Ottoman dream sours

The Daily Telegraph (UK) Thursday, February 20, 2014, p. B1

by Ambrose Evans–Pritchard

Turkey was to have been Europe’s last great hope

p. B2

Turkey highlights struggle facing emerging markets as politics go off the rails

Turkey is the first big domino to fall in emerging markets, a cautionary tale for investment tourists who came late to the party and skipped the political fine print.

Its catch–up growth spurt sputtered out in 2007. The consumption boom that followed has been driven by inflows of hot money, like the final bubbles in Ireland or Spain.

Its showcase Muslim democracy came off the rails when police opened fire last June on demonstrators in Istanbul’s Taksim Square and cities across the country, killing six and leaving 8,000 injured. Amnesty International decried human rights violations on a « huge scale ».

Matters have since gone from bad to worse. European diplomats say premier Recep Tayyip Erdogan is in such clear breach of the EU’s Copenhagen Criteria on democracy and the rule of law that Turkey’s accession bid is in doubt, and with it the « convergence story » that underpins foreign investment.

No country so rudely exposes the illusions behind the $8 trillion (£4.79 trillion) stampede into emerging markets, though Ukraine must be ahead on points by now. Investors came to believe that all humanity is moving in the same direction, that free markets and open societies are ineluctable, that we are seeing the « End of History » on liberal terms. « The West should wake up, » said Kemal Kilicdaroglu, Turkey’s opposition leader.

Muharrem Yilmaz, head of Turkey’s industry lobby Tusiad, issued a cry of alarm three weeks ago. « A country where the rule of law is ignored, where the independence of regulators is tainted, where companies are pressured through tax penalties, is not a fit country for foreign capital. » For this he was accused of « treason » by the prime minister.

The new twist – the « events of December 17 » – is the eruption of a power struggle within Mr Erdogan’s Islamist movement, triggered by corruption probes against four cabinet ministers.

Mr Erdogan retaliated with a purge of judges and police, as well as banking and TV regulators. He claimed that a « parallel state » led by the Gulenist brotherhood – a sort of Islamist Opus Dei that runs elite schools – was trying to overturn democracy.

« Claims of a judicial coup cuts no ice with us, » said one EU diplomat. « The prime minister is circling the wagons. Anybody not considered sufficiently loyal is being forced out.

« There are no credible parliamentary balances to hold the executive to account. Erdogan cannot roll up democratic institutions like this. He was told in no uncertain terms in Brussels that these are persistent breaches of the Copenhagen Criteria, and imperil Turkey’s accession process. »

The armed forces have already been decapitated in the Stalinesque « Ergenekon » trials, accused of plotting a military coup with a « black ops » campaign to blow up mosques and murder Christians.

European leaders have so far bitten their tongues, merely expressing « concerns ». There is no plan yet to invoke the nuclear option of suspending EU talks. Few wish to « lose Turkey » so soon after « losing Ukraine ». But such drastic thoughts are circulating. That alone is a new strategic fact.

Discussions with officials from six EU states left me in shock. Most think that Mr Erdogan will stop at little to keep power. Over 100 journalists are already in prison, the highest number in the world.

The latest escalation is an internet law that would let censors shut down websites without judicial review. Freedom House says the new bill lets Turkey’s leaders block « anything it does not want their people to know ».

Vice–premier Ali Babacan told The Daily Telegraph that the internet has become a jungle. « We have to protect the public against ill–willed people on the net who exploit freedom, » he said.

Turkey is at an inflection point. The first half of its boom after 2002 was a genuine catch–up story. A bail–out by the International Monetary Fund set the ground rules. Mr Erdogan followed the script, helped by delirious global growth.

Renault and Fiat built state–of–theart car plants in Bursa. Foreign investment (FDI) flooded in, lured by Turkey’s access to EU markets. An 80m–strong Ottoman Tiger was bursting on the scene.

Yet such models have their limits. The middle income trap awaits, once the low–hanging fruit has been picked. Countries cannot rely on imported plant and low wages to drive growth for ever.

Air is thin at the technology frontier. Intangibles matter: the rule of law, free thought, and education. Turkey is making hash on all fronts. Average years in school are 6.5 compared with 11 in the EU. The labour participation rate for women is 32pc. Turkey is not Korea.

Turkey’s economy hit the buffers in 2007. FDI has slowed to a trickle. Progress up the technology ladder has wilted. The last six years have been a bubble, leaving a current account deficit of 7.6pc of GDP funded by hot money.

« Turkey is trying to grow at speeds far above its investment rate [12.6pc]. No country can do that for long, » said an official.

The IMF warns that Turkey is on an « unsustainable » path and risks a sudden stop in capitals flows as the US Federal Reserve turns off dollar liquidity. Gross external financing requirements have reached 25pc of GDP per year. Turkey’s foreign asset position has crashed since 2008, dropping to minus 53pc of GDP. Shortterm foreign debt has jumped fivefold to $90bn since 2007, and has to be rolled over continuously.

The shock hit in May 2013 when the Fed turned hawkish. Mr Erdogan thought he could keep defy gravity. The central bank – attentive to his hatred for the « interest rate lobby » – kept its foot to the floor, with real interest rates of minus 2pc. It burned through Turkey’s foreign reserves in a doomed attempt to defend the currency, reducing import cover to two months.

This was a fiasco. The lira fell 20pc against the dollar as inflows dried up, and 10–year bond yields rose from 6pc to almost 11pc. The authorities capitulated in January with a « shock and awe » rate rise of 550 basis points, calculating that the risk of a further collapse in credibility was even greater than the damage from a monetary squeeze.

Turkey’s saving grace is that it is not trapped in fixed exchange system with a viciously overvalued currency, unlike East Asia in 1998 or the Club Med bloc today. Public debt is just 35pc of GDP, all in lira.

In theory, Turkey should be the EU’s great hope. With an average age of 29, it should be the answer to Europe’s demographic atrophy. But between theory and fulfilment lies a political chasm. Much the same applies to Russia, Brazil, and India. Sustained economic take–off is harder than it looks.