Only last week the International Monetary Fund’s (IMF) Turkey desk chief, Reza Moghadam, told reporters "the Turkish economy is on the right track".

This, he said, demonstrated the effectiveness of the IMF backed economic programme the country has been following since the financial crisis two years ago.

In 2001, the Turkish lira halved in value overnight, interest rates soared and unemployment sky-rocketed after a major banking crisis. The country’s economy shrank by 9.4% that year.

All these factors ”indicate that the 2001 crisis is finally over”

Analyst at Garanti Securities

Currency appreciation

Since May this year, the lira has appreciated 20% against the US dollar, interest rates have more than halved and both international & domestic investment has risen. Unemployment has also fallen to an historic low of 15%.

”It all indicates that the 2001 crisis is finally over,” said an analyst at Garanti Securities who declined to be named.

The strengthening lira has been good news for Turkey’s debt servicing. With most debt denominated in US dollars, the weakening dollar has lightened the country’s giant public debt burden which stands at $187 billion.

International confidence in the Turkish economy was further strengthened on 9 September when public sector workers called off a hunger strike aimed at securing higher annual pay awards.

Had the strike continued the government would likely have been forced to stray from the IMF’s strictly monitored stipulations.

Outstanding risks

Nevertheless, all this good news could be in jeopardy. Two political and international disputes threaten new found investor confidence.

The first of these is the latest chapter in the long running conflict surrounding Turkey’s ethnic Kurds, while the second is the US-led war in neighbouring Iraq.

On Monday, a Turkish court ruled that the country’s largest legal pro-Kurdish political party DEHAP had broken electoral rules during last year’s national vote.

Officials will now have to decide whether to annul the results of last November’s elections - along with all the legislation passed by the government since then. A fresh nation-wide ballot would then have to be held.

”We’re all waiting to see what they decide. The economy is doing well at the moment, but if there is a call for fresh elections, then the instability this will cause will send markets tumbling”

Refik Ulusoy,
Economist,
Bosphorus University

Redistribution

They could, instead, decide to redistribute DEHAP’s votes which, under the Turkish electoral system. This would dilute the ruling party’s majority, potentially swinging the political bias of the legislature.

Alternatively, they could decide to simply fine DEHAP, most likely sending its leaders to jail. Still, the political instability that the court’s decision could result in is giving the markets the jitters.

”We’re all waiting to see what they decide,” says economist Refik Ulusoy of Istanbul’s Bosphorus University. “The economy is doing well at the moment, but if there is a call for fresh elections, then the instability this will cause will send markets tumbling.”

The court’s decision prompted the Istanbul Stock Exchange to fall 3.7%, the lira to slide 0.84% against the dollar and the yield on the benchmark May 2004 bond to rise 300 basis points to 35%.

Iraq risk

The conflict in neighbouring Iraq also threatens to derail Turkish economic growth.

The US has requested Turkey deploy its troops under coalition command in the war-torn country, a move that Turkey’s leaders support. They see it as a good way to patch up relations with the Americans after they failed to support the US-led invasion of Iraq in March.

Turkey’s decision to stay out back then led to the loss of an aid package estimated to be worth as much as $20 billion. Now however, another sizeable US economic package is on offer.

Last week, the US announced that it would loan $8.5 billion to Turkey at the Dubai IMF summit. While both Ankara and Washington have since denied that there is any link between this money and Turkish military support in Iraq, financial analysts are distrustful.

“Of course there must be conditions attached,” says Istanbul businessman Cevik Ezran, whose textile company recently began hiring workers for the first time since 2001. “For there not to be would go against the whole way international politics is conducted.”

US loan package

News that the $8.5 billion loan was agreed was initially greeted with a surge in Turkish markets. Since then, further statements from the Turkish government have cast doubt on whether Turkey will commit troops to support the US-led coalition.

“Yet looking at history, it seems that whenever there was a chance for the authorities to make the wrong decision, they made it”

Analyst at Bender Securities, Istanbul

Speaking on 18 September, Prime Minister Recip Tayyip Erodgan appeared to move away from his original support for sending troops unconditionally by saying, ”Undoubtedly, we would like to see UN leadership in Iraq in the first place.”

Meanwhile, political analysts in Ankara are suggesting that if the Turkish parliament were to vote on troop deployment, the motion would fail, perhaps sinking the $8.5 billion loan along with it.

”These are the hot issues now,” said an analyst for Istanbul based Bender Securities.

Storm clouds

“Behind DEHAP and Iraq the economy is in better shape. The lira is strong, which is helping bring down inflation and interest rates, while low labour costs and a strong Euro mean that the impact on Turkish exports has not been that severe,” he added.

”However, if either issue develops, then we could see a rush out of lira, inflation going back up and interest rates climbing, with a lot of the good work that’s been done coming undone.”

The looming threats have left Turkey’s markets nervously awaiting resolution.

”We can’t say for sure what will be the decision in either case,” the analyst continued. “Yet looking at history, it seems that whenever there was a chance for the authorities to make the wrong decision, they made it.”