May 12 - 18, 2008

Political Developments:

The Queen’s visit took up much of the last week’s visible political agenda, including a debate about Erdogan’s garb for the state dinner. While the Queen underlined U.K support for Turkey’s accession, British Foreign Minister David Milliband who accompanied the royal party repeated the same messages that the Barroso and Rehn conveyed in the last few weeks, taking a stance against AKP’s closure.

The agenda in the background was focused on post-verdict options for AKP. The view that early general elections will be called in the fall of 2008 or spring of 2009 regardless of the outcome is becoming prevalent among the pundits. In the event of closure and banning more than 28 MPs (the case at the Constitution Court calls for banning 71 AKP officials for five years), parliamentary elections will need to be held within 90 days. According to the Chairman of the Elections Board, banned MPs could not be member of a political party, but could run as an independent for the parliament. This would mean that a successor party to AKP would be led by an Erdogan stand-jn for the next five years. In a similar situation six years ago, Abdullah Gul had assumed the prime minister position for a number of months until the ban that did not allow Erdogan to run for office was lifted and he got into the parliament in a by-election. In the event of acquittal, one school of thought speculates that Erdogan would want to renew mandate and hoping go above 50 percent by combining the parliamentary elections with the municipal elections currently scheduled for March 29, 2009, possibly advancing it by a few months. In either case, the remainder of 2008 would be marred with political turmoil. (see below for economic and financial implications) EPA assigns a greater probability to a closure verdict and expects that parliamentary elections to be held sometime in late 2008.

A Constitution Court clerk (rapporteur) who was responsible for preparing a brief for the justices recommended that the court should reject the case to strike down the constitutional amendment that would lay the legal basis for lifting the headscarf ban in universities. The brief will now allow the case to be put on the Court’s docket this week. It is, however, non-binding and there have been several precedents when the Court ruled in the opposite direction of the rapporteurs’ recommendations. A ruling, expected in the next two weeks, regardless of its outcome is likely to cause protests and disturbances particularly on campuses that are already in disarray.

An investigation is launched following the claims by Osman Paksut, the deputy chief justice of the Constitution Court that he was under surveillance and eavesdropped by the security forces. While the Government denied the charges, Mr. Paksut indicated that the surveillance had been going for the last two months.

Opposition parties seem to have stepped up their efforts to come out of hibernation. CHP, with its notoriously checkered history with the EU crowd, decided to set up a liaison office in Brussels. Baykal has been traveling extensively and making stump speeches. Bahceli has argued last week that Erdogan would actually want the AKP to be closed down as he sees it as an opportunity with a clean slate and play the “oppressed and victimized”. DP is trying to bring back its discredited former chairperson Tansu Ciller to lead the party instead of trying to rejuvenate the botched merger attempt last year. The disarray that the opposition parties are in now is probably one of the key reasons why Erdogan would expect a landslide victory in case of early elections.

Government spokesperson Cemil Cicek said that claims that Minister of State (in charge of the Treasury) Mehmet Simsek had worked as a “sworn-in” interpreter for the CIA were unfounded. Cicek also indicated that Simsek was a British subject as well as a Turkish citizen. In 1999, Merve Kavakci, a a member of the Islamist Virtue Party who caused uproar when she wore her headscarf to a swearing-in ceremony in parliament was stripped off her Turkish citizenship after she was found to have taken dual American citizenship earlier this year without informing the authorities. Regardless of the legal rules for a minister holding dual citizenship, a full public disclosure before running for the office would have been the ethical thing to do.

Labor safety has become an important issue with the number of work-related accidental deaths in Tuzla’s shipyards reaching 23 in the last nine months. Of the 25,000 thousand workers in Tuzla yards, more than 90 percent work for subcontractors that are outside the regulatory coverage. This dismal record, close 100 fatalities per 100,000 workers compares very poorly with three fatalities in 2006 in the entire shipbuilding industry in the US or 4 fatalities per 100,000 workers in all sectors.

Representative Adam B. Schiff (D–CA) introduced a bill urging the President and Secretary of State to put pressure on Turkey to lift the embargo that the Armenian lobby claims existed for the last fifteen years. The draft "End the Turkish Blockade of Armenia Act" requires a report from the Secretary of State within 30 days of final passage that will outline steps taken by the U.S. Armenian lobby in the United States had sponsored a similar bill two years ago that never made it to the floor.

Economic Developments:

The rate increase pushed lira higher, appreciating about 3 percent against the dollar and the euro. ISE-100 that struggled around 42,500 closed the week with a 0,5 percent gain. Oil prices hit a new record last week, passing the $127 market and closing the week at $126.29


The Central Bank raised its benchmark rates by 50 basis points that was consensus estimate. The overnight rates now stands at 15.75 percent following a twenty-two month period during which the rate was brought down from 17.50 percent. The decision by the Monetary Policy Committee is seen as an effort to counterbalance the fiscal relaxation signals from the Government since the stand-by arrangement with the IMF has ended last week. While the Committee emphasized that the “lagged pass-through impact of the exchange rate movements and rising energy and processed food prices may lead to a temporary rise in inflation in the short term”, the core inflation numbers which exclude the energy and food price increases pointed out to need for tighter monetary policy. The Committee also left the door open for a future rate hike in June, stating that “the extent and timing of 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.”

