Success eludes the victors

TURKEY’S LIBERAL ISLAMIST government was only elected in November but it has already disappointed the markets because of its perceived lack of direction, coordination and skill.

Tayyip Erdogan’s Justice and Development Party (AKP) won control of nearly 70% of the seats in the Meclis (national assembly) but has often behaved as if it were a novice coalition.

Matthew Vogel, head of emerging markets strategy at Barclays Capital Research, summed up the market verdict when he wrote that “across foreign and economic policy matters [the Turkish government has] been unable to provide clear answers on a number of critical issues. Lack of focus and coordination are [its] characteristics.”

Vogel made this assessment in a report after a week-long visit to Turkey last month. “We arrived in Ankara with questions about the government’s stance,” he wrote, “and we left with the same ones.”

The question is are these failings a temporary affliction or is this as good as the AKP government will get?

“I have never seen a new government run out of capital so quickly,” says a European banker. “It is possible that once they get settled in they will become more efficient. But I doubt it.”

In Vogel’s view the market will remain cautious until the Turkish government grants the US permission to station troops on its soil and in return receives a financial package of up to $25 billion that will ease concerns about fiscal shortfalls. These developments are likely to be followed by the IMF’s stamp of approval, which has been hanging in the air since the fourth quarter of 2002.

One of the main reasons for the government shambles, which came as something of a surprise considering the AKP’s commanding majority, is that Erdogan is not at the helm as prime minister. He led his party to a sensational victory in the elections but was barred from standing himself because he had a short spell in prison for breaking laws that enforce secularism. Under the Turkish constitution, only deputies elected to the Meclis are eligible to become prime minister. So Erdogan chose Abdullah Gul (pictured above), a soft-spoken popular man, as his surrogate.

Turkey has therefore ended up with two leaders. Everyone knows, though, that Erdogan will replace Gul as soon as he can gets elected to the Meclis in a by-election, probably in the next few months. In Turkey, though, nothing is simple. Whether Erdogan can stand in a by-election has become a matter of legal dispute. Sabih Kanadoglu, Turkey’s chief prosecutor, claims the AKP leader is not eligible and is planning to take legal action to stop him. He might or might not succeed.

In the meantime, Kanadoglu is pressing ahead with a case in which he is seeking to get the constitutional court to close down the AKP on the grounds that it has fallen foul of laws protecting secularism. If this were to happen not only the man who won the elections but also the party that won it would be excluded from the legislature.

Since the general election, Erdogan has spent most of his time travelling, probably to avoid treading too much on Gul’s toes. He has visited almost all the EU countries, Russia and the Turkic states of Asia and China. But despite not cramping Gul’s style, things have gone badly in his absence.

Gul lacks Erdogan’s charisma, authority and force of character. Moreover, he is weakened by the fact that many of the cabinet ministers owe their position not to him but to Erdogan. Gul, who worked as an economist at the Islamic Development Bank in Saudi Arabia, also has little experience in government, although this is his third stint as a Meclis deputy.

Gul quickly entered into a debilitating conflict with Turkey’s powerful military when he objected to the expulsion of officers who had ties to banned religious sects or made overzealous displays of Islamic faith. The army considers itself the guardian of Turkey’s democracy and regards fundamentalism as a threat to the republic.

In practice, though, the AKP represents different views of the place of Islam in politics. Broadly speaking, there are three factions. Representatives of the first include deputy prime minister Abdullatif Sener and education minister Erkan Mumcu. They are politicians who joined the AKP from right-of-centre parties that sank without trace in the general elections. They are not Islamic fundamentalists in the classic AKP mould.

Erdogan and Gul belong to a second group that, at heart, cherishes the ideal of a Quran-based state but understands that this is not a practicable option for Turkey. Erdogan, Gul and people like them have buried their ideals in order to be able to rule. They have learned from past mistakes: all Islamic parties that have been formed since 1970 were forcibly abolished as soon as they started threatening the established secular regime.

The third faction, probably the majority of AKP supporters, comprises those who subscribe to what is known as Milli Gorus. This is an indigenous form of Islamic fundamentalism with traits of Turkish nationalism as upheld by Necmettin Erbakan, who the army forced to resign as prime minister in 1997. Meclis speaker Bulent Arinc, who was one of Erbakan’s top lieutenants, is a prominent member of this faction. Although virulently anti-American and generally hostile to the west, Milli Gorus is not known to have engaged in violence.

