Events in Turkey over the past week have amply demonstrated the risks investors face when investing heavily in emerging economies. To some extent too the outcome of those events and accompanying equity and currency market volatility go some way towards illustrating the threat posed to investors generally when geo-politics assumes the upper hand in apparently serene financial market conditions. In the following paragraphs we look behind the events of the past week in some detail and argue that just because frantic efforts are now being made to give the impression of stability one of the best performing equity markets of 2007 is far from out of the woods.
Why Turkey is important for investors
Turkey is important to investors for three major reasons. Firstly, the country is wending its way towards EU integration in 2015 and has consequently to prove greater economic policy rigour than in the past. Secondly, 2005 saw the completion of the world’s longest oil pipeline (1776km) stretching from Baku in the east to the Turkish port of Ceyhan in the Mediterranean via Tiblisi. The venture was financed by $4bn US money and BP with a 30% stake in the project is the lead partner.
The creation of this feat of engineering across the Caucasus mountains and Eastern Turkey is regarded as being of crucial strategic significance. Of equally crucial strategic significance is Turkey’s geographic location between Russia and other former Soviet states to the north, Europe to the west and the Middle East to the east. The country has proved pivotal throughout history and retains enormous geo-political significance to the West as a relatively stable location from which events to the north and east can be kept under careful watch.
Such strategic significance forms the backdrop to a volatile political backdrop. The modern Turkish Republic was founded by Mustafa Kemal Ataturk in the 1920s and the presidency, although holding only limited constitutional power, retains considerable symbolic significance amongst the Turkish people. The longest-running topic in Turkey remains the relationship between religion and state, the latter enshrined in the modern constitution and guarded jealously by one of the world’s largest armies. Friction between secularism and Islam is never far below the surface at any time and periodically explodes into violent confrontation.
The economic process through which Turkey can become more closely integrated with Europe has, to some extent, reduced the army’s influence over political control. Although the army has broadly accepted this reduced influence, it has not done so entirely willingly and from time to time seeks to remind the nation that it remains a powerful, if dormant, force.
Turkey’s constiutional crisis
On Friday 27th April the ruling (Islamic) AK Party’s presidential candidate Deputy PM and foreign Minister Mr Abdullah Gul achieved 357 votes (out of 361cast) in the first round of the country’s presidential election, leaving him 10 votes short of the two thirds (367 out of 550) required for outright victory. The result emerged in the wake of a boycott by the secularist centre-right ANAP and DYP and the main opposition Republican People’s Party (CHP). The CHP then challenged the result through the Constitutional Court claiming that an insufficient quorum had been achieved to allow the vote to stand, a move which would, if upheld, result in annulled election and an early general election.
The CHP claim would, by itself, have struggled to hold much water as, normally, only one-third of the votes are needed for a sufficient quorum to be established in parliament and that in previous presidential elections a two-thirds quorum was not sought. Significantly, however, seven (out of eleven) Constitutional Court judges were appointed by the current president, Sezer, who is known not to favour the ruling AK Party and regularly vetoes proposed legislation and appointments.
The CHP move caused a frisson in the Turkish equity market and caused the Lira to fall sharply on the foreign exchanges. An already tense situation was then exacerbated by the army’s threatening to intervene were the first round ballot not to be annulled. What lay behind the army’s move was the fear that a moderate government might adopt a more tolerant stance towards Islam (Mr Gul’s wife wears an Islamic headscarf, an act still regarded as potentially incendiary) and a possible further marginalisation of its power. A tense situation was further exacerbated by a massive secularist public demonstration in Istanbul on 29th April. Clearly, the polarisation between Turkey’s secular elite and a reformist government has sowed the seed of financial market volatility. The resurgence of political polarisation represents a throw-back to the 1960s and 70s and lies at the very heart of the country’s economic instability.
Turkey’s constitutional court ruling
Perhaps unsurprisingly, given the above, the Constitutional Court followed the pressure exerted by the military and annulled the first round ballot, thus paving the way for an early general election. The ruling AK Party has proposed 22nd July as an appropriate date, bringing forward the timetabled date from November in the hope of capturing what could prove to be considerable public support for the Party. Opinion polls taken between now and July 22nd are likely to confirm this upsurge in popular support, particularly so since the public’s perception of a Constitutional Court in the firm control of the secularist elite has been reinforced. The clear risk is that, buoyed by an overwhelming show of popular support at the forthcoming poll, the AK Party pushes ahead with an even more radical presidential candidate than Mr Gul, a move that would almost certainly provoke an aggressive response from secularists and the military.
Turkish crisis: lessons for emerging markets investors
Turkey has entered a chaotic electoral mill-chase in the wake of the Constitutional Court decision. Financial markets have settled down, indicating that investors appear confident that the electoral process was always going to run its course anyway and that the military’s broadside will result in a more consensual presidential candidate emerging in due course. We are not comfortable with the view that the ruling AK Party’s hands are tied and that a moderate candidate to replace Abdullah Gul will emerge. We suspect that driven by a wave of indignation regarding the handling of the presidential ballot, the pressure could be on the Party (assuming it emerges victorious on July 22nd) to opt for a more insular, confrontational, candidate, a move which could provoke a reaction from secularist supporters and throw the markets back into turmoil.
It is significant that, thus far, there has been little in the way of spill over into other emerging markets, either in terms of equity market performance, currency reaction or a marked widening in credit spreads. Although we infer from this that global investors believe events unfolding in Turkey to be entirely domestically orientated, we suspect that what has happened represents a unique insight as to what might happen to any emerging market were the perceived status quo to be upset.
By Jeremy Batstone, Director of Private Client Research at Charles Stanley