On 3 November last year the Turkish
government of prime minister Recep Tayyip Erdogan celebrated its third year in power. It is the longest surviving single-party government in Turkey since that of late premier Turgut Ozal between 1983 and 1987.
Despite occasional friction with the secular establishment, high rates of unemployment and increasing urban crime rates, Erdogan’s Islamist-leaning Justice and Development Party (AKP) is politically unchallenged and will probably endure to the next general election in November 2007.
A recent public opinion survey by Turkish pollster KAMAR puts AKP’s popularity at 35%, unchanged from the 2002 election. But the popularity of the main opposition, the Republican People’s Party (CHP), has plunged from 21% in 2002 to 13.5% today.
The most crucial date for domestic politics, however, is not November 2007 but May 2007, when the AKP-controlled parliament will elect Turkey’s eleventh president.
Although Turkish presidents have only symbolic power, they have a right to veto or delay laws and bureaucratic appointments and can appeal to the constitutional court to have laws annulled. President Ahmet Necdet Sezer, formerly a top judge and a hardline secularist, has been at odds with Erdogan’s government over several legislative and administrative issues.
Although Erdogan could easily secure the presidency for himself in 2007, his closest aides say he is reluctant to take on the job. A top adviser told IPE Real Estate late last November that the prime minister would consider running for president in the next election after 2007, which would be in 2014.
The adviser said: “Erdogan is concerned that AKP might split into various groups if he quit as party leader. He would rather see one of his party confidants in the president’s job.”

Sweeping tax cuts
The need to create jobs and attract foreign investment is putting pressure on Erdogan’s government to cut taxes. The official unemployment rate was 9.1% in June 2005, and joblessness is particularly high in urban areas and among young people where the rate reaches 22.5%. That stems partly from Turkey’s high birthrate: 1.3% in 2003, but 2% from 1973 to 2003.
Late last November, Erdogan unveiled sweeping cuts in corporate, income and investment taxes to take effect in 2006. The desire is to attract more foreign investment. Corporate tax will fall from 30% to 20% and income tax for top bracket earners will fall from 40% to 35%. Tax for the lowest income earners will remain at 15%. The total tax burden on foreign investment will fall from 37% to 28%.
The government hopes the tax cuts will contribute to Turkey’s ability to compete effectively with other emerging market economies such as Romania and Poland. To attract more foreign investment and boost Turkish exports, Erdogan’s fiscal planners are taking the risk of having to compensate for an extra burden of $1.5bn (e1.3bn) on the 2006 budget.
Last November, a group of companies buying a majority stake in fixed-line telecoms operator Turk Telekom finalised Turkey’s biggest ever privatisation. Led by Saudi Oger Telecom and including Telecom Italia, the group took a 55% stake in the company with a bid of $6.55bn.
The deal adds to a wave of Turkish sell-offs amounting to a record high for 2005 of $17bn (compared with $1.3bn in 2004). Finance minister Kemal Unakitan predicts 2006 privatisations will hit $23bn. Similarly, foreign direct investment is estimated to have reached an all-time high of $5bn in 2005, compared with $2.8bn in 2004.

Real estate boom
Turkey’s residential and commercial property markets are high on the agenda these days. Foreign banks are coming in mainly because of a cleaned-up banking sector after a 2001 financial crisis. European buyers are queuing up because of the positive market sentiment after 3 November. Gulf buyers are lining up too because of their good political relations with Erdogan’s government.
Global developers are attracted by the presence of foreign banks (HSBC bought Demirbank, Fortis purchased Disbank and BNP Paribas and UniCredito purchased 50% stakes in Turk Ekonomi Bankasi and Kocbank, respectively). Most recently, for example, estate agency Jones Lang LaSalle chose Pega, an Istanbul-based property services company, as its Turkish partner.
Just before that, in October, Dubai International Properties, in cooperation with the municipal government of Istanbul, announced plans to build a pair of $500m glittering office towers in the city’s premier business district. This formed a part of Dubai International’s plan to invest $5bn in projects in Istanbul over four years.
The towers will house a five-star hotel, luxury residences, shops and office space. The City of Istanbul holds a 20% stake in the venture, the highest individual holding allowed under Turkey’s capital markets rules.
Dutch real estate firm Corio said it was planning to invest around $500m in the Turkish retail real estate market in the next three years. This amounts to 10% of the company’s total portfolio. Corio has a 46.9% interest in Akmerkez, which runs a shopping centre in Istanbul. A company spokesman said: “In the Turkish market there seems to be an increase in prices as a result of great interest in investment properties on the part of foreign investors.”

Boost for home loans
These announcements have come at a time when maturing financial markets in Turkey and macroeconomic stability have driven interest rates down and fuelled growth in the country’s nascent housing finance market. Falling interest rates make home loans more affordable to the public. Interest rates for 15- to 30-year loans have recently come close to 1%, compared with an average 2.5% last year. And some analysts are predicting that there will be a further fall to below 1%.
Meanwhile, Turkish lawmakers are updating legislation on mortgages and the sale of property to foreigners. Turkey is struggling with the nature of its infrastructure model. British financiers claim their mortgage system suits Turkey better than the US variety because the country’s reliance on privately backed securities is more suited to the European way of doing business. Turkey’s Capitals Markets Board, the capital markets watchdog, favours a hybrid system incorporating both government-issued and commercial bank securities.

