships were not allowed thru the Bosphorus was and example of it without mentioning the fact that the Montreux Convention severely restricts the passage of warships from the non-Black Sea states and imposes advance notification requirements. EPA hopes that the administration understands that influencing territorial borders in the Caucauses is more complicated than changing the master plan for Silivri. The Caucauses Stability Pact, an idea that has been around for a number of years, that Erdogan was peddling in Moscow

As messy as it can get. UK’s Tesco supermarket chain got entangled in messy real estate deal where Saban Disli, one of the deputy chairpersons of AKP – the ruling party- is being accused of taking a $1 m kickback for facilitating the amendments to Silivri’s master plan that allowed changing zoning to a commercial property, and tripling its market value to $13 m. Disli denied any wrongdoing as did Tesco.

Economic Developments:

Turkish financial markets muddled through last week, on one hand, trying to gauge the global markets, on the other hand, attempted profit taking when they can. YTL appreciated against the Euro by about 2 percent while the dollar floundered between 1.179- 1.1850 range.


Taking a break! The Central Bank left its benchmark interest rate unchanged, taking a break from three months of increases despite the signals of slowing down in industry and the construction sector. Turkey has the highest key rate, among 59 countries tracked by Bloomberg, so far making it possible run up an unsustainable current account deficit.

Must be Ergenekon. Last week, Turkstat published the index of industrial of production for the month of June. It registered a meager 0.8 percent growth y-o-y and a decline of 2.3 percent over the previous month. While no minister so far blamed it on Ergenekon – a semi-science fiction court case against would-be coup plotters-, it would not be surprising to hear soon that slowdown in industrial growth was also an Ergenekon plot. On a more serious note, textiles suffered a major decline in June, registering a 21.4 percent decline y-o-y, production of electronic appliances (tvs, radios) declined by 20 percent. Even the automotive industry that has been propelling exports declined by 5 percent over May 2008. EPA estimates that July industrial production index will register a decline in the 4 to 6 percent range. Given the serious concerns about a eurozone recession, Turkey’s major trading partner, a slowdown in exports would lead the drop in industrial production. Disruptions in Georgia, particularly in Gori that is a transit point for Turkish trucks heading to Nothern Caucauses are also likely to slowdown in production and exports.

More unemployed but same unemployment rate. Turksat published May 2008 unemployment numbers that remained at 8.9 percent, the same level as in May 2007. Non-agricultural unemployment that EPA tracks as a more reliable indicator also remained unchanged at 11.5 percent. While 442 thousand new jobs were created in the non-agricultural economy during the last 12 months, the rate of unemployed rose by 41 thousand during the same period. If those at the working age but not actively seeking employment are included, a more realistic estimate of the unemployment rate would be 16.4 percent.

The debate goes on. Whether Turkey should have an agreement with the IMF or not has been going on for more than four months now. It looks like that the Fund is not happy with some of election spending items that were put into the budget (e.g. block transfers to local governments) and urges the government either to drop them or find financing(e,g. more taxes). With the economy slowing down and six months before critical local elections, it is unlikely that the Government can stomach either option. The fact that there are disagreements on a program is bad signal itself, a lesson that Simsek seems to learn by trial and error.

Global Developments:

Vlad the Impaler? Russian invasion of Georgia took up much of the last week's global events, The top item on the list that BBC’s Paul Reynolds drew up as early lessons from the conflict is that “Do not punch a bear on the nose unless it is tied down”. That aside, there are couple of important conclusions that can be drawn. First, Putin is in charge, playing the bad cop while Medvedev is playing the confused good cop. Second, Russia is very and determined to deal with thorns this time. It wouldn’t be surprising to see clashes in Ukraine sparked by the Black See fleet hosted in Odessa or events that would accelerate the annexation of the Transdniestr breakaway region in Moldova. Third, it is a matter of months before westbound land access – road and rail transport, oil and gas pipelines- of Azerbaijan and the Central Asian republics will be under directly or indirectly under Russian control. This effectively kills the new enterprises like Nabucco and others at the design stages, leaving the Iran-Turkey route as the only plausible transit corridor with its own risks. That is, of course, if the US does not start a military engagement with Iran before W leaves the office so he can crown his legacy of failed wars. Fourth, after almost two decades, West still has no clue about how to deal with Russia and for that matter other republics of the former Soviet Union. Fifth, it is also not clear how keen the leaders of the breakaway regions to join Russia as these areas have become centers of smuggling and contraband trade and sources of rents for the local rulers. While the cease fire agreement stipulates withdrawal of Russian troops from Georgia on Monday, the news reports so far are not very encouraging.

More to come? The 15 economies of the Eurozone as group declined by 0.2 percent in the second quarter, reflecting contractions in the German (-0.5 percent), French (-0.3 percent) and Italian economies, increasing concerns about a recession in the eurozone and spreading across the channel to the U.K. The signs of slowing down to Asia's emerging economies have began emerging. The Chinese Government revised down its own GDP projection to 7.7 percent. The fears of spreading economic gloom triggered a sell-off in commodity markets and started a downward trend for the commodity markets that will only price supply constraints now rather than expectations of a booming demand. In what is labeled as "macro risk switching", dollar is like to continue strenghtening despite the fact that doldrums in its financial markets are far from being over.

What to expect this week:

There will be a stream of not so good news from the European and Asian markets. Turkish markets will try to balance between the those and the signals from Wall Street that is likely be volatile.

August 17, 2008

August 7 - 10, 2008

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Political Developments:

"What is the charge?”
“Unnecessarily occupying the left lane”

It is reported that CHP, the main opposition party, is establishing a museum to commemorate its 85th anniversary. EPA thinks that it is an appropriate move to house the current management of the party.

