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

June 30 - July 6, 2008

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Political Developments

More drama, please? Last week, political tensions peaked with the “Ergenekon” investigation taking a new dimension and the Constitution Court hearings for the AKP’s closure case. On Tuesday, hours before the Chief Prosecutor was to make his oral presentation the Court, some two dozen people including two retired senior generals, former military officers, journalists, businessmen and politicians were detained for links to a group known as Ergenekon suspected of trying to engineer a military takeover in 2003 and 2004. (Click for Reuter’s Fact Book on Ergenekon There is an arrest warrant for a former AKP deputy and Erdogan’s personal physician, Turan Comez who was expelled from AKP for his vocal criticism of corruption and mismanagement of the leadership. Comez is said to be in the UK attending a language training program. Two journalists who were held for four days without charges were released later in the week. Ten of the detained, including two former four-star generals were arrested on Saturday and put in prison. The prosecution, however, has not yet produced an indictment for the 13- month investigation. It was reported that the indictment would not be ready for sometime. The high-profile arrests and their timing have raised a lot questions about whether the Government’s intentions were to move the public focus away from the closure case and retaliate against the secular establishment. Turkey's main opposition leader Deniz Baykal said that “these arrests create an environment of fear and resemble events in Iran prior to the Islamic revolution of 1979. There is a suspicion in society that it is turning out to be a political revenge process rather than a legal process." To boot, AKP-leaning Sabah reported that a secret plan was seized during the swoop which called for illegal protests on July 7 across 40 provinces, assassinations and attacks on security forces.

Disputing jurisdiction? Deputy Prime Minister Cemil Cicek delivered AKP’s oral defense in the closure case that lasted for more than six hours. AKP argued that “the charges against the AKP were not credible, accurate or legal and should never have been filed in the first place” (Click to see the AKP’s oral defense in Turkish) According to the deputy chief justice of the court, the court will review the case “as soon as possible” and will not take the annual vacation – normally the entire month of August – before reaching the verdict on this case. It is thus likely a verdict could be issued sometime in late July or early August.

Everybody is listening to everybody else! Last week, the Coast Guard filed a request with the Telecommunications Board to be allowed to tap cell phone communications to help fight smugglers. This request, coming shortly after it was revealed that the Police, National Security and The Gendarmerie were tapping all electronic communications in the country. One of the detained journalists who was released later during the week said that much of the questioning was based on his recorded phone conversations. It is safe to assume that everything said or written, communicated electronically, is being tapped and or recorded in Turkey. When feeling lonely, pick up the phone and say something!

Early elections? Ninth President of Turkey Suleyman Demirel said in an interview that once the verdicts of the two Constitution Court cases are out, the resulting political turmoil could last until a new election. Demirel also said that the AKP administration chose to battle with country’s institutions instead of seeking accommodation among them.

Signs of rupture? Abdullatif Sener, a former deputy prime minister during the last AKP administration who opted out from July 27 elections, is reported to be exploring establishment of a new political party. Sener who is a member of AKP’s governing council has been critical of the AKP’s leadership in handling the latest crises. There are also reports that preparations are under way to set up Güçlü Türkiye Partisi (Strong Turkey) Party for the surviving AKP deputies to migrate in the case of a closure verdict. These may however not be the only two parties emerging from AKP in case of a closure. EPA estimates that a new party close to the aspirations of the core base (Islamist/Sharia-minded) will also emerge with or without a merger with Saadet Party. Which one of these parties will end up being the phoenix rising from the ashes of AKP remains to be seen, bearing in mind that Turkish political version of the phoenix lives for 5-6 years before burning itself again but regenerates when hurt

Escalating political tensions reached to a new height last week with the Ergenekon probe polarizing the country in an unprecedented way. If, as claimed by the opposition, mounting the Ergenekon probe was to deflect public opinion from the closure case, AKP seems to have accomplished it. There are concerns about an environment being created, not unlike in the post 9/11 US, that pits people against each other with statements like “if you are not one of us, you must be a terrorist”. It is a worrisome development for a country if the political factions start thinking about “our prosecutor” vs. “their prosecutor” in matters that should be handled by a truly independent judiciary. One of the factors that affect a country risk premium is the degree of domestic political stability, measured not only the percentage of votes that the ruling party has garnered in the last elections, but how well the democratic institutions work in the country. Democratic institutions provide an inherent bias in policy, reducing the ability of leaders to enact sweeping policy changes that could potentially harm investors.

