EurasiaNet Business & Economics - Turkey's Economy Likely to Survive War, But What Next?

BUSINESS & ECONOMICS

TURKEY’S ECONOMY LIKELY TO SURVIVE WAR, BUT WHAT NEXT?

Mevlut Katik 3/28/03

For the first time in years, Turkey’s government enjoys the backing of a sizeable parliamentary majority, instead of a relying on a fragile coalition. The solid governing majority had raised hopes for Turkey’s economic recovery, easing the concerns of investors watching the due dates on the country’s roughly $160 billion in domestic and foreign debt. But economic calculations have been upset by the Turkish parliament’s refusal to grant basing rights to US forces ahead of the Iraq conflict. The ensuing US-Turkish political row has Prime Minister Recep Tayyip Erdogan’s government scrambling to develop an emergency economic strategy.

Parliament, which is dominated by Erdogan’s Justice and Development Party (AKP), rejected the American basing rights proposal March 1. It later approved a much more limited plan that allows US forces to utilize Turkish airspace. [For background see the Eurasia Insight archive]. Turkey’s stance prompted the Bush administration to take an aid package worth potentially $30 billion off the table.

News that the aid would not be forthcoming sent Turkish currency and stock markets plummeting. To protect against similar future shocks, Turkey has taken measures to raise revenues from taxes, rather than borrowing new money at a time when investors have little faith in its credit or its currency. Analysts are not sure that these measures will raise enough money to keep Turkey’s economy stable over the next several years.

Finance Minister Kemal Unakitan tried to promote confidence while outlining new measures on March 28. "We stand up on our feet," he said. "I am not pessimistic at all. I am hopeful." The minister said the government had submitted a budget amendment to Parliament that hopes to promote a surplus in fiscal 2003.

In seeking to offset the potential budget hit caused by the Iraq conflict, the government is also trying to raise taxes on cars and homes, and calling for public-sector cost savings. The government wants parliament to ratify the budget on March 29, bringing it closer to satisfying a schedule set by the International Monetary Fund (IMF). Turkey drew $9.9 billion from the IMF in 2002. By seeking money from tax collection rather than new debt, Turkey can keep a cap on the costs of paying back its debt. As part of this push, the government passed a plan it calls "tax peace" on January 16, before Erdogan became prime minister. This partial tax amnesty, according to sponsors, could bring an estimated 24 percent of Turkey’s unpaid taxes into the treasury.

Erdogan’s government still must show that it can reform finances enough to attract investors after the war ends. On March 25, Fitch Ratings, the international credit rating agency, downgraded Turkey’s long term debt with a negative outlook. In a March 26 conference call with investors, Fitch Ratings’ lead Turkey analyst Nick Eisinger said the next several months would be suspenseful times for investors. Without the expectation of the American $30 billion, he said, "the margin for error has become very, very limited indeed."

The short duration of many domestic loans leave the treasury "vulnerable to adverse market sentiment," Eisinger said. If investors become pessimistic, Fitch analysts have calculated that a sudden increase in interest rates, combined with a worsening of the Turkish lira’s exchange rate, could create a gap of $9 billion to $16 billion between what Turkey owes and what it has on hand.

Eisinger stressed that Fitch expects the government to "muddle through" the current crisis without defaulting on debts. One reason for cautious optimism is that both Turkey and the United States have taken steps to reconcile. US Secretary of State Colin Powell declared on March 25: "Turkey is a great friend." Turkish Chief of General Staff Hilmi Ozkok, who visited Turkish troops near the Iraqi border, announced March 26 that Turkey would coordinate with coalition forces before sending its own troops into northern Iraq.

A statement issued by Turkey’s National Security Council on March 28 also sought to reassure both a domestic and international audience. "There should be no doubt that mutual and multilateral cooperation with the United States, which has been mutually beneficial to both sides, will continue," the statement said. "With this understanding of cooperation, a close dialogue with the United States concerning northern Iraq is being maintained."

In Washington, the Bush administration is reportedly mulling a $1 billion grant package that could support up to $8.5 billion in loan guarantees. Such aid would go a long way towards ensuring Turkish economic stability in 2003.

However, observers worry about what happens next. Sudden developments, especially concerning northern Iraq, could easily deal a new blow to US-Turkish relations. Turkey is vigorously defending its self-proclaimed right to enter northern Iraq, despite strong US objections. "Turkey is determined to take necessary measures to provide humanitarian aid, prevent a mass refugee influx and make sure a conflict will not break out between different groups in northern Iraq," the Turkish National Security Council statement said. "Suffering from terror that is a global threat, Turkey will not hesitate to take necessary measures against the terror threat that may emanate from the PKK [Kurdistan Worker’s Party]." [For additional information see the Eurasia Insight archive].

Another concern is that lingering resentment may prompt the Bush administration to exert influence on the lending practices of international financial institutions. In the past, the IMF in particular has readily extended credit to Turkey.

Eisinger of Fitch Ratings said that Erdogan’s team seems "serious" about complying with IMF demands on privatization and government efficiency. However, with Turkey due to pay at least $9 billion back to the fund by 2005, investors and officials want to see concrete changes before feeling secure that the IMF will remain a funding source. "We have yet to see any shred of evidence that Turkey has taken ownership of its IMF program," Eisinger told investors on March 26.

While the IMF similarly welcomed fiscal measures announced by Turkish officials on March 23 and 24, its officers have said that they need to see further reform progress before completing a review that would ease the release of a fresh $1.6 billion tranche. On March 27, Turkish Economy Minister Ali Babacan promised that the government and the Central Bank would keep the economy going while war fears and IMF scrutiny delay new funds. "We are prepared for weeks for a scenario in which there would be no [foreign] economic support during the course of war," he said. "We will finish off the debt by repaying, step by step."

Eisinger shared that sentiment: "Banks continue to be willing to fund the government," he said. This is a short-term solution, though, since over-reliance on Turkish banks can inflate the currency and discourage foreign investment.

Even if the Iraq conflict comes to a quick conclusion, without significant numbers of refugees in Turkey needing vital services, Ankara will need foreign revenues to offset what it loses in tourism and what it pays for energy. Turkey and the United States will surely cooperate on some level as the war continues. Turkish soil will probably provide a channel for aid to get to Iraq, and allied planes may eventually seek to refuel at Turkish bases. US-Turkish discussions on military cooperation were scheduled to resume March 29, when the Bush administration special envoy Zalmay Khalizad is expected to arrive in Turkey.

Editor�s Note: Mevlut Katik is a London-based journalist and analyst. He is a former BBC correspondent and has also worked for The Economist.

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