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Turkey in free-fall

Turkey's stock markets, reflecting a stalling economy and doubts over International Monetary Fund loans in the run-up to polls next year, have intensified a year-long plunge, with a key benchmark tumbling more than 36% in barely 11 weeks. The ISE National 100 equities index has taken a 36.8% hit from its level at the end of August, the last time I reviewed the country's economic and financial situation (See Turkey has a rough road ahead, 28 August 2008). At just above the 25,000 level, it is now down 56.8% from its all-time high of mid-October 2007.

The ISE 100 is now in a short-term trading range between the low 24,300s and the mid 29,300s, but will sooner rather than later break out of this range on the downside. The next support level is in the 19,000-20,000 range, after which a medium-term recovery should kick into gear that could take it back as high as 30,000.

However, it is more than likely that the recovery will be followed by another decline of indeterminate but substantial proportion. Any fall in the index significantly below 20,000 in the meantime will signify that that medium-term recovery is foregone and the further steep falls are to be expected.

The domestic economic outlook justifies this pessimism. Declines in industrial production steepened in September to 5.5%, the biggest drop since 2002, from a 4.1% fall in August. With car manufacturers such as the local units of Ford and Toyota temporarily closing plants, and textiles manufacturing plunging 17.6% in September, the government's 2009 spending plans based on 4% economic growth are now looking unrealistic, according to analysts.

The economy expanded 1.9% year-on-year in the second quarter, down from 6.7% in the first quarter. Meanwhile, the central bank has kept its benchmark interest rate at 16.75%, more than four times the level in the euro zone, as it tries to bring down an inflation rate the central bank said this month could exceed 11% at the end of 2008.

The government plans to increase key spending 17% next year as Prime Minister Recep Tayyip Erdogan's Justice and Development Party prepares for municipal elections due to be held by March.

Foreign confidence in the economy plays a disproportionate role in Turkey's stock market. Morgan Stanley estimates that foreign investors hold 16.5% of domestic debt stock and 72% of the free float in the stock market itself.

International financial players, as well as domestic business interests, accordingly, are strongly in favor of Turkey signing a new agreement with the IMF, which is considered an important lever in encouraging further economic reforms.

Turkey's last agreement with the IMF, involving US$10 billion, expired in May. It was the most recent in a series of stand-by agreements beginning in 1999 that have been nearly universally viewed as an "anchor" instilling the discipline necessary to implement successive reform agendas, many of which would bring the country further into line with European Union standards.

The government has continually claimed that it is bringing its economic, legal and financial structure into line with EU norms only because this is to the benefit of Turkey itself. Negotiations for Turkey's accession to the EU are stalled in a number of key fields and the trading bloc has as yet no power to impose conditionality on the country's reforms. Turkish public opinion in favor of accession, meanwhile, has recently declined.

Turkey's business community has been calling for another loan deal to help to limit the fallout from the global financial crisis. There is also concern in the national and international banking sectors that only an IMF agreement can supply the incentive for further reform and greater fiscal discipline. The IMF, meanwhile, admits that Turkey is better able than in the past to deal with external shocks, thanks to more diverse export markets and a flexible exchange rate.

Perhaps partly because the present domestic financial crisis is not of Turkey's own making, the government has hesitated to explore possibilities for a precautionary stand-by agreement with the IMF, of the sort that Ukraine and Hungary have recently concluded.

The absence of a precautionary agreement would not necessarily cut Turkey off entirely - it could conceivably receive up to US$8.8 billion under the Short-Term Liquidity Facility that is dedicated shoring up emerging markets. Still, Erdogan would prefer to put off any agreement until after the local elections in March so as to avoid giving his political opponents any additional momentum in their criticism of his policies.

To increase government spending in the run-up to the local elections. Erdogan would like to take the state unemployment fund and label it as revenue, but an agreement with the IMF could tie his hands in this respect.

As a result, he may request a currency swap agreement from the US Federal Reserve Bank, of the sort that it has extended to other countries lately. While these funds might be intended to ameliorate the current-account deficit, there would be nothing to prevent the government from using them, in the place of existing state revenues, for expenditures in view of the upcoming local elections.

The IMF and Turkey are expected to hold further talks during this weekend's summit of industrial and developing nations in Washington.

Even so, "It is not very easy to say whether there will be an agreement with the IMF or not," Deputy Prime Minister Nazim Ekren said last week, according to a Reuters report.

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URL:  http://www.robertcutler.org/blog/2008/11/turkey_in_freefall.html
First published in Asia Times Online, 15 November 2008.

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