It seems that Prime Minister Erdogan is for some reason convinced that the onset of the Turkey’s economic woes is the day the closure case was filed. As seen in the chart below, Turkey’s risk premium started going up in the second quarter of 2007 when the snap elections were called and the Government embarked on an election spending spree. There was a short-lived period of comfort for investors’ right after the elections, but once it became obvious by October 2007 that the new AKP administration had no economic program and it lacked both the skills and the ability to conduct sensible economic policy. As the global financial crisis deepened and started spreading in the emerging markets, Turkey’s policy performance did not make the cut compared to expectations. Dithering and lack of clear communications at the end of the stand-by program did not help. The Prime Minister and his economic advisers would be better served to seek the roots of declining investors’ confidence in the sustainability of economic policies as well as the Government’s own performance in dealing with recent political crises.

Economic Developments:

On Tuesday, Istanbul stock market index plummeted by 6.1 percent as lira depreciated by about a percentage point against the euro and the dollar. The markets rebounded on Friday, in part taking advantage of absence of US market news because of the July 4 weekend. Bond yields on benchmark lira debt rose by 48 basis points to 22.83 by Thursday declined to 22.36 percent on Friday.

Headline inflation for June slowed down to 10.6 percent (y-o-y, annual rate) from 10.7 percent from May mostly on account of slowdown in food prices. June CPI numbers also reflect a Russian import ban for Turkish tomatoes and other vegetables that led to domestic tomato prices plummeting by 50 percent in June. The worrisome development is, however, the increase in the core inflation – that excludes the prices of energy and food products - that jumped to 10.4 percent in June from 9.8 percent in May. This goes against the authorities’ contention that inflation in Turkey reflects the increases in world wide energy and food prices. It is yet another example of bad diagnosis that leads to bad policy. The direct impact of electricity tariffs at a rate of 20 percent on July 1 is expected to boost inflation by 0.6 – 1.0 percent for the month of July The Government postponed a planned increase in gas tariffs to avoid bunching of inflationary pressures to August. (Click to see Governor Yilmaz's speech at the congress)

Getting priorities right. In the midst of the political and economic crises, the Government presented a bill to the parliament to move the Central Banks to Istanbul within two years; an idea that was rebuffed by the Governor of the Central Bank when it was floated by then Minister of Economy Babacan. The government also plans to relocate state-run bank Vakifbank, the Banking Regulation and Supervision Agency (BDDK), and the Capital Markets Board While the justification behind the move it to turn Istanbul into a global financial center, the location of the central bank is hardly the most important criterion towards that objective. There are examples of Central Banks being in commercial; capitals (e.g. In Pakistan, Karachi vs. Islamabad, In Kazakhstan, Almaty vs. Astana, in the Netherlands, Amsterdam vs. The Hague) There are also other examples where the CB is collocated with the seat of the Government. The jury is hung on the question of which model has worked best. EPA recommends that the Governor and his colleagues get a better sense of how to reestablish a credible of inflation targeting rather than playing Martha Stewart for the next two years.

Unfavorable international conditions and domestic political uncertainty caused an upward shift in the country’s risk premium, an OECD report said on Sunday. "2008 Economic Outlook Report" by the Organization for Economic Cooperation and Development (OECD) said the inflation figure was expected to increase to 9.6 percent this year and decrease to 7.5 percent in 2009. The report predicted that unemployment rate could rise to 10.2 percent in 2008 and 10.5 in 2009. "In a context of uncertainties on a broad range of public governance conditions, maintaining confidence in the resilience of economic policies is important," it stated. OECD foresees a 3.7 percent GDP growth and 9.8 percent inflation for 2008. EPA believes that both variables reflect and optimistic view of the economy compared to EPA’s own estimates.