PKK escalates attacks. Kurdish rebels threatened on Friday to stage more attacks on economic targets in Turkey, days after claiming responsibility for a fire at a key oil pipeline, a pro-Kurdish news agency said. The Baku-Tblisi-Ceyhan (BTC) pipeline has been shut down since August 5, cutting a throughput that has averaged over 850,000 barrels a day in recent months. Turkish authorities initially said that the explosion was due to technical reasons. On August 7, however, the People’s Defense Force (HPG), the military wing of the Kurdistan Workers’ Party (PKK), issued a statement claiming that the explosion was the result of sabotage by one of its units. BP PLC (BP), operator, and part owner of the Baku- Tbilisi-Ceyhan oil pipeline has warned of a 21-day delay on Azeri crude lifting from the Ceyhan terminal, Turkey, traders of Mediterranean crude said Friday. While BP has said one of its alternatives to transport some of the spare Azeri crude would be to use rail links through Georgia, in view of conflict that broke in South Ossetia Friday, this option now looks almost impossible. Rerouting the crude to Russian Urals pipeline system through Novorossiisk would downgrade it to Urals quality, resulting in a loss of more than $4 a barrel, traders said. In separate incidents, a mortar attack on the headquarters of the 1st Army in Istanbul failed, but attacks on gendarmerie posts in Mus and Elazig took the lives of two soldiers last week.

A partial tinkering? It is reported that AKP has given up the complete overhaul of the 1982 constitution but decided to introduce a “democratization package” involving amendment of about 40 articles, including those on the closure of political parties, once the parliament is back from its recess.

Really? Investigators from the Religious Affairs Department, looking at the explosion and the collapse of a dormitory that took the lives of 18 girls aged between 8 - 16 last week, claim that the dorm housed students attending an English course, and not a Koranic school as widely reported in the media!

Not too soon? AKP Deputy Chairman Edibe Sozen withdrew a draft legislation to “enhance youth protection” following fierce reactions from many quarters. The draft law proposed construction of places of worships for students from all religions at schools and providing identification for those purchasing pornographic materials.

World is changing? More Russians than Germans have made their way to the beaches of Turkey for the first time this year. In the first seven months of 2008, 1.27 million Russians went on holiday to Turkey, compared to 1.21 million Germans. Last year, the numbers were approximately 4 million Germans and 2.5 million Russians. According to Bild.de, German travellers are enraged by the Russian invasion. Moscow finance agencies report, however, that Russians spend eight times as much as Germans when on holiday.

Economic Developments:

Last week, the euphoria that swept the Turkish financial markets after the non-closure verdict, has died down. As predicted, ISE, decoupled from global markets, 5.3 percent of its value while SP-500 gained 3.8 percent during a volatile week as stocks dived and rallied on alternate days. Oil prices which spiked to over $120 on the news of BTC pipeline explosion a day earlier, closed at $115.2 on Friday. Another significant development of the week was also the reversal of fortune for the dollar. It rallied against other major currencies and gained 3.3 percent against a basket of these currencies.

A bottomless pit? Current account deficit in widened 78.2 percent year-on-year to $5.6 billion in June, bringing the deficit for the first half of 2008 to $ 27.3 billion, according to a report released by the Central Bank. Rapid growth in imports and slower export growth contributed to the widening of the current account deficit despite better than expected tourism revenues. Private sector borrowing ($21.4 billion) financed more than three quarters of the deficit during the six month period. DFI declined to $5.8 billion from $11 billion and portfolio investment plummeted to $1.7 billion from $6.0 billion during the first half of 2007. Private sector’s external debt is estimated to have risen to $180 billion at end-June from $158 billion at end-2007. Much of the private sector borrowing was in the form of syndicated loans to the banks and large corporate groups. While most market analysts as well as Minister Simsek expect the deficit exceed $50 billion, EPA expects that financing will become a constraint and limit the deficit to $44 billion to $46 billion range unless the Government decides to use up reserves.

Central Bank published its expectations survey for the first half of August. It reflects the post-verdict optimism in terms of growth and exchange rate expectations. Year-end inflation expectations, however, were upped to 11 percent.

It’s all IMF’s fault. Minister Simsek said that Turkey's economic success depends on having a reformist government rather than on any IMF program and that large current account deficits were the result of IMF programs. EPA agrees with the minister, however, thinks that it is easier to sign a deal with the Fund than looking for a reformist government. Simsek added that “Turkey needs to focus on developing its physical infrastructure and human capital to increase its competitiveness in the future and it cannot expect help from the IMF doing this. The areas which we need to work on are the issues outside the IMF's typical specialisation field." EPA reads this as a clear signal of Government’s clear intention not to have a formal program with the Fund.

HSBC is sharpening its focus on Islamic lending in Turkey and across the Middle East, the deputy general manager of its Turkish unit told Reuters in an interview. He said the bank this year had issued some 6-7 Islamic murabaha facilities, under which a financier buys a commodity and sells it to the customer at a higher price, complying with Islam's ban on interest. But he said that the volume of such syndications was set to decline to $300 million-$400 million this year from $500 million- $600 million a year earlier due to global market conditions. "There is a serious contraction in international lending markets and this has had an impact on Turkey. There is a change in the profile of investors and a decline in liquidity," he added.

Minister Simsek, in a gathering of business people in Tatvan. told that regional investment and tax incentives will be put in place in 2009. EPA has concerns about the fiscal impact of half baked incentive schemes in the absence of an industrial strategy. So far, the Government has not been able to put in place any strategic framework in any sector.

Global Developments:

A first? Russian troops engaged an army of a former Soviet republic for the first time. Escalating tensions between Tbilisi and Tskhinvali since April when Russia declared expanded support to South Ossetia and Abkhazia led to clashes between the South Ossetian and Georgian forces in July. Russia started reinforcing the 58th Army positioned in the Northern Ossetia. The trigger for the fresh escalation began last weekend, when South Ossetia accused Georgia of firing mortars into the enclave after six Georgian policemen were killed in the border area by a roadside bomb. On Friday, what was labeled a “frozen conflict” so far turned into armed strife with Georgian troops taking over the control of Tskhinvali and parts of South Ossetia. Late Friday, Russian 58th army rolled into South Ossetia and Russian Air Force bombed the port city of Poti, Gori, Vaiziany military base near Tblisi, and airfields in Delisi and Kutiani. While the Georgian authorities said that bombs fell not to far from the BTC pipeline route, it is not clear whether the pipeline was specifically targeted during the air raids. On Saturday, Abkhazia joined in the action, attacking Georgian positions, particularly in the Kodori Gorge together with the Russian forces. Putin, just back from Beijing arrived in North Ossetian capital Vladikvkaz to “coordinate humanitarian assistance.” Cease fire attempts, so far, have failed. EPA speculates that the Russia’s military intervention may have multiple objectives including (i) discouraging the former Soviet republics from flirting with NATO membership, particularly Ukraine; (ii) making the point that oil and gas transport bypassing Russian territory may pose risks, particularly when the competition between Nabucco and South Stream is fierce; and (iii) toppling Mikhail Saakashvili who became a thorn for the Russian dominance in the Caucuses. It is also hard to imagine that Saakashvili would have taken on Russia without any promise of support from the West. But it looks like George Bush is busy playing beach volleyball in Beijing.

