BMI View: The power struggle within Turkey's ruling Justice and Development Party (AKP) has major short- and long-term implications for political stability, macroeconomic trajectory and investor sentiment. Over the short term the impact is clearly negative, but the longer-term result could be more centrist politics, which would view as positive for investor sentiment and Turkey's rebalancing process.
Recent events in Turkey have prompted us to assess the potential for the ruling Justice and Development Party (AKP) to split ahead of the 2015 parliamentary elections, and the possible implications of such a scenario.
The rift within the AKP was brought to the fore on December 17 with the mass detention of individuals considered loyal to Prime Minister Recep Tayyip Erdogan. Although unexpected, this development now appears to have been part of plan by US-based Islamic cleric Fethullah Gulen, leader of the influential Hizmet movement, to weaken Erdogan's grip over the AKP leading into a crucial year, which includes local elections (scheduled for March 2014), presidential elections (some time after August 2014), and the build up to the 2015 general election.
The Hizmet movement, whose membership is estimated to be around one million and includes high ranking members of the AKP, the judiciary and the police, has been increasingly sidelined by Erdogan since his parliamentary election in 2011. This has been in line with Erdogan's attempt to boost his control over the party and his increasingly apathetic stance towards the EU, which contrasts with more centrist, Western-focused views of Gulen and his supporters. The result appears to have cemented Gulen's support for the current president and former head of the AKP, Abdullah Gul, who remains popular among the electorate and the most likely candidate to run against Erdogan in the 2014 presidential election.
The growing rift between Erdogan and his predecessor has become increasingly evident since January 2012, when Erdogan tried to prevent Gul from standing for a second consecutive term in office. However, his efforts were overturned by Turkey's constitutional court, which ruled that while Gul had become president under the former constitution (which barred any president from re-election), the 2007 constitutional change which allowed for presidential re-election meant Gul was now allowed stand again for office in 2014. Erdogan, on the other hand, is barred from standing for prime minister in 2015, hence why it now looks like the two former allies will run against each other for the presidency in 2014.
Until recently it had appeared that Erdogan's grip over the AKP was relatively uncontested, and that even with the unrest witnessed over the summer he had no credible domestic political opposition. This is no longer the case, since the Hizmet movement under Gulen appears to have thrown its support behind Gul, and is now making a very overt challenge to Erdogan's power base.
Whether this remains an internal AKP power struggle or results in the creation of two new parties - one headed by Erdogan, the other by Gul and Gulen - is hard to call at this stage. In our view, the main goal of the prime minister's opponents is to control the executive and legislature, and since the presidency remains a largely ceremonial role (particularly now that Erdogan's efforts to boost the powers of the presidency appear to have failed), we believe the 2015 parliamentary election will be key.
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In short, we believe that Gul and Gulen's decision whether or not to create a new party will be based on their assessment of the strength of support from within the AKP, and whether this support is sufficient to nominate their own AKP candidate for prime minister in 2015. If not, they may well chose to break away at some point soon, and in the process hope to attract large swathes of existing AKP members plus more liberal Islamist and perhaps secular elements of the electorate who feel disenfranchised by existing political parties. In particular, Gul and Gulen may feel they can capitalise on the anti-Erdogan sentiment demonstrated by the recent protests, which other parties have so far failed to do.
Over the short term we believe the power struggle will have a very negative impact on investor confidence and Turkish assets, which were already suffering from higher global rates on the back of rising US Treasury yields. Indeed, to a large extent we believe that until mid-December the rapid depreciation in the lira and equity weakness had been driven almost entirely by rising US yields (a symptom of Turkey's heavy reliance on short-term foreign financing to fund its massive current account shortfall) rather than domestic political unrest. This view is backed up by the high correlation of US Treasury yields, the Borsa Istanbul Equity Index and the lira.
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The level of uncertainty caused by the current AKP infighting is likely to exacerbate this weakness, given the direct impact it is already having on the country's business environment (the CEO of state-run lender Halkbank and construction tycoon Ali Agaoglu were among those recently detained). There are now signs that Erdogan is striking back against the Hizmat movement, with the removal from office on December 18 of the police chiefs who reportedly oversaw the high-profile arrests the previous day, and as long as this continues we expect investors to continue reassessing their commitment to the Turkish economy.
However, once the political positions of key actors become clearer, we believe the result could actually benefit both political stability and investor confidence, and in turn aid Turkey's longer-term economic rebalancing. This view is based on our belief that while Erdogan appears to remain very popular among his party's support base, Turkish society has become more polarised by his increasingly belligerent rhetoric and Islamist policies. Gul, on the other hand, appears better able to unite both the Islamist and secular elements of Turkish society, and therefore a government under his control would likely be in a much better position to attract the level of foreign investment required to reduce the country's reliance on short-term capital.
As we have long argued, a shift away from the highly-leveraged consumption-based growth model towards one based more on longer-term investment would significantly reduce the country's exposure to financial market volatility. Under a more centrist administration we believe such a policy would become much more likely. Nevertheless, given the current level of uncertainty this is a long way from becoming our core scenario, and for now we remain very defensive towards Turkish assets.