Investing in Turkey sometimes appears similar to driving across a large city: no matter how far the country travels, it always seems to be at a crossroads.
Critical choices loomed again this year. In July, the Turkish electorate made their choice very clear, re-electing the conservative Justice and Development Party (AKP) with an absolute majority reduced by just 22 seats. This was welcomed by investors and local businesses, offering the promise of five more years of political stability and prudent macroeconomic policy-making.
The selection of AKP deputy chairman Abdullah Gul as president has evoked a much more ambivalent response. When Gul was first nominated in April, army chief-of-staff general Yasar Buyukanit posted an article on the military’s website describing his fears over the creeping Islamicization of Turkey’s institutions. This was the signal for mass demonstrations in support of secularism. But the AKP’s decision to put their popularity to the test by bringing forward the parliamentary election “changed everything”, according to Nihat Ali Ozcan, political analyst at the Ankara-based Economic Policy Research Foundation (Tepav).
General Buyukanit is unlikely to take any action in the short term, says Ozcan. “He has only one year left before retirement, so he will want to leave strategic decisions to his successor. He also knows that the climate in Turkey and internationally would not support it.”
The parliamentary election success reinforced the AKP’s power enough for the party to re-nominate Gul in August – this time successfully. Since his election by parliament, Gul has said he is ready to run for office again if voters decide, on October 21, that the president should be chosen by popular vote. But Ozcan believes the party leadership understands the need to maintain a balanced relationship with the military.
Zafer Ali Yavan, the Ankara representative of the Turkish industrialists’ and businessmen’s association Tusiad, is less confident, and warns that Gul could yet cause disquiet in his new position. “The role is partly ceremonial, but he has the power to appoint university deans, constitutional and administrative court judges, the national auditor, and some senior civil servants. We hope that these appointments will be impartial,” Yavan tells Emerging Markets.
The AKP’s track record on impartiality is not spotless: the selection process for central bank governor in 2006 caused widespread controversy following the AKP’s nomination of a religious conservative, Adnan Buyukdeniz, head of Al-Baraka bank – one of Turkey’s few sharia-compliant institutions – to replace Sureyya Serdengecti. The nomination was rejected as inappropriate by Ahmet Sezer, the then president.
“To set interest rates, they chose the head of a non-interest bank. After all the effort to start EU talks and comply with the IMF programme, why take such a political short cut?” asks Yavan incredulously. The eventual selection of Durmus Yilmaz, however, was met with widespread relief, and Yavan believes that one of the highly capable vice-governors, such as Erdem Basci, would offer a suitable smooth succession to the 60-year-old governor a year or two down the line.
Social insecurity
There is at least one advantage to a president more in tune with the ruling party, says Blaise Antin, head of research for the $1.9 billion TCW emerging markets fixed income fund, based on the US west coast. Gul is unlikely to repeat Sezer’s veto of several critical pieces of legislation, including the social security bill, on which the previous head of state objected to plans for an increased retirement age.
“Social security reform has to be the top priority,” Antin tells Emerging Markets. “There is no way that a country with such a young labour market should be running a net deficit on the social security system.”
Yavan, who was previously a director of the Turkish state planning organization, says the deficit of around 4% per year stems from actuarial errors that underestimated the level of employee pension contributions required, as well as from evasion by employers and employees. Previous governments have been reluctant to clamp down for fear of provoking public backlash, he says, but the reforms are urgent: every year of lost contributions is amplified by a loss of earnings on those funds, aggravating the mismatch with outflows.
“Even if passed in its original form in the first quarter of 2008, the social security bill will still take about seven years to cut the deficit by just one percent of GNP,” says Yavan.
Lowering unemployment from current levels of around 10% would also help improve the social security situation. At the central bank, Governor Yilmaz is urging the AKP to use its second term for labour market reform, to allow Turkey to sustain high growth rates without the risk of a labour supply bottleneck. But Yavan notes that, whereas around 85% of unemployment in the early 1990s was cyclical, as much as 80% today is structural, due to factors such as regional economic disparities, complicated tax and benefits systems, and skills mismatches.
The creation of a single health insurance package will help to simplify paperwork for employers, and Yavan is also hopeful about the AKP’s plans for a $20 billion employment agency. “This is a major resource for active labour market policies – even 10% of that sum would make a significant contribution to combating structural unemployment.”
Back on track
Another element of structural reform on the agenda is the electricity sector. An opaque system fragmented between national generators and regional distributors and split between public and private ownership makes it unclear whether the sector as a whole is recovering costs. A hike in prices for end-users would fuel inflation, but Governor Yilmaz is encouraging the government to do what is necessary for sound financial management.
“If there is a need for price adjustments for public-sector goods or services, it should be done without delay and transparently, so that the central bank can forecast the inflation effects,” Yilmaz tells Emerging Markets in an interview.
Finally, the fiscal easing that occurred before the elections, in particular through public-sector wage rises and tax cuts, will need to be reversed. Yavan estimates that the primary fiscal surplus will come in at 4.5% of GDP in 2007, well below the target of 6.5%.
According to Treasury under-secretary Ibrahim Canakci, the lower primary surplus does not threaten the government’s financing plans. “Despite the expected deviation in the primary surplus, the overall balance and Treasury’s financing need remained intact, thanks to non-debt creating revenues, particularly from privatization. Consequently, we expect the need for domestic plus external borrowing to remain unchanged compared to our original financing programme,” says Canakci.
Even so, Yilmaz voices concern about the macroeconomic implications of public wage increases. “In the services industry especially, the labour market is largely closed to international competition, so wage setting in both the public and private sectors determines whether productivity is maintained. Any wage hike should be in line with the inflation target,” the central bank governor warns.
At the mercy of events
But Ozcan at Tepav is sceptical about whether the AKP will be willing to move quickly on potentially unpopular measures such as curbing tax evasion and reining in spending, in view of local elections due in March 2008. “The party has built its support from local politics. This also makes it difficult to deal with some of the structural issues concerning local governments, like rationalizing taxes and cutting corruption,” he tells Emerging Markets.
And the government’s popularity is also at the mercy of external events. If the global slowdown hits the Turkish economy hard [see box], Ozcan believes this may embolden the army to become more confrontational toward the AKP’s religious agenda – prime minister Tayyip Erdogan recently announced that he would like to lift the ban on women wearing headscarves in universities.
Turkey’s prospects for EU accession are also becoming increasingly tenuous. French president Nicolas Sarkozy, within weeks of his May election, began calling for an arrangement that stops short of the country’s full membership. Yavan at Tusiad argues that this is not a serious setback, as the process of legal alignment with the EU’s acquis communautaire is not vital to secure domestic political support for macroeconomic reforms, in the way that the bid to open negotiations was in 2000-05. “[EU accession] is a more subtle anchor now, not an everyday one. Besides, convergence is good for Turkey, so the AKP cannot change its policy to suit the French political cycle,” he says.
For analysis of Turkey's vulnerability to the global credit crunch, please see "Giving Turkey credit where it's due"