A Cloud over Turkey's Economy Recedes

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"Once the euphoria dies down, attention will again turn to run-of-the-mill issues, like global markets, oil prices, and the domestic macro situation," says economist Banu Tokali of Istanbul brokerage FinansInvest, citing "inflation and monetary policy, in particular, coupled with the still-gaping current account deficit."

Turkey's central bank raised rates a further 50 basis points in July, repeating identical hikes it made in May and June. The latest increase brings the overnight borrowing rate to 16.75%, with the lending rate unchanged at 20.25%. The bank has been cagey about projecting its future monetary course, given the uncertain outcome of the AKP case and the unknown duration of the recent drop in oil prices. But in its July inflation report, the bank hinted at a slowdown in rate hikes. The bank also revised upward its projected inflation rate for 2008, from 9.7% to 10.6%, and pegged next year's rate at 7.9%.

Headscarf Controversy

There's little doubt the controversial case dampened Turkey's outlook when it was launched on Mar. 14. Turkey's chief prosecutor stunned the government by filing an indictment against the AKP, seeking to close it down on charges of having become "a center of anti-secular activity" and of harboring a hidden agenda to impose Islamic law on the country. The prosecutor sought to ban Erdogan—who had just won reelection by a landslide the previous July—as well as President Gül and 69 other party members from political activity for five years.

In his 162-page indictment, the prosecutor cited one concrete example. In February 2008, the Prime Minister pushed through Parliament two constitutional amendments to allow women to wear headscarves at universities, a practice previously banned in Turkey as a violation of the Republic's secular tradition.

The Constitutional Court overturned the headscarf amendments as unconstitutional in June, raising concern that an AKP ban was also likely. Investor interest in Turkey slowed on fears of political instability, and the international community, from European Union officials to U.S. Secretary of State Condoleezza Rice, spoke out against the unusual legal proceedings. Analysts warned that closing the AKP could ruin Turkey's EU membership ambitions, derail the economy, and possibly tip the country into civil strife.

The palpable relief over the resolution of the case and continued tenure for the probusiness Erdogan should now reinvigorate Turkey's business climate. But a worsening in the global economy still could weaken the country and take the shine off the AKP's victory.

Kuser writes for BusinessWeek.com from Istanbul .