What to expect this week:

Oil markets may take a pause from its downward trend, responding to the developments in Georgia and price potential impact of the conflict on long-term availability of the BTC pipeline. Turkish stock market is likely to be concerned about the widening current account deficit and the signals from the Government on future of the Turkey's relations with the IMF.

August 10, 2008

July 28 - August 6, 2008

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Political Developments:

At last, a verdict! The Constitution Court ruled not to ban the ruling Justice and Development Party (AKP) with a six to five vote last week. It, however, imposed a did impose a financial penalty stripping the party of half its public funding next year (about $20 million) with a ten to one vote. While the Chairperson of the Court, in his statement, said that the verdict was a strong warning for AKP, it is clear that the party brass has seen as a vindication and retorted that the case should never have been filed in the first place.

These developments turned out to be different than EPA’s expectations that the verdict would lead to AKP’s closure that would trigger snap general elections. Indeed, the 6-5 ruling was a close call. Why the court’s decision went in that direction has been a staple for the Turkish media, feeding on speculations about the “secret meeting between President Gul and Prime Minister Erdogan” the night before the verdict, whether the court followed the appropriate legal procedures and how Mark Parris, a former US Ambassador to Turkey, could have been so sure about the outcome, and so on. While the verdict has ended a prolonged period of political uncertainty, it has done little to release underlying political tension. On the contrary, it exacerbated polarization in the society. On Wednesday, markets were rattled again with reports that a new case for closure could be filed, based on a Reuters report.

While EPA believes that political tensions will continue to persist, it no longer expects that early parliamentary elections will be called for a “mandate renewal”. Erdogan is unlikely to risk an election in the face of rising inflation and worsening overall economic situation even though no credible opposition exists.

There are expectations that Erdogan will reshuffle the cabinet, realigning the representation of AKP fractions in the government within the next two months. It is also expected that a draft constitution will be tabled once the parliament returns from its summer recess at the end of September. Discussions on the new constitution are likely to create controversy particularly if AKP decides to exclude the opposition and civil society institutions. A referendum on the new constitution or the municipal elections, scheduled for March 2009, will be the next step in testing the popular support for AKP whichever comes earlier.

Wildfires destroyed more than 10,000 acres in Antalya, leaving two persons dead, and dozens homeless. Six villages have been evacuated in the Manavgat and Serik districts. The fires destroyed 60 houses, a school, a mosque and a dozen barns.

The Ice Warrior? General İlker Başbuğ was appointed as the new chief of General Staff following the retirement of General Yaşar Büyükanıt as the country’s current top commander at the end of the month. The Supreme Military Council (YAŞ) has concluded its annual four-day meeting and defined the new command structure without any real surprises. For the first time in a long while, though, the military did not expel any personnel engaging in fundamentalist religious acts. The Sunday Times reported that General Basbug “is called in military circles the “ice warrior” because he has a reputation for being calm and pragmatic. Sandhurst-trained Basbug, 65, will have the top job for the next two years. He is a formidable military figure and an ideological hardliner who will ensure that Erdogan’s government - which was elected last year with 47% of the vote but is mistrusted by the military, which sees itself as guardian of a secular society - walks a narrow political line.” According to Sunday Times, “Erdogan is wary of Basbug and would have preferred to have appointed someone else, but I’d be very surprised if he would be stupid enough to try to stop Basbug. This is no time to upset the armed forces’ hierarchy,” said the military source."

Economic Developments:

Markets went on a joyride after the verdict. ISE-100 gained 10.7 percent within a week. In what Greenspan would have called irrational exuberance, lira appreciated 4.3 percent against the dollar and 5.7 percent against the euro. Treasury paper rate declined by about 100 b.p. The buying spree ended on Tuesday when ISE-100 lost 3 percent of its earlier gains.


Inflation accelerated to its fastest pace in more than four years with the CPI increasing 12.1 percent (y-o-y) and the PPI 18.4 percent in July. According to the Central Bank, the increase in power tariffs that took effect on July 1 has contributed 0.5 percentage points to the CPI increase of 0.58 percent in July over the previous month. Core inflation – EPA uses Turkstat’s D series that exclude energy and unprocessed food – was running at 10.64 percent, pointing out that price pressures are not solely coming from energy and food. Last week, Central Bank published its inflation report for the third quarter, a week ahead of the publication of July inflation data by Turkstat where it argued that the increase in core inflation – The Central Bank uses Turkstat’s I series – was due to the depreciation of lira during the second quarter. EPA believes that the Central Bank is off the mark in its assessment of sources of inflationary pressures and its forecasts for the end-year inflation figures. The secondary and tertiary impact of increases in power and gas tariffs has not yet worked themselves in. Although declining oil prices are likely to offset part of the further adjustments expected in these tariffs in the months ahead, EPA expects that the year-end headline inflation is more likely to be in 14-16 percent range. Central Bank's monetary policy committee is scheduled to meet on August 15 to decide on interest rates which are expected to remain unchanged.

Trade deficit reached $37.0 billion during the first half of 2008, representing a 33.6 percent increase over the previous year. Imports rose by 36 percent to $19.5 billion, overtaking the growth in exports that slowed down to 31 percent. Untamed increase in imports and relatively slower growth in exports will add to the burgeoning current account deficit that is financed by a rapid increase in private sector borrowing as seen by a range of syndicated loans contracted by the banking sector and to a lesser extent the corporate sector.

Ministry of Finance reduced the target for 2008 budget deficit to YTL 15.9 billion ($13.3 billion) or 1.6 percent of GDP because of higher than expected tax revenues. It also increased the target for primary surplus to YTL 39.8 billion (4.1 percent of GDP) from YTL 38 billion.

Standard & Poor's Thursday revised its outlook on Turkey, affirming the country's credit rating at "BB-". "The stable outlook on Turkey balances the improvement in the republic's external financing prospects and underlying fundamentals against its vulnerability to financing shocks," S&P said."If the government continues to reduce the economy's vulnerability to external financing shocks through continued reform and fiscal consolidation, the ratings on Turkey could improve."

