Turkish Politics Take an Economic Toll

The fight over secularism is dimming the economic prospects of the republic: Growth has slowed, inflation is up, and the lira is down

The political drama in Turkey this spring may turn out to be a rite of passage for Turkish democracy. After an intense year of infighting between the country's powerful secular establishment and the popular Islamist-rooted government of Prime Minister Recep Tayyip Erdogan, matters have come to a head with the Mar. 31 decision by the nation's Constitutional Court to hear a lawsuit seeking to abolish Erdogan's party for undermining the secular nature of the republic.

If the court decides against Erdogan's ruling AK Party, the organization could be outlawed and both the Prime Minister and President Abdullah Gül, who also hails from the AKP, could be banned from politics for five years. Although most observers think that outcome unlikely, the mere possibility has thrown Turkey into turmoil and cast a shadow over its economic prospects.

It may be difficult for outsiders to understand the stakes—or even to imagine the scenario. After all, nobody has tried to sue the Republican Party in the U.S. for violating the separation of church and state because President George W. Bush is an avowed Christian. But the entire history of modern Turkey is staked on the legacy of Mustafa Kemal Atatürk, who led the battle for Turkish independence after World War I and founded the Republic in the 1920s on secular principles.

Growth Forecasts Lowered

Turkey today is an advanced country of 72 million people with a gross domestic product of $420 billion. But political turmoil is dividing the people, distracting politicians from needed reform, and threatening business. Already, economic growth has slowed from the 7% it averaged between 2002 and 2006 to potentially just 4.5% this year, and inflation is hovering around 9%, well above the Turkish central bank's yearend target of 4%.

In an Apr. 8 note to clients, economist Banu Tokali of Istanbul brokerage FinansInvest noted that her 2008 growth forecast for Turkey was set at 4.7% before the Constitutional Court agreed to hear the lawsuit against the AKP. Now, Tokali says, "This faces a downward revision depending on the extent that domestic demand responds to the recent political disturbance."

That uncertainty is giving investors pause. The Istanbul stock exchange is currently trading down more than 25% from its 2007 peak. The Turkish lira has fallen 8.7% against the dollar since the start of the year, and 14.8% vs. the euro—a particular problem since Turkey trades so much with Europe. There are early indications that foreign direct investment could fall by 16% this year, to a projected $18 billion. And on Apr. 3, Standard & Poor's (MHP) downgraded Turkey's outlook to "negative" due to concerns over domestic political instability and broader global economic conditions.

Economy Booms Under Erdogan

For Erdogan, who was convincingly reelected last summer in part due to his successful stewardship of the economy, the turn of events presents enormous challenges. Turkey has long coveted membership in the European Union, and voters rewarded the Prime Minister for convincing the EU to open accession talks in 2005. Although Erdogan is a practicing Muslim and his wife wears a headscarf—a traditional symbol of observance—he is known as pro-Western and pragmatic. Many Turks, regardless of their religious views, think his government has been the most effective and competent in decades.

The Prime Minister, who was first elected in 2002, has managed to wipe out the punitive inflation that sapped Turkey throughout the 1990s and has boosted foreign investment to levels 20 times higher than a decade ago, attracting businesses including automobile manufacturers (BusinessWeek.com, 1/10/07) and investment banks. Sectors such as tourism, real estate, telecommunications, and technology have boomed.

Secular Resentment

The current political crisis threatens to dim those achievements and complicates Turkey's uncertain path to EU membership. The situation first heated up a year ago, when Turkey's secular-dominated military attempted to strong-arm the Prime Minister into nominating a "suitable"—that is, secular—candidate to fill the vacant office of President. Turkey's entrenched secular order has distrusted the Islamist-leaning AK Party from its inception, and sought a counterbalance to Erdogan.

The Prime Minister held to his prerogative and nominated his urbane Foreign Minister, Gül, who was duly elected by parliament. The activist Constitutional Court annulled the vote and forced early elections. But the AK Party won reelection last July with 47% of the popular vote and now holds 340 seats in the 550-seat Parliament.

Erdogan used the victory to force the army to accept Gül's election and swearing-in as President. The military backed down, but resentment burned among secularists. Erdogan took the fight a step further by pushing through a constitutional amendment allowing women with headscarves to attend university, a practice that had been banned. The state prosecutor who brought the case against the AKP to the Constitutional Court specifically mentioned the headscarf issue in his indictment.

Perceived Move Toward Islam

To shift focus away from the court case and bolster his international image, Erdogan now is trying to clear away a sore spot in Turkey's foreign relations. In a speech on Apr. 3 in Stockholm, the Prime Minister proposed abolishing the notorious article 301 of Turkey's penal code, a statute that makes it a crime to insult Turkish identity and that has been used to prosecute numerous writers and journalists. The enforcement of article 301 has been a human-rights sticking point for the EU.

Moves such as these could help counteract concerns that Turkey is drifting toward a more Islamic-flavored government and society. And most observers think the Constitutional Court will stop short of throwing the government out of office. "People still believe the AK Party will find a way through," says EFG Istanbul Securities research director Cüneyt Demir Güres. Savvy foreign investors, he says, understand that crises of this sort arise every year in Ankara—and aren't taking this one too seriously.

Still, with the global economy on shaky ground and many economic indicators moving in the wrong direction in Turkey, the battle over headscarves and other matters of faith could have an outsize impact on Turkey's financial wellbeing. Businesses and investors are hoping that doesn't prove to be the case.

For more about the turmoil in Turkey, see the BusinessWeek.com slide show.

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