Eurobarometer Spring 2008 survey point out that 72 percent of the Turks responded say that things are not going in the right direction in Turkey. Compared to the surveys in the last year, there has been a considerable drop in positive evaluations on this matter both in the EU and in Turkey. According to Turkish Public opinion, the two foremost problems are unemployment and terrorism, followed by economic conditions, crime, inflation and education. While the top priority has not changed since last year, it seems that terrorism has significantly declined in salience in the minds of the public. In autumn2007, terrorism was cited by 77% but, in spring 2008, only 44% cited it among the top two problems facing the country. While the salience of unemployment as one of the country’s top two most important problems has not changed much, concerns about inflation and thought that things are not going in the right direction in Turkey. According to Turkish public opinion, the two foremost problems are unemployment and terrorism, followed by economic conditions, crime, inflation and education. While the top priority has not changed since last year, it seems that terrorism has significantly declined in salience in the minds of the public. In autumn 200 terrorism was cited by 77% but, in spring 2008, only 44% cited it among the top two problems facing the country. While the salience of unemployment as one of the country’s top two most important problems has not changed much. When asked about conditions in Turkey compared to the EU average, we see that Turkish public opinion is not optimistic. For instance, only about 14% thinks that economic conditions in their country are better than the EU average while 35% in Europe thinks so. Taken together with the Consumer Confidence data released last week point out to a very somber mood for the near future.

Turkey's Garanti Bankasi has been named Turkey's Best Bank by Euromoney Magazine. Garanti got the Euromoney Award for Excellence for the ninth time. "Our growth and service performance were appreciated not only by our customers but also by Euromoney," said Ergun Ozen, Garanti's CEO. "We continued our sound growth during a time of global fluctuation. We had a very good performance in the first half of 2008." Garanti Bank, established as a privately owned commercial bank in Ankara in 1946, provides retail, commercial, corporate and private banking services to over 6.2 million customers.

A third airport for Istanbul? The government plans to build a third airport in Istanbul at a cost of $500 million, Sabah newspaper reported Friday, citing Transport and Communications Minister Binali Yıldırım. The airport would be developed as a build, operate and transfer project and be constructed northwest of Istanbul's main Atatürk Airport, the newspaper cited Yıldırım as saying. The facility's yearly handling capacity would be 10 million passengers, he said.

Parliament passed a bill late Thursday regulating property sales to foreigners after it was re-arranged bearing in mind the Constitutional Court's annulment of previous legislation. Foreigners and foreign foundations will be able to own up to 10 percent of land within a building scheme, according to the new amendment. In case of liquidation of foreign companies in Turkey, the legislation will apply certain limitations which will enable foreigners to buy land in strategic and important areas only through special permission. The Council of Ministers will be authorized to determine the sales of land in areas of importance to water, mining and energy supplies or in religious and historical sites. While foreign ownership of real estate in military-restricted areas will be possible only by permission from command headquarters that are authorized by the General Staff, real estate in security areas will be purchasable by foreigners only through a special permission of the related governor's office, the legislation states.

Global Developments:

The European Central Bank lifted its main interest rate by a quarter percentage point to 4.25 per cent in the eurozone for the first time in more than a year on Thursday as it stepped up efforts to control mounting inflation pressures .At the press conference following the rate announcement Jean-Claude Trichet, ECB president, said the bank had no bias on future policy moves. Mr Trichet did not use either of the phrases ”heightened alertness” or ”strong vigilance” which have heralded past rate increases, though he cautioned against drawing conclusions from this. ”The fact that we have not mentioned heightened alertness nor strong vigilance doesn’t mean anything,” he said. Financial markets scrutinised Mr Trichet’s comments for signals on whether further interest rate increases were likely and took his comments to mean that the central bank was unlikely to raise rates again soon.

Nicolas Sarkozy, France’s president, berated the ECB for putting price stability before economic growth and raising its main interest rate. José Manuel Barroso, the European Commission president, defended the European Central Bank against political critics. He said: “When it comes to inflation, I have more confidence in the position of central bankers than in politicians...central bankers are not moved by short-term political pressures.”

U.S. stocks fell last week, giving the Dow Jones industrial average a 20 percent bear-market drop from October's all-time high as record oil prices threatened global economic growth. The Standard & Poor's 500-stock index lost 1.3 percent to 1262.90 for a fifth-straight weekly retreat. The index dropped to 1261.52 on July 2, down 19.4 percent from Oct. 9 to its lowest since July 2006.