Concerns over legal system
Investors, both local and foreign, have often viewed the Turkish legal system as complex, inefficient, slow, unpredictable and partly corrupt. Unfair trials apparently constitute the second-largest source of complaints about human rights violations in Turkey. But there is progress, too.
According to the European Commission’s 2005 annual report on Turkey, substantial progress has been made in the Turkish judiciary, in particular with the enactment of the new penal code and the code of penal procedure. The adoption of a law enabling the recruitment of some 4,000 judges and prosecutors could boost the efficiency of the system.
But, as the EC notes, there are still concerns about the independence of the judiciary, and in particular the influence of the justice ministry in the recruitment of judges and prosecutors (a government-controlled body decides on the appointments, postings, promotions and disciplinary action for all judges and prosecutors). Further steps need to be taken to ensure equality of prosecution and defence before the court and to ensure that all citizens enjoy access to justice.
According to a World Bank survey of the business environment in central and eastern Europe, Turkey has significantly improved in such areas as taxes, macroeoconomic and government policies, corruption, anti-competitive practices and financing costs.
All the same, more than 40% of Turkish companies consider these issues to be constraints on their development. In a separate study last December, a group of private companies aiming to protect intellectual property rights and trademarks in Turkey claimed that violations in these areas cost the Turkish economy $4.5bn each year.
The World Bank data for Turkey last year show an improvement in corruption over the situation that existed in 2002. Furthermore, in half of the corruption categories surveyed, the improvements actually moves Turkey ahead of the newest EU member states.

EU challenge
A top challenge for Erdogan’s government in 2006 is the fragility of accession talks with the EU. Ankara will come under increased pressure from Brussels to open Turkish ports and airports to vessels and aircraft from (Greek) Cyprus, which is a full member of the EU and the internationally recognised government on the island.
Erdogan’s government has said it will not grant access to Cypriot traffic to Turkish ports unless the EU removes economic restrictions on the breakaway Turkish Cypriot statelet in the northern third of the island.
An EU ambassador in Ankara said that the talks might stall “at any time in 2006” because of the Cyprus dispute. But a senior foreign ministry official in Ankara said a compromise could be found if, for example, Turkey agreed to grant access to Cypriot traffic while still not actually recognising Cyprus. Turkey has said it will not recognise Cyprus until a settlement is reached on the island.
Cyprus is not the only headache. Olli Rehn, the European commissioner for enlargement, is demanding that Turkey put a stop to continuing domestic violations of freedom of expression. He has warned that if Turkey does not correct the situation, the EU could suspend membership talks.
There is evidence that the EU’s procrastination on Turkish accession is prompting a backlash among the public. A recent opinion poll put Turkish support for EU membership at an all-time low of 53% compared with a range of 70-75% until a year ago.

Economic outlook
Turkey’s macroeconomic performance seems strong, with the Turkish lira looking, if anything, overvalued but stable against major western currencies. Inflation is at its lowest in nearly three decades, consumer confidence is back, bond yields are falling (although real interest rates are still the second-highest among emerging markets, after Brazil), economic growth is strong (despite a slowdown from last year) and fiscal performance is satisfactory. On 25 October last year the Turkish government successfully concluded discussions on the first and second reviews of a $10bn stand-by agreement with the International Monetary Fund. During discussions the Turkish government submitted a budget for 2006 consistent with an IMF condition of achieving an overall primary surplus of 6.5% of GNP. The IMF said the proposed budget would help contain the widening external current account deficit.
Economic growth is slowing to a more sustainable pace of 5% last year (compared with 8.9% in 2004). However, after slowing significantly in the second half of 2004, domestic demand has started to strengthen, helped by lower interest rates and a pick-up in credit.
The Central Bank might struggle to meet its 2006 year-end inflation target of 5%. The target for 2007 and 2008 is 4%.
Pessimists warn that Turkey’s economic success is under threat because a large exchange rate adjustment would be required to bring the current account
deficit into line if global liquidity conditions were to deteriorate. Various analysts and traders see lira overvaluation in the
25-50% range.
Some analysts think Turkey is walking on thin ice as its trade and current account deficits break fresh records and evoke memories of a severe financial crisis that wiped out 10% of the economy only four years ago. According to Steve Hanke, professor of applied economics at Johns Hopkins University in Baltimore, another crisis might be on the horizon.
Hanke says that Turkey’s balance of payments today is worringly similar to that in 1994 and 2001– when there were two punishing economic crises. He thinks that the lira is perhaps 50% overvalued and this is all happening at a time when the US Federal Reserve is raising interest rates. Political analysts agree that if Turkey were to suffer another self-inflicted financial collapse a political crisis would emerge that would almost certainly bring down the government.
The government has repeatedly said that it would take measures to curb the deficit, if necessary, in addition to existing steps such as cutting spending and piling up central bank foreign exchange reserves.
The current account deficit jumped to $16.35bn in the first nine months of 2005 from $10.62bn in the same period last year, outstripping all original estimates.
From one perspective, the deficit reflects a surge in private sector investment, but it makes the country reliant on external financing and vulnerable to the whims of global markets. Turkey’s total debt stood at $242bn in September last year.

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