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