ECONOMIC IMPACT IF COURT CLOSES AKP

C O N F I D E N T I A L ANKARA 001314 SIPDIS DEPARTMENT FOR A/S FRIED DEPARTMENT FOR A/S SULLIVAN DEPARTMENT FOR DAS BRYZA E.O. 12958: DECL: 07/22/2018 TAGS: ECON EFIN TU SUBJECT: ECONOMIC IMPACT IF COURT CLOSES AKP REF: ANKARA 1221 Classified By: Ambassador Ross Wilson for reasons 1.4 (b) and (d) ¶1. (SBU) Summary: Investors agree that AKP,s closure is the most likely outcome of the court,s deliberations and therefore, the effect of the closure has already been largely factored into market behavior. However, two key unknowns, the fate of PM Erdogan and AKP,s current economic policies, will likely add a new dimension to the market reaction if AKP is closed. To the extent that Erdogan remains on the scene and AKP,s economic policies are continued by a successor government, economic volatility is unlikely. Global economic conditions will also continue to play an important role -- perhaps more so than AKP,s closure -- in Turkey,s economic health. End Summary. Current Economic Outlook -------------- ¶2. (SBU) The Turkish economy is currently suffering the effects of global economic stresses, particularly increasing energy costs. Tolga Ediz from Lehman Brothers told us tensions in the political arena, global credit conditions, and high oil prices have had a negative impact on Turkey,s economy. Ediz said the Turkish equity market has been particularly hard hit. Following an almost sevenfold increase in U.S. dollar terms between 2003 and 2007, outperforming the FTSE Emerging markets index by 175%, the Turkish equity market is now one of the worst performing among its peers with a 43% year-to-date decline (compared with declines of 8.1% for global emerging markets and 13.1% in Europe). Ediz expects the slowdown in global growth will likely affect Turkey,s exports, especially in 2009. The Turkish economy is still reliant on foreign capital flows to finance its growth and tightening global credit conditions mean that foreign investors will become less generous in their exposure to Turkey as well as other emerging markets, according to Ediz. ¶3. (C) Turkish Treasury Undersecretary Ibrahim Canakci closely linked the risks for the Turkish economy with the global economy, citing the key risk factors of high energy prices; slowing global growth; inflation pressure; and tight external financing conditions. He cautioned that Turkey,s external financing need for its high current account deficit puts the country in a vulnerable position; however, he went on to note Turkey,s continued economic strength and ability to raise a substantial amount from international markets this year. Canakci expects Turkey to receive $16 billion in foreign direct investment in 2008, a drop from Turkey's record 2007 FDI of $19.8 billion. He expects Turkey,s growth rate to reach 4-5% in 2008, down from the 6-7% rate of previous years. ¶4. (C) The current outlook for the Turkish Lira predicts a gradual depreciation. Turkey,s private sector has become more vulnerable to fluctuations in the exchange rate. The Central Bank of Turkey estimates that the open position of the non-financial private sector is approximately $60 billion, or about 10 percent of GDP. Emrah Eksi, Central Bank Markets Department Deputy Director General told us that despite uncertainty in global and political developments, the Turkish Lira is still one of the most attractive currencies in emerging markets. Investors expect USD/TRY to settle at 1.35 (USD .74) by the end of 2008, and at 1.45 (USD .69) by the end of 2009. Investors Consider the Economic Effects of AKP Closure -------------- -------------- ¶5. (SBU) Political tension, fueled by the closure case and more recently by the ongoing Ergenekon investigation, remains high. Murat Gurkan from Deutsche Securities and Tevfik Aksoy from Morgan Stanley told us a court ban of the AKP and some of its leaders, including PM Erdogan, is considered the most likely scenario by investors. As such, investors have largely priced the AKP,s closure into Turkish assets, and Turkey has been paying increasingly higher rates because of perceived higher risk. Baturalp Candemir from EFG Securities said his worst case scenario is PM Erdogan,s being banned from party politics, because this will increase and prolong investor uncertainty. ¶6. (C) Aksoy said that if AKP is closed, we should expect a period of political uncertainty, especially regarding the Prime Minister's position. Consequently, Aksoy expects volatility in Turkish asset prices in the immediate wake of the Court decision. Aksoy, Gurkan, and Ediz all expect a decision to close AKP will slow growth further than global economic conditions merit, as domestic firms and consumers become more conservative in their spending and investment decisions. Ediz added that tightening global credit conditions will continue to limit credit availability, and rising real interest rates will cause consumers and companies to cut back on their discretionary spending. GOT Considers Economic Effects of AKP Closure -------------- ¶7. (C) Canakci told us if the Court closes the AKP, the potential effects on the economy could range from marginal to somewhat negative if economic policy is not clarified. Canakci listed four basic pillars of positive macroeconomic performance present since the rise of the AKP to power in 2002: fiscal and monetary discipline with policy stability; favorable global environment; EU accession; and IMF dialogue. The global environment is no longer favorable, and in case of AKP,s closure, policy stability could be shaken along with political stability. Canakci noted that AKP policies have encouraged private sector development and played a key role in Turkey's positive economic performance. If an early general election is called, the Treasury Undersecretary mused the next government would likely follow the basic outlines of the current economic policies, although support for more difficult structural reforms could continue to wane. Canakci noted that Prime Minister Erdogan,s personal commitment to reform has played an important role in the current policy stability. A decision to ban Erdogan from politics could damage this stability -- at least in the short-term -- and shake up markets until his successor makes his economic policies clear. Visit Ankara's Classified Web Site at http://www.intelink.sgov.gov/wiki/Portal:Turk ey WILSON