Assessing Political Risk: Cracks in the Turkish Model

Turkey’s internal crises have been played out in the international spotlight as widespread demonstrations in the summer of 2013 changed Turkey’s image as a darling example of political and economic development.

News of a rapidly declining lira hit newsstands late December 2013. A major corruption scandal targeting the AKP government blew up around the same time. With the passing of a recent Internet censorship law designed to contain the corruption scandal, and elections to take place in August, renewed demonstrations can be expected. The economic turmoil and risk common in emerging market economies will be exacerbated by domestic political tensions in Turkey, and investors will inevitably assess the country with greater caution, if not full-scale trepidation in 2014.

Over the past nine months, a number of developments have taken place in Turkey, pushing back against AKP dominance. While last summer’s widespread protests raised concern over the country’s stability and fractured the model Muslim democracy’s façade, nothing was more damaging to the political reputation of the country than the recent corruption probe that implicated four members of Prime Minister Recep Tayyip Erdoğan’s cabinet and exposed the administration’s seedy mechanisms for securing real estate contracts.

The probe came as a shock to the administration and leaves investors second-guessing their love affair with what has proven over the last decade to be a surprisingly resilient and growing Turkish economy. In total, 91 people were detained, including the sons of two ministers. The Minister of Environment and Urban Planning, Erdoğan Bayraktar, was forced to resign in the wake of the scandal and made waves in the media after claiming that the prime minister himself was involved.

The government reacted by purging the judiciary and the police force, removing thousands of police officers, including the heads of the financial crimes, smuggling, and organized crime units. On December 22, Istanbul’s chief of police Hüseyin Çapkın was fired.

The investigation’s repercussions came at a bad time for the ruling government as it attempts to maintain Turkey’s economy. Questions on the rule of law in Turkey, coupled with the U.S. Federal Reserve’s recent decision to taper its stimulus package, contributed to the lira’s sharp depreciation in 2013.

Muharrem Yılmaz, the head of Turkey’s industry lobby TÜSİAD, summed up mounting economic concerns. “A country where the rule of law is ignored, where the independence of regulatory institutions is tainted, where companies are pressured through tax penalties and other punishments, where rules on tenders are changed regularly, is not a fit country for foreign capital.” Emerging markets everywhere are under added pressure in 2014, though Turkey’s precarious mix of political developments will see investors avoid the country in favor of more stable markets.

The lira’s dramatic depreciation in 2013 further diminishes investor confidence in the Turkish economy moving forward, and the country is likely to see a withdrawal of foreign money well ahead of the presidential elections in August, and possibly sooner if the results of local elections in the spring suggest a weakening of AKP’s hold on the country. Raucous demonstrations this past week confirm that protestors won’t stay quiet in the lead up to a vote, which could see Erdoğan assume the presidency.

Erdoğan has advocated for a strong presidential system, however in the face of opposition, he may not be able to push it through parliament. Last week, Erdoğan started dropping hints that he may change his party’s rule limiting him to two terms as prime minister. While Erdoğan is all but guaranteed a win, the AKP will lose votes, complicating a seamless implementation of political and economic programs to save an economy in turmoil.

Every effort to curb the negative impact of the corruption probe will strengthen protestors’ resolve. On February 22, Turkish police fired tear gas and water cannons to disperse thousands of protestors rallying against a new Internet law giving authorities the power to block web pages without a court order, presumably in an effort to contain the spread of news about the corruption investigation. While the Turkish print and broadcast media have been cowed by the government, independent online media outlets and social media sources have been widely used to spread damning evidence of corruption that the mainstream media would not dare publicize. Demonstrators could have a further negative impact on markets as elections near.

On the back of rising political risk, 2014 will be a difficult year for the Turkish economy. While the summer’s demonstrations had little effect on foreign direct investment, further demonstrations combined with a worsening economy may provoke a rapid withdrawal of foreign money.

The corruption scandal could not have come at a worse time for the AKP, which is struggling to maintain investor confidence in the wake of a much-depreciated lira and the Federal Reserve’s decision to scale back stimulus money being pumped into the world economy. The government will frantically seek to diminish political tensions and clean up its image as the economy prepares for a turbulent year. Demonstrators, eager to exercise their democratic rights, will complicate AKP efforts.

By Eli Lovely, a former analyst at Kroll.