IMF declares victory. The Executive Board of the International Monetary Fund (IMF) concluded the Ex Post Assessment of Longer-Term Program Engagement (EPA) and the Ex Post Evaluation of Exceptional Access (EPE) for Turkey on August 1, 2008. The Fund Board said, in a public information note, that "Turkey still faces challenges to entrench macroeconomic stability, and that disciplined macroeconomic policies will be needed to continue reducing public debt ratios and restart disinflation. Turkey would also benefit from further progress in structural reforms, especially in the fiscal area. " The Fund Board said that "the Fund should be prepared to explore all available options for future IMF engagement."

Turkey's iron and steel sector now ranks 11th among the 15 leading producer countries, producing 25.8 million tons, or nearly 2 percent, of the world's aggregate crude steel last year according to the 2007 Iron & Steel Sector Report published in June. Turkey followed China in terms of rate of growth in steel production and exports. Iron and steel exports reached $12.5 billion in exports last year, increase 30 percent over 2006.

TAV Airport Holding of Turkey, the operator of Istanbul's Atatürk Airport, is among nine bidders seeking to manage Pulkovo Airport in St. Petersburg, according to Vedomosti newspaper. Another bidder is Russian billionaire Oleg Deripaska's Basic Element holding company, the newspaper said, citing the auction documentation. Other participants include a grouping of billionaire Viktor Vekselberg's Renova holding company and Hochtief, and another consortium of VTB Group and Fraport.

Global Developments:

Oil prices continued to decline and closed at $118.58 on Wednesday despite the news that oil flow was interrupted in the BTC pipeline as a result of an explosion earlier during the day. The downward trend in the oil price is expected to continue, albeit at a slower pace.

The Federal Reserve Bank left its benchmark rates unchanged indicating that "Although downside risks to growth remain, the upside risks to inflation are also of significant concern.”

The WTO meetings collapsed last week, effectively killing the Doha round. A new set of discussions is unlikely to start until after the US Presidential elections.

What to expect this week:

The decoupling that Turkish markets have experienced in the last ten days is likely to continue while shaking off the post-verdict exhilaration.

August 6,, 2008

July 21 - 27, 2008

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Political Developments:

The Constitution Court will meet on Monday to discuss the closure case. The verdict, expected in early August, could dissolve the Justice and Development Party, or AKP, and ban 71 members from political party membership for five years. Last week, the rapporteur reviewing the case recommended that the case be dismissed. EPA maintains the expectation of a closure verdict and snap elections before the end of the year. Last week, a number of AKP MPs introduced legislation that would make former members of the parliament eligible for pension. Current rules require that they must serve to years to be eligible for pension payments. Ahead of the court’s deliberations, Prime Minister Erdogan called for peace and reconciliation according to Hurriyet, a Turkish daily.

According the pollster Sonar, 76 percent of the people surveyed think the economic situation is getting worse and 53 percent think that Government is not successful. If there were elections today, AKP would get 32 percent of the votes, CHP 21 percent and MHP 14 percent with 13 percent undecided, the same poll revealed.

An Istanbul court agreed on Friday to hear the “Ergenekon” case against 86 people accused of plotting the overthrow of the government. The first court hearing will be held on October 20. It was reported that a supplementary indictment will be submitted covering the senior retired generals, the chairperson of the Ankara Chamber of Commerce and two journalists arrested last month.

Foreign Minister Ali Babacan was in New York last week drumming up support for Turkey’s bid for a non-permanent seat at the Security Council. Ten non-permanent members are elected by the General Assembly for two-year terms and are not eligible for immediate re-election. Turkey last held a seat in the Security Council in 1961 and is now competing with Austria and Iceland for the term of 2009-2010. Turkey needs the votes of 128 countries out of a total of 192 to get elected.

Turkey is willing to normalize its relations with the neighboring Armenia, Babacan told a press conference in New York. It was reported that Turkish and Armenian officials held a series of secret meetings in Switzerland to start the normalization efforts in early July.

Economic Developments:

Despite the increasing market sentiment that AKP is unlikely to be dissolved, the latest rate hike by the Central Bank and declining oil prices, ISE-100 attempts to rally during the early part of the week did not hold. With a sharp 3.7 percent decline on Friday, ISE-100 closed the week 1.1 percent below the previous week.


Deputy PM Ekren announced that last week’s economy policy review meeting decided to establish a “Current Account Deficit Commission” composed of private sector representatives, academics and government officials. According to Ekren, two working groups, one to explore the causes of the current account deficit and another to explore financing issues, will be set up.

Central Bank’s Real Sectors’ Confidence Index declined to 96.2 in July, An index value less than 100 represents a pessimistic outlook to the economic activity by the real sector agents covered by the Business Tendency Survey. The index that captures of the overall direction of the economy improved slightly to 63.4 in July from 62.2 in June that was the lowest level that index ever dipped to.

Central Bank’s Survey of Expectations, also published last week, showed that year-end inflation expectation is 10.8 percent. Expectation for the current account deficit is $49 billion, up from $48.2 two weeks ago. Expectation for GNP growth remained unchanged at 4 percent and the year-end dollar rate came down from YTL 1.3264 to YTL 1.3116.

Presidents Ilham Aliyev of Azerbaijan, Mikhail Saakashvili of Georgia, and Abdullah Gul of Turkey launched a railway project among the three countries on Thursday. At a railway station in the eastern Turkish border town of Kars the presidents of the three countries held a ground breaking ceremony for the 290 million lira ($241.06 million) Turkish segment of the railway. Three presidents placed three sections of railway track on a large map of the region in a symbolic launch of the project as confetti showered down. The project, involving new track construction and renovation of existing track (74 km or 47 miles), is expected to be completed in 2011. Work on the 29-km (18 miles) stretch in Georgia was launched last year. The 160-km (99-mile) section of rail in Azerbaijan will also be renovated.

