Turkey: More Woes for Government, as Economy Loses Steam

If the secularist-dominated Supreme Court in Turkey doesn't sink the governing Justice and Development Party, the country's slowing economy just might.

Over the near term, the fate of the moderate Islamist Justice and Development Party (AKP) would seem to be in the hands of the Supreme Court, which on March 31 decided to hear arguments in a case that could result in a ban on the party for supposedly seeking to break down the firm barriers in the Turkish constitution separating mosque from state. [For background see the Eurasia Insight archive].

But the economy has fast emerged as a longer-term threat to the AKP's political fortunes. After coming to power in 2002, one year after a severe economic crisis, the AKP fostered an economic turnaround, transforming Turkey into one of the globe's hottest economies. Economic growth averaged 7 percent between 2002 and 2006 and foreign investment poured in at record levels. At the same time, through shrewd fiscal policies and economic reforms, the government was able to bring Turkey's formerly runaway inflation down into the single digits and stabilize the famously wobbly Turkish lira.

But worrying indicators have appeared in recent months. Inflation is again inching up, now standing at 9 percent, above the Turkish central bank's target of 4 percent. Economic growth, meanwhile, is only expected to reach 4 percent this year.

Since the beginning of the year, the Istanbul Stock Exchange has lost 25 percent of its value, while the lira is down 21 percent against the euro and 13 percent against the dollar. "Definitely we are talking about a weaker economy now," says Murat Ucer, an economic analyst based in Istanbul. "We are talking about a pretty ugly picture, which is different from what Turkey is used to seeing over the last few years, where we had lower inflation and higher growth."

In a report on the Turkish economy published this past November, the International Monetary Fund looked at the country's economic vulnerability, comparing it to other emerging markets in several categories, such as external debt and current account deficits. In most cases, Turkey's economy was the most vulnerable among the countries compared. "Turkey faces several vulnerabilities that need to be carefully managed to avoid the boom-bust cycles of the past," the report said.

Lars Christensen, an emerging markets analyst at Danske Bank in Copenhagen, believes Turkey is moving towards a "stagflationary scenario," where growth stagnates while inflation rises, which could lead to a recession and higher unemployment. "What drives this is the double whammy of the global credit crunch and rising commodity prices," he says. "Turkey is probably more sensitive to this than many other countries."

For the AKP government, the economic slowdown couldn't come at a worse time. The Supreme Court is expected to issue a ruling on the AKP ban case within six months, leaving Turkish politics in a state of suspended animation and forcing the AKP to focus on its survival rather than shoring up the economy.

"I believe the government understands the [economic] situation, but they have some other problems, political problems," says Ali Ihsan Gelberi, head of research at Garanti Bank in Istanbul.

In this case, though, Turkey's political and economic problems might go hand-in-hand. Increased political instability, particularly if the AKP is closed down, could drive away the foreign investors that have been a big part of Turkey's recent economic success. At the same time, perhaps to the delight of the AKP's opponents, an economic slowdown would put a dent in the party's reputation as a fiscal miracle worker.

"AKP is popular for one reason and almost one reason only, and that is how the economy has been doing under its stewardship. An economic slowdown could make the political risk [in Turkey] even higher," says Danske Bank's Christensen.

Adds Ucer: "Definitely an economic weakening is something the AKP's opponents are hoping for. The only hope of those who want to get rid is the AKP is the economy."

For many Turks, the fear is that Turkey could see itself rolling back towards the political and economic instability that plagued the country in the period that led to the 2001 economic crisis.

Analysts say Turkey's economy is more robust today, leaving it less exposed than it was in 2001. "But what you risk is the country losing its direction in terms of fiscal discipline," says Ucer. "The biggest risk really is slow growth or no growth. Turkey has to grow. You have to have good growth to mask the social and political tensions here."