Turkish Politics Take an Economic Toll

The fight over secularism is dimming the economic prospects of the republic: Growth has slowed, inflation is up, and the lira is down

by Michael Kuser

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The political drama in Turkey this spring may turn out to be a rite of passage for Turkish democracy. After an intense year of infighting between the country's powerful secular establishment and the popular Islamist-rooted government of Prime Minister Recep Tayyip Erdogan, matters have come to a head with the Mar. 31 decision by the nation's Constitutional Court to hear a lawsuit seeking to abolish Erdogan's party for undermining the secular nature of the republic.

If the court decides against Erdogan's ruling AK Party, the organization could be outlawed and both the Prime Minister and President Abdullah Gül, who also hails from the AKP, could be banned from politics for five years. Although most observers think that outcome unlikely, the mere possibility has thrown Turkey into turmoil and cast a shadow over its economic prospects.

It may be difficult for outsiders to understand the stakes—or even to imagine the scenario. After all, nobody has tried to sue the Republican Party in the U.S. for violating the separation of church and state because President George W. Bush is an avowed Christian. But the entire history of modern Turkey is staked on the legacy of Mustafa Kemal Atatürk, who led the battle for Turkish independence after World War I and founded the Republic in the 1920s on secular principles.

Growth Forecasts Lowered

Turkey today is an advanced country of 72 million people with a gross domestic product of $420 billion. But political turmoil is dividing the people, distracting politicians from needed reform, and threatening business. Already, economic growth has slowed from the 7% it averaged between 2002 and 2006 to potentially just 4.5% this year, and inflation is hovering around 9%, well above the Turkish central bank's yearend target of 4%.

In an Apr. 8 note to clients, economist Banu Tokali of Istanbul brokerage FinansInvest noted that her 2008 growth forecast for Turkey was set at 4.7% before the Constitutional Court agreed to hear the lawsuit against the AKP. Now, Tokali says, "This faces a downward revision depending on the extent that domestic demand responds to the recent political disturbance."

That uncertainty is giving investors pause. The Istanbul stock exchange is currently trading down more than 25% from its 2007 peak. The Turkish lira has fallen 8.7% against the dollar since the start of the year, and 14.8% vs. the euro—a particular problem since Turkey trades so much with Europe. There are early indications that foreign direct investment could fall by 16% this year, to a projected $18 billion. And on Apr. 3, Standard & Poor's (MHP) downgraded Turkey's outlook to "negative" due to concerns over domestic political instability and broader global economic conditions.

Economy Booms Under Erdogan

For Erdogan, who was convincingly reelected last summer in part due to his successful stewardship of the economy, the turn of events presents enormous challenges. Turkey has long coveted membership in the European Union, and voters rewarded the Prime Minister for convincing the EU to open accession talks in 2005. Although Erdogan is a practicing Muslim and his wife wears a headscarf—a traditional symbol of observance—he is known as pro-Western and pragmatic. Many Turks, regardless of their religious views, think his government has been the most effective and competent in decades.

The Prime Minister, who was first elected in 2002, has managed to wipe out the punitive inflation that sapped Turkey throughout the 1990s and has boosted foreign investment to levels 20 times higher than a decade ago, attracting businesses including automobile manufacturers (BusinessWeek.com, 1/10/07) and investment banks. Sectors such as tourism, real estate, telecommunications, and technology have boomed.