Turkish Petroleum Refineries Company, or Tüpraş, topped the list of Turkey's top 500 industrial companies once again in 2007, according to the Top 500 Industries list compiled by the Istanbul Chamber of Industry. Automotive led all other industries when in exports in 2007, reaching $16.9 billion. ISO 500 companies constituted 9.3 percent of Turkey's GDP, however, their collective share in value added declined to 25 percent in 2007 from as high 51 percent in earlier years. (Click to see the list of ISO-500 companies)

Turkey announced last week that it will order six new U-214 class submarines from Germany's HDW in a deal worth around $3.97 billion as part of an upgrade of its naval fleet. The contract was won by HDW/MFI, a joint venture between Thyssen Krupp's HDW unit and U.K.-based Marine Force International. The two other bidders for the contract were France's DCNS, which is 25 percent owned by defense electronics company Thales, and the Spanish government shipbuilder Navantia SA.

Greece's largest gaming companies Opap and Intralot will make bids in a tender for Turkey's national lottery Milli Piyango with local partners, Greek paper Imerisia reported yesterday. Opap and Intralot are in talks with Turkey's Koç Holding and Çukurova Group, respectively, to form separate joint ventures to bid for a license with Milli Piyango, Imerisia said, citing Turkish media reports.

Simsek declared that Turkish economy will be larger than those of Japan, Germany, France and Italy in 2050. Speaking at a meeting in Gaziantep, the Minister of State quoted a Goldman Sachs study that projected Turkey's GDP reaching $5.9 trillion in the year 2050 and said that he has always believed that Turkey would overtake these other "giant" economies.

For the record, EPA would like to note that its principals working on the Turkish economy know where Karagumruk is as well as the meaning of the Turkish saying "Hit the belly of the magpie on the roof with a pick". Erdogan recently complained that those who criticize the Government’s economic policies would not even know where Karagumruk is. It happens to be a neighborhood within the Fatih district of Istanbul.

Global Developments:

Oil prices have tumbled to seven-week lows after the signs of demand destruction in the US and other developed markets began emerging. US sweet, light crude declined to $123.26 a barrel - more than $20 off its record level of $147.27 reached in early July. Oil market, however, remains very volatile and it is not clear whether last week’s price drop was signaling a reverse trend.

At the WTO meetings, ministers from leading nations returned to the table on Saturday following breakthrough Friday on the sticking points of farming and industry. The tentative break through came after the WTO Director-General Pascal Lamy proposed a draft agreement with a further cut in the US farm subsidies to 14.5 billion dollars per year and a clause to prevent developing countries from shielding entire sectors from tariff cuts.

Greek and Turkish Cypriot leaders said Friday they will start reunification talks on September 3, ending decades of deadlock and sparking hope that the island's 34-year division could end. Any agreement that Christofias and Talat might reach in the talks will, however, need to be put to simultaneous referendums on both sides of the island.

Member states of the Collective Security Treaty Organization (CSTO) will set up a joint task force in Central Asia, CSTO Secretary General Nikolai Bordyuzha said Friday. "The joint task force in Central Asia is aimed to become a restraining military and political factor in the region, taking an uneasy situation in Afghanistan into account," he was quoted by the Itar-Tass news agency as saying after the talks attended by CSTO envoys in Moscow. The CSTO, a post-Soviet security alliance, comprises Armenia, Belarus, Kazakhstan, Kyrgyzstan, Russia, Uzbekistan and Tajikistan.

The regular session of the foreign affairs ministers' council of the Shanghai Cooperation Organization (SCO), chaired by Tajikistan, took place in Dushanbe last week. Ministers considered the issues of preparation to the session of the council of the states heads - the SCO members that will take place on August 28, 2008 in Dushanbe.

Russian stock market plummeted nearly 6 percent on Friday after Prime Minister Putin's call for an investigation of mining company Mechel escalated worries about political risk and led to sell off across sectors.

What to expect this week:

Turkish markets are expected to focus on developments in the closure case and will muddle through until a verdict is announced, possibly before the end of the week.

July 27, 2008

July 14 - 20, 2008

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Political Developments

A verdict soon? The Constitution Court’s rapporteur recommended that the ruling AK Party not be closed. In a report submitted to the justices of the court, the rapporteur argued that charges of anti-secular activity that fall under freedom of expression cannot be grounds for closure and that ,since conditions for closure are not met, the 71 party officials, including Prime Minister Recep Tayyip Erdoğan and President Abdullah Gül, should not be barred from party politics for five years. The rapporteur's report is not binding and the court has not followed the rapporteur's recommendation in striking down the constitutional amendment for headscarf earlier this year. Expectation is that a verdict will be issued before the middle of August.

Sublime to ridiculous? A 2,450 page indictment for the Ergenekon probe was submitted to the court on Monday. It is reported that the indictment is a hybrid between an introduction to Turkic mythology and X-files script. It is also reported that the indictment states that “terror organization” that is being probed has taken its roots from "Agartha", a legendary city that is said to reside in the Earth's core. It is related to the Hollow Earth theory and is a popular subject in Esotericism. Agartha is one of the most common names cited for the society of underground dwellers. Shamballa (also known as Shambalah or Shangri-La) is sometimes said to be its capital city]. The mythical paradise of Shamballa is known under many different names: It has been called the Forbidden Land, the Land of White Waters, the Land of Radiant Spirits, the Land of Living Fire, the Land of the Living Gods and the Land of Wonders. It wouldn’t be surprising if the Clintons would soon be charged under the Ergenekon probe because of the “white water” reference. The court is to decide whether to “accept” the indictment before setting a trial date.

The Turkish military denied the newsreports that 20 serving officials are being investigated for alleged links to the Ergenekon probe. Its press statement said that an investigation in the air force is not related to the civilian investigation and asked the people to show "legal and democratic" reactions to slander attempts to the armed forces.

Heavy diplomatic traffic. U.S. advisor for national security affairs, Stephen Hadley, the Iranian foreign minister, Manouchehr Mottaki, and the Israeli minister of national infrastructure, Benjamin Ben-Eliezer were in Ankara last week . Turkey also hosted an informal meeting for foreign policy advisors of some of the NATO countries last week. Ben-Eliezer's visit was to discuss a strategic multi-purpose pipeline known as Medstream to carry water, Caspian oil and natural gas to Israel. Turkey's natural gas cooperation with Iran, saying that progress on such plans amounts to encouraging Tehran accused by the West of seeking to possess nuclear weapons. “It is very, very bad. I think it is the worst thing that can happen to the world -- encouraging Iran,” the Israeli minister, told the Turkish Daily News in an interview Thursday.