Erdogan understands that without the approval of the army and the dominant secular establishment he cannot rule. The line he has taken is that “AKP is not a religion-based party. It is a party that cherishes traditions and conservative values”.

If Erdogan can maintain discipline in the AKP its uneasy coexistence with the army could be long-lived. A basic problem with the party, though, is not that its roots are religious but that it seems to be incapable of making up its mind.

Drift and slippage
“Turkey’s economic and foreign policy has drifted over the past month, and a great deal needs to be done on a difficult IMF programme, Cyprus and Iraq,” says Barclay Capital’s Vogel. Turkey has been tied to an IMF stabilization programme since 1999. Under this, IMF officials review progress and, if satisfied, release funds. Last year’s fourth-quarter review was inconclusive because of the upcoming elections and slippage in targets related to this. A credit tranche of $1.6 billion was withheld pending review in the first quarter of 2003 with the new government in place. The markets were initially expecting this to happen in January but at the end of the month the waiting continued.

The government repeatedly declares that it will remain loyal to the guidelines of the IMF programme while taking piecemeal decisions redolent of populism that confuse the markets and put the IMF on its guard.

The IMF has, for example, been piqued by the government’s plans for a tax amnesty, generous pay rises for pensioners and attempts to amend the state procurement law passed last year to curb corrupt practices.

“There is an acceptance that the government is not doing enough to enable the IMF to sign off speedily on the fourth review,” says Tim Ash, a senior Bear Stearns analyst.

The markets were shocked when deputy prime minister Abdullatif Sener appointed his older brother as deputy chairman of state-owned iron and steel complex Erdemir. Most of the 11 other board seats were also filled with party faithful. Sener is a seasoned politician and the most senior of the four ministers among whom the economic portfolios have been divided. The appointment, which passed without comment from either Gul or Erdogan, demonstrated that the AKP is not immune to the cronyism that has traditionally been one of the biggest weaknesses of the economy.

“On my part, I was willing to give AKP the benefit of the doubt but it blew it big time with this one,” says a senior bank economist. “On the face of it, this appointment may seem to be a small event but it casts a big shadow on the AKP’s governance principles. It took one politically oriented appointment to dash the hopes of an entire nation.”

These developments reinforced uncertainty about the determination of the government to stick to the economic programme. Market sentiment slumped. The proportion of industrialists expecting higher orders in January dropped to 25% from 27% in the previous month.

“The main reason for this pessimism was the rising scepticism over the performance of the AKP government and the accompanying surge in interest rates,” says Yarkin Cebeci, a JPMorgan analyst in Istanbul.

Senior officials from the IMF and the World Bank visited Turkey last month to gauge the government’s intentions. Anne Krueger, the IMF’s first deputy managing director, highlighted the need to do more on the fiscal front, urging the government to stick to the stand-by agreement.

“In the very first weeks in office, the AKP government looked sincere about solving Turkey’s long-standing problems,” says Cebeci. “This resulted in market euphoria and rapid improvement in market variables. However, instead of making the government more enthusiastic about its intentions, the positive market reaction resulted in a wave of complacency. The resulting worsening in market sentiment was as pronounced as the improvement a couple of months ago.”

In response to criticism, the government introduced two packages. Prime minister Gul brought in a fiscal discipline package and deputy prime minister Sener announced an ambitious privatization programme.

Neither was able to impress the market, which feels that substantial work needs to be done in order to reach the 6.5% of GNP primary surplus target for 2003. The market’s assessment was that the revenue package announced by the prime minister was insufficient by a large margin.

Sener said the government aimed to get $4 billion (more than 2% of GDP) from privatization in 2003. “If accomplished,” says Cebeci, “this would correspond to half of the $8 billion of total privatization income in the past 17 years.”

But Turkish privatization has up to now been more bark than bite, so the markets were not impressed. The “privatization track record has been miserable,” says Cebeci. “Except in 2000, when a mobile phone licence was sold, the yearly privatization revenue was never north of 0.5% of GDP.”

The companies on the 2003 privatization list include petrochemicals company Petkim, oil refinery Tupras and Turkish Airlines. Sener announced that an unspecified stake in Petkim would be offered as a block to a strategic investor in the first quarter of this year. Tupras and a stake in state tobacco and liquor monopoly Tekel are planned for sale in the second quarter. The Turkish Airlines sale is planned for the third quarter.

