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