Economic Developments:

As promised, last week was not a dull one with a lot of factors at play. On the global front, the slide in oil prices, Paulson/Bernanke hearings and the rally in financials with better than expected earning reports boosted the equity markets, the S&P 500 index ended with a weekly rise of 1.7 per cent, having fallen to its lowest level since November 2005 on Tuesday. On the domestic front, the lira rose to the highest level in four and a half months against the dollar after the Central Bank raised its key interest rate for the third time in as many months and the Constitution Court was advised to reject a request to outlaw the governing AK Party. ISE-100 closed the week with an 8.4 percent gain and the Treasury paper yield was 20.86 on Friday, about 73 bp below its level a week ago.


The Central Bank raised its benchmark borrowing rate by 50 bp to 16.75 percent, bringing the rate increase to 150 basis points since May and pushing it to the steepest among the emerging market economies. It left the lending rate unchanged at 20.25 percent. In its statement, the Central Bank left the door open for future hikes indicating that [“the bank] will consider a further measured rate hike when needed, so as to prevent the potential second-round effects of such risk factors. The timing of a possible future rate hike will depend on developments in global markets, external demand, fiscal policy implementation, and other factors affecting the medium term inflation outlook.” Last week, central banks in Thailand, Mexico, and the Philippines also raised interest rates this week to ward off mounting inflationary pressures.

EPA believes that while the rate hikes are important to signal the effort to curb inflation, the underlying causes of inflation have been misdiagnosed by the Central Bank. For the fourth month on a row, the Central Bank has been claiming that primary cause of inflation has been the energy and food prices while Central Bank’s own core inflation figures run higher than the headline inflation. In June, the core inflation defined by the Central Bank as to exclude energy and unprocessed food, was 0.89 percent while the headline inflation declined by 0.36 percent. Causes for the accelerationin the core inflation, other than the secondary and tertiary impact of the energy and food prices should be sought in the private capital flows that take place outside the central bank’s monetary policy sphere.

Treasury borrowed YTL 6.3 billion ($ 5.2 billion) last week with an average yield of 21.65 percent for 24-month paper, making Turkish domestic debt paper one of the highest yielding instruments. The higher rates are at odds with the Treasury’s medium-term financing plan that assumed a decline in borrowing costs and a larger fiscal space for the additional spending. The Treasury’s cash realization figures for June 2008 also point out to a slowdown in revenues that were 10 percent below its 2007 level, and declines in tax revues in nominal terms since May.

Stimulation package a la Turca. On July 28, the Government will start refunding the “Housing Fund” payments that were deducted from payrolls during 1987 and 1999. Ziraat Bank is expected to disburse YTL 2.8 billion to approximately 8.5 million people who were subjected to payroll deductions during that period. While the amounts are small – 3,8 million people will receive a payment less than YTL 50 while the highest amount will be YTL 1,391 roughly to about 1 million recepients-, rapid injection of liquidity (about 0.3 percent of GDP) is likely to add to inflationary pressures in August.

Turkey's unemployment rate fell to 9.6 percent in April 2008 from 9.8 percent a year earlier, according to TurkStat. The unemployment rate in non-agricultural sectors that EPA believes to be a better gauge was 12.3 percent in April compared to 12.4 percent a year ago, reflecting an increase of new 373,000 jobs in these sectors. The decline in the unemployment rate was largely due to a rush for signing up for social security before an April 30, 2008 deadline that changed the benefit coverage with the implementation of the new legislation. An estimated 1.7 million people signed up for social security, a significant part of which was underage children, before the April 30 deadline.

OECD issued its “Economic Survey of Turkey” last week. The report points out to the slowed down growth as a result of loss of competitiveness in large areas of the economy, the deterioration of international conditions, and a weakening of confidence domestically. It calls for: (i) preserving the gains of fiscal consolidation and making fiscal policy more compatible with higher growth; (ii) resuming disinflation and better aligning structural policies as well as fiscal policy with the inflation targeting framework; and (iii) reducing barriers to formal employment in order to mobilise the productivity potential and improve the resilience of the economy. (Click to see OECD's Policy Brief for Turkey)

Seven Turkish cities, Ankara, Aydin, Corum, Erzurum, Nevsehir, Sinop and Sirnak, are suffering from lack of water and 34 more could join them by 2010, according to the Forestry and Environment Minister Veysel Eroglu. Turkey will need to invest 2.9 billion liras ($2.4 billion) over the next four years to ensure drinking water supplies across the country.

A drought in southeastern Turkey is forcing farmers to abandon their land to look for work elsewhere and has led to at least two deaths in a dispute over irrigation, Referans newspaper said last week. Yields have plummeted as rainfall declined to one-fortieth of normal levels, Livestock has also been hit because farmers are unable to afford surging prices for feed.

Brief Company News

• Gazprom has proposed setting up a company in Turkey to handle urban gas distribution as well as a planned extension of the Blue Stream pipeline to Israel.
• Turkish airport services firm Celebi said on Tuesday it will participate in a consortium to bid in a tender for ground-services rights at an international airport in Delhi. The Turkish company will own 67 percent of the venture with Indian Shaurya Aeronautics, Celebi said in a statement to the Istanbul Stock Exchange.
• ArcelorMittal is to acquire full control of its stainless steel service centre in Turkey and double its operations, the company said in a statement on Monday. ArcelorMittal struck a deal to buy 35 percent of Uginox Sanayi ve Ticaret Limited Sirketi that was owned by German company Primex.
• The Carlyle Group has acquired a 50 percent share in Turkish shipbuilding company TVK Gemi Yapım. While the price of the acquisition was undisclosed, plans to make further investments in Turkey, announced a company spokesperson last week.
• Turk Ekonomi Bankasi AS, a Turkish bank co-owned by BNP Paribas SA, sold 75.6 million liras ($62 million) of non-performing loans for about one-seventh of their face value. TEB, which specializes in lending to businesses, sold the loans to Girisim Varlik Yonetim AS for 10.9 million liras, the bank said in a filing with the Istanbul Stock Exchange.

Global Developments:

More regulation, but how? Last week’s hearings on Fannie Mae and Freddie Mac brought out a number of issues regarding the regulation in the financial sector. It looks like that this debate, including the independence of the central banks, is going to continue given the architecture of financial markets make regulation and policy intervention very difficult.