In a surprise move the government put new companies on the privatization list. These include the Istanbul stock exchange, the Istanbul gold exchange, and the national lottery administration. The two bridges that span the Bosphorus strait, linking the Asian and European sides of Istanbul, will also be privatized, together with some highways. Before this can be done, new laws have to be enacted to make the transfer of operation rights to private companies possible. The biggest obstacle, though, is that both the domestic and international environment is unfavourable for the sale of massive Turkish assets. Turkish companies are strapped for cash and the public offering market has been virtually dead for two years.

“They prepared a shopping basket to look good to the IMF and the public,” says the CEO of a large Istanbul securities company. “By my estimate at best they can realize a quarter of their target.”

Instead of paying attention to government promises, the market bent its ear to the IMF’s Krueger, who delivered tough messages on fiscal discipline. After describing Gul and Sener’s packages as “helpful initial steps” she said that an IMF mission would come to Ankara to discuss the 2003 budget and other key issues when the government had spelt out its policy plans more clearly.

The IMF has two important goals for Turkey: to ensure that fiscal discipline is maintained; and to see that the reforms enacted in the past two years stay in place and are vigorously implemented.

Turkey has missed the 2002 fiscal targets by a large margin. The primary surplus at the end of 2002 is believed to be around 4.5% of GNP rather than the target of 6.5%. The November 2002 consolidated surplus was about TL11 quadrillion ($6.6 billion) compared with a target of about TL15 quadrillion and a year-end target of TL16 quadrillion. Fiscal tightening will be required in order to make up for this deficit but there is no sign that it is happening, although the government continues to promise that it will stick to the IMF’s primary surplus target.

This, though, is probably impossible to achieve, irrespective of the 2002 shortfall, because it assumes that there will be no war between the US and Iraq. Some analysts calculate that even if there is no war Turkey will have a financing gap of $5 billion. The treasury is heavily indebted and a shortfall in targets automatically raises doubts about its ability to repay.

Gul’s package envisaged raising just over TL6.2 quadrillion. This would more than offset the cost of the pension increases. But except for higher taxes on tobacco and alcohol, his measures require supervision, which analysts believe will not be ready in the very short term.

“As a result, we should not get carried away by these high figures,” says JPMorgan’s Cebeci. And sounding as if he is clutching at straws, he adds: “We argue that those who understand economic policy within the new Turkish administration have enough influence in the government to convince AKP leader Erdogan that the incentives to follow the IMF are too strong to ignore. Don’t lose faith yet.”

Bear Stearns’ Ash says: “Prime minister Gul’s fiscal package is underwhelming. The 1.7% fiscal adjustment proposed appeared long on gimmicks and short on hard policy measures. In any event, a larger 2% to 3% fiscal adjustment is required, given the 2002 shortfall on the primary surplus.”

Complicating the fiscal outlook is the possible US invasion of Iraq, with which Turkey has a long, mountainous, permeable border.

Krueger has told Turkey that conditional on reaching an agreement on fiscal targets and a structural reform agenda for 2003, the country could become eligible for supplementary loans to relieve the pressure on fiscal balances certain to be created by Iraq-related developments. Similar promises of help have come from the US government, which has spoken of a $4 billion to $15 billion bailout in grants and soft loans.

The US has asked Turkey to allow it to base 80,000 to 100,000 troops in eastern Turkey and requested access to Turkish airports and harbours. Turkey delayed making commitments, at least publicly, while Gul tried to bring together a coalition of Middle Eastern countries including Egypt, Iran, Jordan, Saudi Arabia and Syria to avert war.

Turkish indecision is delaying US plans to have between 200,000 and 250,000 troops in place in the Gulf region by mid-February. It is not difficult to see why Ankara is wavering. Some 80 % of Turks are opposed to an invasion of Iraq. After Iraq, Turkey would be the biggest loser since its economy would suffer a severe setback.

However, eventually Turkey will probably be forced to accommodate the US, its most solid ally since World War II. If it doesn’t, it will forgo the US-sponsored loan package, which is critical to its fiscal health. It will also lose the opportunity of being at the victors’ table when they shape the future of Iraq. Turkey is keen that Iraqi Kurds, who occupy the space between the Turkish border and the Arab population of Iraq, don’t use the war as an excuse to declare independence. Turkey has a large Kurdish population in the provinces bordering Iraq and is fearful that this might lead to renewed agitation for independence among Turkish Kurds.

Because its economy is so weak, Turkey is neither strong enough to stop a war nor to remain neutral if it takes place. As army chief of staff general Hilmi Ozkok has said: “Regrettably our policies derive their support not from the economy but from the armed forces.”