There was a heavy diplomatic traffic chasing gas markets in Central Asia. Russian President Medvedev visited Azerbiajan, Turkmenistan and Kazakhstan, to ensure Russia's monopsony for the Central Asian natural gas. During their meeting in Baku, Medvedev and Aliyev issued a declaration of friendship and presided over the signing of four intergovernmental agreements covering such areas as customs and privatization. The friendship declaration was vaguely worded and short on specifics, although Russia did seem to endorse Baku’s position that any political settlement of the Nagorno-Karabakh conflict should not undermine Azerbaijan’s territorial integrity, according to a report distributed by the APA news agency. At the same time, Medvedev was non-committal in his public comments, saying that Russia favors resolution of the Karabakh conflict through direct talks between the Azerbaijani and Armenian presidents. Miller, the Gazprom CEO, made perhaps the biggest news of the visit, telling journalists that Russia and Azerbaijan had agreed to start talks covering the purchases of Azerbaijani gas. "Azerbaijan will become another country where Gazprom can buy gas while just few years ago, our [Russian] gas was purchased by Azerbaijan," Miller said. He declined to speculate on how much gas Gazprom was hoping to buy from Azerbaijan, saying only that the company was prepared pay market prices to obtain "maximum volume." While on its surface the Kremlin’s ability to cajole Azerbaijan into talking about gas sales may seem like a diplomatic coup. But Azerbaijani experts are skeptical that Medvedev’s visit alone will prompt Baku to make a geopolitical shift in Moscow’s direction. During his visit to Turkmenistan, Medvedev and Berdymukhammedov also issued a joint statement underlining the importance of the new pipeline along the Caspian. An agreement, Medvedev said, would be implemented "in the near future" after Russia, Kazakhstan and Turkmenistan complete the necessary formalities. The Kremlin reached a deal with Kazakhstan and Turkmenistan in December to build a new gas line along the Caspian Sea coast to Russia. But Turkmenistan has irritated Russia by hinting that it wants to take part in the rival Nabucco pipeline to deliver gas to Europe while bypassing Russia. But the thorny issue did not crop up in Friday's talks. "The word 'Nabucco' was not mentioned in the talks," a source in the Russian delegation said. Medvedev and Nazarbayev on Sunday discussed the construction of a pipeline for Caspian Sea gas through Turkmenistan and Kazakhstan and increasing the capacity of an existing line, according to a statement on the Kremlin web site. They also discussed cooperation in "nuclear energy, peaceful projects in space, and matters of CIS integration," the statement said. Medvedev also held talks Sunday in Astana with several visiting dignitaries, including Turkish President Abdullah Gul and Jordan's King Abdullah II.

President Gul, visiting Astana for the tenth year anniversary celebrations of Kazakhstan's new capital, met with Presidents of Russia, Georgia, Tajikistan, Azerbaijan, and Armenia. During the courtesy meeting with Armenia's President Serj Serksyan, Gul eceived a formal invitation to visit Yerevan for a football match in September,Armenia and Turkey will play against each other in the Armenian capital of Yerevan on Sept. 6 in a qualifying match for the 2010 FIFA World Cup, scheduled to be held in South Africa.

What to expect this week:

Oil was around more than a dollar below the record levels above $145 a barrel hit last week. Nymex light sweet crude for August delivery was trading at $143.75 by late morning in Singapore.Asian stocks rose on Monday, snapping a six-day losing streak on optimism that China's banking sector has thrived despite market turmoil and bargain-hunting investors picked over battered shares. Fears that stagflation would hit company earnings and continue to depress consumer spending kept enthusiasm under wraps as European, Asian and U.S. equity markets all lingered in bear market territory.

Leaders of the world's top industrial powers were under pressure Monday to live up to pledges to help Africa as they opened a summit dominated by skyrocketing oil and food prices. The G8 was joined for Monday's so-called outreach session on Africa by the leaders of Algeria, Ethiopia, Ghana, Nigeria, Senegal, South Africa, Tanzania and the head of the African Union.
Balance of Payments figures for May will be released this week. EPA estimates the current account deficit for May 2008 at the $5.2 billion - $ 5.4 biliion range.

Turkish markets will continue to be decoupled from the US and European markets, preoccupied with domestic political. Futher appreciation of lira extending to the 1.26 - 1.27 range.

July 7, 2008