The European Commission could freeze hundreds of millions of euros in assistance for Bulgaria this week because of its spending irregularities, corruption, organized crime and slow moving judicial reforms, officials said Friday. The country has seen some 150 mafia-style slayings since 1989, but no convictions, and it is a frequent target of EU complaints about lax controls on the spending of EU money.

The World Bank raised its forecast for Ukraine's inflation this year from 17.2 percent to 21.5 percent, the Interfax-Ukraine news agency reported on Friday. It also revised its forecast for Ukraine's gross domestic product (GDP) growth this year from 5.5 percent to 6 percent. Ukraine's consumer price index (CPI) rose 15.5 percent in the first half of this year, according to the reports.

What to expect this week:

Next week will provide a better sense of where the oil prices are heading following the $15 a barrel decline last week. Existing and new home sales data as well as a series of earning reports to come out next week is likely to depress US equity markets. ISE is likely to mimic the US and European markets this week, barring significant domestic political developments.

July 20, 2008

July 7 - 13, 2008

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Political Developments

Terrorists at work again. Gunmen attacked a police post outside the U.S. Consulate in Istanbul, killing three police officers. Three gunmen were also killed while the fourth assailant fled in car. He was later captured along with other suspects who may have had a role in the attack. Turkish authorities linked the attack to al-Qaeda and detained 12 people so far. In a separate incident, three members of a group of German mountaineers were kidnapped by rebels belonging to the Kurdistan Workers' Party (PKK) from a camp on Mount Ağrı (Ararat) late Tuesday. “The PKK members said the kidnapping was in response to the recent action taken by the German government against PKK sympathizers and associations linked to the group,” according to the Governor of Agri province.

Smoke and Mirrors? Ankara was focused on developments in the “Ergenekon” affair much of the week with a lot of twists emerging in the media. The indictment that is said to run 2,500 pages is still not ready yet, but expected to be made public on Monday. On an amusing note, the investigation is turning into a reality soap opera. Two of the detainees got married in the jail last week. On a sad note, one of the suspects who was detained for thirteen months without being charged had passed away five days after being released because of his deteriorating cancer that was not properly treated while in custody. A spokesperson for the Human Rights Foundation said that there are 53 cases in critical medical need that are not receiving adequate care in the Turkish penitentiary system. Long detention periods without charges are also becoming a serious issue. (Click to see a Newsweek article or a Reuters analysis of the recent events in Turkey)

Fission started? Abdullatif Sener, one of the four founding members of AKP and a former deputy prime minister, resigned from the party last week, after he sought “forgiveness” (helallesme) of his former colleagues in the governing council. Sener is in the process of setting up a new political party that would cut into AKP’s base. It is not clear how much support Sener garnered within the AKP ranks and whether there will be some migration to his party if AKP is closed. It is also likely that new splinter groups may emerge, particularly those who have ANAP backgrounds, by setting up (a) party(ies) closer to center-right in case of the closure. It was reported that AKP is already in discussions with the Guclu Turkiye Partisi (Strong Turkey Party) to host its deputies in case of closure. Erdogan who often likens his political career to a rail journey said about Sener’s departure that “he has nothing to do with those who get off the train”. In the mid-1990s, he had said that “democracy is like riding a tram; you ride it until you get to your destination and get off.”

The blame game. A periodic poll conducted by Metropoll on the “images of leaders and confidence in institutions” showed that 17.3 percent of the respondents think that causes of political tensions are the Government and AKP, 10.6 percent CHP, 10.2 percent all politicians, 10 percent Erdogan and 7.8 percent Baykal.

Good neighbor. Prime Minister Erdogan, the first Turkish leader to visit Iraq in a long time, pledged to boost ties with Iraq on a one-day trip to Baghdad on Thursday. Erdogan said both Baghdad and Ankara wanted to form a "security area that would eliminate terrorist threats between the two countries". Erdogan and Iraqi Prime Minister Nuri al-Maliki established a council for "strategic cooperation". Ministers for security, energy, trade, investment and water resources would sit on the council and meet three times a year, a joint statement said.

Economic Developments

Anxiety over the US financial markets and the oil prices spiking to $147 a barrel dominated markets in the second half of the week. ISE-100 which recovered from 32,960 a week earlier closed the week barely above 35,000. Benchmark Treasury paper rate that had eased to 21.56 percent by Friday noon, reversed in the afternoon and closed the week at 21.72 percent.

Industrial production rose by 2.4 percent in May, its smallest increase this year. Automotive led the growth by a 21 percent increase while textiles, leather products, TV and other consumer electronics registered largest declines. June capacity utilization declined from 83.5 percent to 82.3 for the manufacturing industry as a whole.

YTL 100 billion loss? Minister of State Simsek declared that the cost of the closure case to the economy has been to the tune of YTL 100 billion (about 10 percent of GDP), YTL 20 billion of which has been in terms of increased borrowing costs for the Treasury and the rest in terms of declining market capitalization for the listed companies. Next day, Deputy Prime Minister Ekren tried to clarify Simsek’s comments saying that “we have to see if there is duplication of costs in these calculations” and backed away from those figures. Simsek has not yet provided any background analysis about how he came up with the numbers despite requests from economic columnists throughout the week. In the last week’s review, EPA presented the data that rising borrowing costs and risk premium for the Treasury predate the filing of the closure case by about a year. At a time when preserving their credibility should be utmost importance, Simsek joined the bandwagon in making statements that are not supported by facts. Domestic political instability, of course, has a cost, but so does incompetency in policy analysis and design as well as in crisis management. These factors seem to have escaped Simsek’s calculations. EPA will refrain from commenting on a statement that seems to confuse apples and oranges until Simsek or the Treasury provides the analytical underpinnings of his statement.

Eenie, meenie, miney, mo? Prime Minister Erdogan and Minister Simsek have both indicated that the government is assessing whether to request a new stand-by arrangement and will announce their decision soon. Simsek said that the IMF has completed its post-program review and that the government would make decision by end-August regarding the future of the IMF relations. "We will decide on the manner of our relations with the IMF according to Turkey's interests and looking at internal and external developments," Simsek said. "There is no final decision yet but we are carrying out technical studies on the precautionary stand-by deal option." Deputy Prime Minister Ekren said on Saturday “We will do whatever Mehmet [Simsek] recommends [for the future IMF relationship]”.