While the rate hike was, in part, an attempt by the Central Bank to restore its eroding credibility, it is unlikely to curtail the inflationary pressures from the fiscal expansion that is being put in place by the Government. EAP is of the view that the spending plans, initially geared for upcoming municipal elections, are now targeting a spree for a likely parliamentary election. There are several reasons that give credence to such a scenario. For instance, The rider to the recently passed employment creation bill (see below) that forgave the arrears of social security premiums by busineses carries a price tag of YTL 23.4 billion ($ 18.7 billion or 2.7 percent of GDP) out of YTL 42 billion owed to the social security institutions, primarily by AKP’s core base. Spread over two years, SS tax forgiveness would wipe out more than twice the “savings” from the lowering primary surplus. There are indications that no serious discussion has taken place on the bill with the ministries dealing the economic policy. The Minister of Labor Celik told the press that he acted on instructions from Prime Minister Erdogan at the last minute. A second example is the revision of the public procurement legislation that has been trimmed beyond recognition in the last six years from an internationally acceptable from. Each revision, done in the name of improved efficiency, has allowed in at least one non-kosher practice with a view to providing preferential treatment to “one of them”. These changes result in jacking up the cost of doing business with the government and getting obstacles out of the government’s way for distributing political favors. A third example is block grants to local governments – which has probably the highest political return to the center. It is very likely to be used to beef up small contracts which repair the same sidewalks four times by four different companies over a three month period.

The compression of infrastructure spending under the stabilization program for several years has created an “infrastructure gap – both physical and social". Closing this gap will require increased spending as well as a decent policy framework to maximize public-private initiatives. Done with moderation, bringing the primary surplus down to levels could still allow implementing a prudent debt management strategy, taking into account the depreciation of the domestic debt stock as the exchange rate further depreciates. EPA believes that there should be life after the IMF provided that it is managed properly. A significant part of running good economic policies comes from managing expectations that requires effective coordination, transparency, and credible communication – a set of skills that AKP has not been able to demonstrate. On the contrary, when uncertainty becomes a concern in the markets, the Government’s actions or inactions add to the uncertainty. A case in point is the future of Turkey-IMF relations. Instead of developing a coherent and credible storyline for the short- and medium-term policies and communicating it well before the stand-by concluded, they are behaving like Ferris Bueller on the day he cuts school. (For those not familiar with the film “Ferris Bueller’s day off”, please click for a synopsis.)

One of the news stories of last week was the growing rift between the Government and the Central Bank that added to the concerns about lack of policy coordination within this administration. Governor Yilmaz made a presentation to the council of ministers on the economic situation after a five hour wait according the press reports. The presentation was meticulously prepared and covered both domestic and global developments. (click for a copy of the presentation in Turkish.) While the Prime Minister said that the Government had no intention in interfering in the Central Bank’s business, the policy disagreements need to be ironed out, Governor Yilmaz chose not to comment on the state of the relationship with the cabinet ministers some of whom commented that the Governor’s presentation was too complex and incomprehensible.

In 2008, Turkey failed to make any headway on the World Competitiveness Scoreboard that ranks economies from the most to the least competitive by taking 323 criteria into account. Turkey remained 48th in ranking among 55 countries for the second year in a row. The scoreboard prepared by the International Institute for Management Development (IMD), highlights the difficulties the country endures in the global marketplace. This year's list shows Brazil and Poland that ranked behind Turkey last year, surpassed it and ranked as 43rd and 44th. The seven countries ranked behind Turkey are Croatia, Mexico, Indonesia, Argentina, South Africa, Ukraine and Venezuela.

Unemployment is on the rise. February data showed that the rate of unemployment has gone up to 11.6 percent compared to 11.4 percent in same month a year ago. A more telling indicator is the unemployment in non-agricultural sectors that stood at 14.2 percent. A total of 104,000 jobs were created during the preceeding year while 55, 000 joined the ranks of unemployed.

The consumer confidence index, published jointly by the Central Bank and Turksat dipped to its lowest level, 76 in April 2008 from its peak of 111.9 in February 2004. It stood at 82 in March 2008. For the subcategory of the overall economic situation in the next three months, the index was 60.5, again at the lowest level since end-2003.

The Parliament passed a law amending Labor Law which is known as the "employment package". The law opens the way for a five percentage point reduction in the social security premiums paid by employers. It also provides for subsidizing social security premiums of newly employed women and unemployed youth between the ages of 18 and 29 for five years from the Unemployment Insurance Fund. Under the law, the government will forgive 85 percent of interest owed by those who pay their premium debts on time and 15 percent of interest for those who are in arrears not more than a month. The law also provides for transferring interest income of the unemployment fund and the part of privatization revenues to fund a series of projects in the Southeast Turkey to the tune of YTL 12 billion until the end of 2012. While it makes eminent sense to complete the unfinished projects under the GAP framework, a set of institutional reforms and provision of improved farm services (e.g. extension, training) would need to be undertaken. It is not clear from the information made available by the government that spending plans go beyond physical infrastructure.

Turkey became the 25th Non-Regional Member of the African Development Bank. Turkey's membership will allow Turkish contractors to bid for AfDB financed projects. Trade volume between Turkey and African countries is currently $10 billion. Turkey aims to increase this figure to $30 billion by 2010 after the membership. Currently, the AfDB has 53 African (Regional Members) and 25 Non-Regional members --Argentina, Austria, Belgium, Brazil, Canada, China, Denmark, Finland, France, Germany, India, Italy, Japan, Korea, Kuwait, Netherlands, Norway, Portugal, Saudi Arabia, Spain, Sweden, Switzerland, Turkey, United Kingdom and the U.S. The Bank was established in 1964 to develop economic cooperation among newly independent African countries.

What to expect this week:

Markets, particularly those in Asia, are expected to be volatile. On Tuesday, the Producer Price Index for the US, which is expected to have increased 0.4 pct could set the tone for the US markets. Turkish market which will be closed on Monday is expected to start pricing the Constitution Court decision on turban.

May 18, 2008