July 28 - August 6, 2008

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Political Developments:

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

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

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

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

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

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

Economic Developments:

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


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

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

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

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

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

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

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

Global Developments:

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

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

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

What to expect this week:

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

August 6,, 2008