Caspian/Black Sea weekly review

Greetings to readers of our nascent Caspian/Black Sea research product. At this early stage we are continuing to test different ways of delivering timely and insightful analysis to you. In that spirit, welcome to our first CBS weekly review.

The main topic this week must be Turkey, but first a few words about ENRC.

ENRC

Although ENRC is a company with Kazakh roots and 95 per cent of its assets in Kazakhstan, it is not a typical Kazakh play from the perspective of the market. Nothing likely to happen on the ground in Kazakhstan has the capacity to affect the company’s share price to the same degree as changes in the market prices for its main products, most of all ferroalloys (which accounted for nearly 60 per cent of profits in 2007) and specifically ferrochrome.

If anyone needed a reminder of this, they got it this week with news from South Africa that the European price for ferrochrome had been set at US$2.05 per pound for the third quarter of 2008, significantly lower than market expectations. In response, ENRC shares dropped 20.1 per cent in two days.

Ferrochome prices spiked early this year in the wake of South Africa’s power generation crisis; this had been an important driver of ENRC’s share price growth to begin with. With South African capacity still constrained, the expectation had been that prices would stay high. In fact, it now appears that buyers had the same expectation, leading some steelmakers to switch to substitutes, and thus to this week’s negative price surprise.

Sooner or later, talk of ENRC and Kazakhmys merging to create a Kazakh national champion will inevitably come back onto the agenda. Our view is that such a merger will not happen until a clear decision is made by the one individual who can, if he chooses to, force a solution on both companies: President Nazarbayev.

The idea of creating a single national champion, publicly listed but with a significant state share, must have some appeal for Nazarbayev. But this is not a decision that can be made lightly or quickly, since sorting out the terms of a merger will be highly contentious. Nor is there any particular pressure on the president to reach a decision quickly. Therefore we do not subscribe to the view that a merger will be agreed before year-end. The restart of rumours and whispers about a potential merger, however, are all but guaranteed.

HIGH DRAMA IN TURKEY, BUT NO CHANGE TO THE POLITICAL OUTLOOK

Our house view on the Turkish political crisis – that the situation will deteriorate rather than remain in “muddle-through” mode - was confirmed by this week’s dramatic arrests of alleged coup plotters. That said, the outlook is no worse than it was before this week; and in fact, the likelihood of a worst-case outcome – direct military intervention - has been reduced from miniscule to zero.

Link to our house view on Turkish political crisis: http://www.trustedsources.co.uk/caspian_black_sea/turkey_existential_crisis/turkey_existential_crisis

The facts: A quick review

On 1 July, Turkish police arrested 21 men in five different cities on charges of participation in a coup plot being planned by an underground organization called Ergenekon. Among those arrested were two very senior retired generals, two journalists and the head of the Ankara Chamber of Commerce. The timing of the arrests – on the same day that another public prosecutor was presenting the case to ban the AKP and its leadership to the Constitutional Court – was widely seen in the secular camp to be intentional and highly provocative.

The Ergenekon investigation, which has been underway for a year and which has resulted in nearly 70 arrests, is being carried out not by the AKP government but by an independent public prosecutor, Zekeriya Oz; the arrests were made at his request.

No urgent danger

It is now clear that some of the more dramatic interpretations of this episode one could hear in its immediate aftermath are not valid. The precise timing of the arrests may have been determined by the police, who are subordinate to the AKP government; but the prosecutor Oz remains the driving force behind these arrests. Oz is not an AKP appointee, there is no reason to believe that he is actively working to promote the AKP’s interests and his wife does not wear a headscarf (this is significant in the Turkish context). Thus the arrests should not be seen as a “pre-emptive attack” of AKP against its opponents.

Turkey’s military has reacted calmly. Indeed it cooperated in the arrest of two suspects who were in a military officers’ club at the time of the police raids. Ilker Basbug, who will become chief of the general staff in August, put out a statement calling for calm and “common sense.”

It is generally believed that the military leadership was not only informed in advance about the arrests of the two recently retired generals, but also that it tacitly supported the arrests. This can be easily understood if one believes the information that has been leaked to the media about the Ergenekon plot. According to these leaks, the goal of the plot was to create public disorder through assassinations and violent demonstrations such that the military would be forced to intervene.

Assuming these facts are borne out, it is now clearer than ever that the military under its current leadership has no desire to seize power by force, or to be pushed into a coup.

What next?

Indictments in the Ergenekon case are set to be announced imminently, and while they will stimulate further rounds of controversy, we assume that they will also reveal the existence of solid evidence to back up the charges of conspiracy. This should go a long way toward quieting the most damaging charge being aired, which is that the entire Ergenekon case has been cooked up in order to silence critics of the AKP government. It would be helpful in reducing tensions if the journalists who are being detained were released.

It is not clear why this episode would have any effect on the AKP case now being heard by the Constitutional Court. Our view on that process is unchanged, and negative in terms of its impact on political stability.

THE LIRA'S SURPRISING RESILIENCE
For a currency that has a reputation for volatility, the Turkish lira has shrugged off the recent political news. Since early June, spreads on Turkey's benchmark local bond have increased by almost 300 bp, and the equity market is down about 16 per cent over the past month. In contrast, the lira has remained within a band of 1.22 to 1.27 to the dollar since early May, after recovering from an April low of 1.33 to the dollar.

In the past, Turkish political instability has tended to be reflected in the currency. But the current resilience of the lira shows that things have changed. After a bit of wobbling in the latter part of 2007, the Central Bank has begun to restore its credibility with a series of rate hikes aimed at keeping inflation in check. Meanwhile, despite some reduction in the primary surplus and talk by the government about a large spending programme for Turkey's southeast, the fiscal position remains under control for now.

Could this situation hold? Perhaps, as long as the Central Bank is willing to keep hiking rates despite the impact this will have on the overall economy. That said, a lot could go wrong as the political crisis continues to play out. The Central Bank’s efforts could be undercut by negative psychology if political outcomes are worse than expected. This could take the form of the embattled AKP government (or a successor) opening the spending floodgates to help consolidate popular support; or of nervous local holders taking refuge in dollars or Euros. An unfortunate wild card is the recent submission by the government of a draft law to relocate the Central Bank from Ankara to Istanbul, something that is opposed by the bank's management. An open fight about this at the wrong time would be extremely unhelpful.

Recent research reports:

Turkey's Existential Crisis
Why Turkey's political crisis will be long and painful
Caspian/Black Sea Monthly Report
CBS Monthly: implications of the Kashagan dispute; Ukraine's troubled politics; and Georgia back on track
The risks of NATO enlargement
There is a way from zero-sum to win-win

With best regards,

Laurent Ruseckas
Director, Eurasia Research
Trusted Sources