Istanbul's Economic Tension

By Andrew Purvis/Istanbul

Turkey has attracted a lot of attention lately thanks to a series of political crises--from armed forays into neighboring Iraq in pursuit of autonomy-seeking Kurdish militants to an atavistic attempt by Turkish prosecutors to ban the country's own ruling party. The political intrigue has created a speed bump--or maybe a stop sign--for an economy that had been striding with determination toward inclusion in the European Union and recharging its ancient trade links with the Middle East.

Since 2002, annual foreign direct investment in the mainly Muslim but officially secular country of more than 70 million people, which has traditionally served as a crossroads between East and West, has jumped more than 30-fold, to about $22 billion. Investment in banks, retail and commercial real estate has risen sharply. Turkish businesses have been investing aggressively in oil-rich Russia and the Middle East. All told, an economy that was shrinking as recently as 2001 expanded more than 5% a year through last year.

Turkey's economic surge is, moreover, a sign of underlying political progress. The West couldn't hide its nervousness when the Justice and Development Party (AKP) was elected in 2002. The AKP is moderately Islamist, but its economics have turned out to be decidedly liberal. The party has nurtured economic reforms that have tamed inflation, stabilized a jittery currency and entrenched the independence of the country's central bank. Privatization of state-owned properties continues to attract outside investors. Turkey's application to join the E.U. is stalled on objections by France and Germany, among others. But the process of meeting reform benchmarks for membership eligibility has already paid off nicely. Whether or not Turkey joins the E.U., its government says its chief goal is to increase incomes to European levels.

But its Old Guard secular establishment is now backing a lawsuit aimed at banning the democratically elected AKP, casting a shadow over Turkey's prospects, at least in the short term. The suit seeks to bar the party and its members from political activity for allegedly violating Turkey's constitutional prohibition against mixing politics and religion. The move has rattled markets. After tripling from 2002 through last November, Turkey's stock index has dropped 32%. The global credit crunch has not helped. The ratings agency Standard & Poor's in April cut Turkey's credit rating to negative from stable, citing a fraught political and global environment. "The Turkish economy is in a major transformation with high efficiency gains, whose impact will be even more evident in the next decade," asserts Suzan Sabanci, chairwoman of Akbank, Turkey's largest privately owned bank, and a scion of one of Turkey's wealthiest families. "Global events will have an influence on the Turkish economy," she notes. "But I do not expect them to be dramatic."

Modern Turkey has looked Westward since its staunchly secular founder Mustafa Kemal Ataturk decreed the separation of mosque and state shortly after World War I. The pro-Western political bent did not immediately translate into liberal economics. Corruption, cronyism and protectionism continued to cloud prospects until the 1980s. Even then, after a period of economic liberalization under reformist Prime Minister Turgut Ozal (a pal of Margaret Thatcher's), the old habits died hard. In 2001, Turkey suffered a full-blown financial crisis in which the Turkish currency lost nearly 50% of its value overnight.

That shock proved to be a wake-up call. Turkey was compelled, as a result, to accept World Bank and International Monetary Fund prescriptions, including fiscal discipline and regulatory changes, that have since paid off handsomely, triggering five years of more than 6% annual growth, single-digit inflation and rising incomes.

Turkish banks have been particularly attractive to outside investors. Citigroup last year bought a 20% stake in Akbank (for $3 billion). "The foreign appetite for Turkish companies and stocks is high," said Hakan Avci, director of asset management at the Istanbul office of Raymond James Securities, a U.S. company, before the recent political blowup. In the past 18 months, Lehman Bros., Morgan Stanley and Credit Suisse bought local brokerages in the country. Avci has since lowered his projections because of the political turmoil but says he is "optimistic that this crisis will be overcome and a solution found." The Turkish government has vowed to press ahead with privatization plans, including a 15% treasury-owned stake in Turk Telekom, the Turkish telephone operator, as well as regional electricity-distribution grids and Halkbank, Turkey's second largest state-owned bank.

Commercial real estate in big cities like Istanbul has become particularly attractive to foreign investors who see markets in Turkey that have yet to be picked over. The graceful domes and minarets of Istanbul and other cities are being augmented by a thicket of building cranes, and futuristic shopping malls are competing for space among the red-tiled roofs. Analyst Roger Barris at Merrill Lynch predicts that outsiders will pour more than $15 billion into Turkish real estate in the next five years. Turkish coffee may be famous, but Turkey is now one of Starbucks' fastest-growing markets.

Turkish businesses, meanwhile, invested $28 billion in Russia last year, up from $15 billion in 2005. They are poised to take advantage of the $1 trillion that Russia says it will spend on infrastructure by 2020. And while Turkey refused to permit U.S. troops to invade neighboring Iraq from its territory in 2003, Turkish construction and retail companies have since invested up to $10 billion in the war-torn country.

Falling trade barriers with the West have also reinvigorated some of Turkey's ancient trade centers. In the old Silk Road city of Kayseri, formerly Caesarea, 150 miles (240 km) southeast of Ankara, some 400 factories producing everything from electric cables to blue jeans have sprung up in the past several years. Exports from that city and its sister "Anatolian tigers," as Turks call the industrial hubs of the central part of the country, have doubled since 2002. "We will take care of Europe in its old age," jokes Mustafa Boydak, head of Kayseri's Chamber of Commerce, citing Turkey's entrepreneurial efforts and the youthfulness of its population, 70% of which is under 35. The region's growing economic clout, says Gerald Knaus, director of the European Stability Initiative, an Istanbul-based think tank, suggests that divisions in Turkey between wealthy, secular elites and the conservative Muslim middle class are disappearing. "We are seeing the transformation of an agrarian society into an industrial economy," he says.

But the latest political problems show how Turkey's old secular establishment, a wealthy class rooted in western coastal cities, is not ready to surrender its prerogatives yet. It is backing the court challenge to the AKP, whose electoral base, incidentally, is central Anatolia. (Turkey's President, Abdullah Gul, is from Kayseri.) "The reason the economy was booming in recent years," says Raymond James analyst Avci, "was that there was finally political stability with a single-party government. That is now in jeopardy, which is worrying." And yet businessmen like Serdar Bilgili remain upbeat. The Istanbul entrepreneur just invested in a $75 million project to build a new W Hotel in the trendiest part of Istanbul. "We are very positive in the long term," he says. "The outlook might seem unclear now, but financial markets and bank reserves are strong, and we are confident in the potential of Turkey to grow." The fact that he is not alone in that view is, ultimately, Turkey's real headline news.

With reporting by With Reporting by Pelin Turgut / Istanbul