Current account deficit rose to $4.6 billion in May, reaching $21.5 billion for the first five months of 2008, representing a third increase over the same period in 2007. Jan- May trade deficit was $22 billion, also representing a third increase compared to 2007. Rising cost of energy imports added $7.6 billion to import bill during the Jan-May period that accounted for more than the increase in the current account deficit. While Ministers Simsek and Unakitan talk about current account deficit exceeding $50 billion (6.8 percent of GDP), EPA confirms its estimate of $44 b - $45 b, mainly on account of financing constraints. EPA’s estimate assume a reserve drawdown of $25 billion – a stretch, given the Central Bank’s net external position is hovering around $35 billion.

Deficit was financed primarily by the private sector’s borrowing from abroad ($15.9 billion) and the use of reserves ($3.6 billion) in view of the decline in FDI flows and outflow of portfolio investment. According to the balance of payments figures published by the Central Bank last week, net FDI was 4.4 billion. These figures are, however, at odds with the data published by the Treasury in its latest report on international investment according to which net FDI flows were $ 6.1 billion, representing a decline of 46 percent during Jan-May 2008 over the previous year. EPA assumes that these discrepancies will be resolved when the Central Bank issues its own international investment position data next week. (Click to see Treasury’s International Direct Investment Report)

Private sector’s debt is estimated to have reached $187 billion at end-May 2008. While the banks’ own net external position is manageable, what is worrisome is their exposure to the corporate world that is holding about $120 billion of external debt. A tighter monetary policy with higher interest rates and depreciating lira could potentially play havoc with the banking system that is so far considered to be out of harm’s way. There is no reliable data on the risk exposure profile of the private sector. There is anecdotal evidence that large groups such as Koc, have improved their net external positions, but the extent that real sectors hold unhedged external positions is source of ambiguity and, hence, serious concern.

July and August are going to be difficult months for the Treasury when it plans to borrow YTL 12.2 billion ($10.1 billion) in July and YTL 10.6 billion in August from the domestic market against redemptions of YTL 19.8 billion in July and YTL 16.6 billion in August. On Wednesday, Treasury will hold the Reference T-Bill auction to be followed by two zero coupon YTL auctions on Thursday. The yield on the Jan 13, 2010 benchmark bond was 21.72 percent on Friday. Investors’ concerns about Turkey are reflected in CDS prices trading at 335 basis points, near its three-year high and about 200bp higher than six months ago. (Click to see Treasury’s Public Debt Management Report)

According to Reuters, Moody's Investor Service said on Wednesday that Turkey rating could face downward pressure if economic and political developments hit debt ratios. The rating agency said it did not expect deterioration in Turkey credit metrics to warrant rating downshift. "The rating could come under downward pressure should either economic or political disarray meaningfully reverse the virtuous trajectory of the government's debt ratios.… However, the Constitutional Court case deliberating the closure of the ruling AK Party represents a potential roadblock to implementation of these reforms," Moody's said in a statement. Moody's rating for Turkey outlook is stable and government bonds rating is Ba3. Standard & Poor's rating is an equivalent BB- and in April the outlook was downgraded to negative from stable, citing concern about the current account deficit.

Global Developments

Unlike the EU, Washington does not want to burn bridges with Ankara regardless of the outcome of the closure case. Bush Administration has been careful not use harsh rhetoric while the closure case is on and it stressed support for "democratic processes" while making clear that whatever happens, Washington wants good ties with its NATO ally.

Another fluff? G-8 Summit in Toyako was more like a three-day debutante ball for Dimitri Medvedev and Gordon Brown and produced hardly anything more than handful of larch trees planted on the mountainside. With the global financial markets in deep crisis, energy and food prices causing major hardship on the world’s poor, world could have survived without last week’s demonstration of the impotence of the industrial world’s leadership. On Africa, what was promised in Heiligendamm was repeated. On greenhouse gases, nothing but a lot of hot air came out. The key issue is how relevant the G-8 is to global concerns. Even with Russia, the G-8 accounts for only 14 percent of the world's population, and less than 50 percent of the growth in the global economy. It will probably take several more summits before the question of how G-8 can better fit into the architecture of the 21st century where the role for BRIC and other emerging economies is more than a side show, could be answered. While Medvedev is trying figure out whether being called “a smart guy” by Bush is a good thing or not, the only bright side of Toyako was the “Goodbye from the world's biggest polluter,” Looks like, however, Bush was also wrong on that one too. The Netherlands Environmental Assessment Agency recently suggested that China might already be the world's greatest polluter, with emissions rising by nine per cent last year, compared with 1.4 per cent in America. (For a somewhat Pollyannaish view on the outcome of the G-8 summit, click here)

Armenian President Serzh Sargsyan has proposed a fresh start with Turkey, with the goal of normalizing relations and opening the border between the two countries that has been closed for almost 15 years. In his article published in The Wall Street Journal's online edition last week, Sargsyan said he expected to “announce a new symbolic start in the two countries' relations” with his Turkish counterpart Abdullah Gül when the Turkish president visits Armenia to watch a football game between the countries' national teams this coming September. It seems that Sargsyan’s call has found a positive response in the Turkish capital.

Club Med Weekend? Erdogan left for Paris on Saturday to participate in summit organized to launch Sarkozy’s brain-child: the Union for the Mediterranean. It builds on the EU's Barcelona Process, which was launched in 1995 and is generally seen as having failed to achieve much of substance. From the outset, Ankara has suspected initiative to be a scheme by Sarkozy, himself a fierce opponent of Turkey's EU accession, to keep the Turks out of Europe. European Commission has outlined four projects for the union: cleaning up the Mediterranean Sea, promoting solar energy, and developing shipping and ports as well as building a new road link for North Africa. EPA assumes that Turkey has received assurances that its involvement will not undermine its EU candidacy. The joint declaration states that the Union will be independent from EU enlargement policies and accession negotiations and Turkey is identified as a negotiating candidate country. Libyan leader Muamar Khadafi who described the union as a post-colonial initiative of France, boycotted the summit.

What to expect this week?

With the financial and oil markets in turmoil on the global front and domestic political developments, this week promises to be not a dull one. The outcome of Treasury auctions scheduled for Monday and Tuesday will set the tone for the Turkish market for the rest of week. EPA expects the benchmark rate in the secondary market will tip over the 22 percent mark. Central Bank will decide on its benchmark rate on Thursday. Expectations vary between a 25 bp to 50 bp increase.

July 13, 2008