CBS Weekly Review: Turkey - Misplaced optimism as the AKP decision approaches

The Constitutional Court’s eleven judges began consideration of the AKP closure case this week. Most observers now seem to think that a decision will come by the end of the week, although I would not be at all surprised if it was stretched out for another week or two.

Our own call on the closure case and what follows it – Turkey’s existential crisis – remains sharply negative. Yet the past two weeks have seen a positive shift in Turkish market sentiment which I find somewhat mysterious. Since mid-July the ISE-100 equity index is up about 12 per cent and the Turkish lira has strengthened about 4 per cent against the Euro; meanwhile several investment banks have come out with (heavily hedged) predictions of AKP survival.

One cynical explanation for this shift might be that the judges have already decided on a "soft" ruling which stops short of banning the AKP – and that one or two of them may have let something slip to an acquaintance in the financial sector. But I mention that only to dismiss it. What actually seems to be happening is a case of wishful thinking.

Our position has not changed since we first presented it in June: We consider it very likely that the Constitutional Court will ban AKP as well as a group of party leaders including Prime Minister Tayyip Erdogan; and we believe that this decision will kick off an extended and damaging period of political disarray.

Market implications

Before getting into the political details, a word about the market implications of this view.

When we initiated coverage of Turkish politics in June, there was a strong consensus in the market that AKP would be shut and Erdogan banned. We shared this view, and differed from the consensus only with our more negative take on the medium and longer term.

The recent burst of optimism in the market will make the immediate impact of a negative decision more severe. An AKP closure and Erdogan ban are no longer fully priced in to the equity or fixed income markets, or the currency; if the court rules as we expect, markets will decline and the lira will weaken.

The most important question for the markets concerns the scale of the impact on the currency. As noted in the CBS Weekly of 4 July, the lira has shown strength on the basis of inflows from locals and foreign carry trades since the Central Bank began a series of interest rate hikes beginning in May. Yet a widening current account deficit is creating some downward pressure on the lira; and following its most recent rate hike on 17 July, the Central Bank signalled an end to current round of monetary tightening. In this context, the danger that a negative political surprise will knock the lira out of its recent trading ranges is evident.

In our view, in the event that the decision goes against AKP, the difference between a moderate lira-negative outcome and a more severe currency shock will relate to the language of the decision and some of the nuances, particularly as concerns the political ban on Tayyip Erdogan. This question is addressed below. On balance we believe that efforts to prevent Erdogan from returning to government will come later, rather than forming part of the Constitutional Court’s decision.

Why the court will ban AKP and Erdogan

In the face of recent sentiment, I will just take a brief moment to reiterate the key points that underlie our call.

1. The AKP closure case is a political process rather than a judicial one. The case was not launched in March 2008 so that eleven judges might consider the evidence on its merits: it was launched so that the AKP could be banned and Erdogan removed from politics. This is not to say there is zero chance that five of the eleven judges might defect from this plan; but this too would be a political decision. Any discussion of the legal nuances is irrelevant.

2. Outside observers tend to make judgements about the political and economic consequences of a decision to ban AKP and then conclude that the Constitutional Court will stop short of taking a step that they believe would be so damaging for Turkey. But the leaders of Turkey’s secular institutions (a group which I assume includes at least seven of the eleven judges) now consider themselves to be making a final stand to preserve the Turkish Republic and its secular character, or to put it another way, Ataturk’s legacy. In this context a political and economic crisis – which in any case is not exactly a rare event in recent Turkish history – is a blip.

3. Having come this far down the road toward banning AKP, to stop now would give the party and Tayyip Erdogan a victory far greater than anything they have won at the ballot box. It would effectively represent the end of serious institutional resistance to AKP and its agenda, and this is not something that five or more of the judges are likely to want to take responsibility for.

A few nuances related to Erdogan

Assuming that AKP is shut down and Erdogan and some others banned from politics in the standard way, the conventional wisdom will continue to support a medium-term "muddle through" scenario which would see AKP and its leadership returning to government under a new name after new elections, a scenario which is seen to limit the overall impact on the Turkish economy and capital markets.

Our more negative suggestion is that Erdogan’s forced resignation and his loss of parliamentary immunity will quickly trigger the restart of frozen criminal cases against him, with the intent being to remove him from politics permanently, one way or another.

However we feel that this plan will unfold later, and that nothing in the Constitutional Court decision will explicitly block a "muddle through" scenario where Erdogan returns to parliament as an independent, or even returns to the cabinet earlier as a State Minister from outside parliament.

However, this could be wrong: The court decision might contain language which attempts to pre-empt any later moves by Erdogan to return to government by using legal loopholes. This is the scenario in which the announcement of the court decision could result in a more severe shock to the markets, and to the lira in particular.

The only chance for AKP: an Ergenekon-related epiphany

None of the points made above is affected by the Ergenekon case or the shocking picture of criminal conspiracy painted in the recently released 2455-page indictment. The judges were never part of this conspiracy and they have no reason to feel weakened or compromised by its exposure.

That being said, if I had to make a case for predicting a "soft" ruling by the Constitutional Court, it would rest on the potential for the Ergenekon revelations to have a profound personal impact on a few of the judges. Some of the journalists who have read through the Ergenekon indictment and written about it profess to have have been affected in this way. In the words of the editor-in-chief of one Turkish newspaper, referring not to the present conflict over secularism but to other past clashes: "Those who killed, those who were killed, and us, who tried to build a set of ideas to get our country out of chaos. It turns out that we lived a wasted life. It turns out we were all puppets."

I don’t know enough to start analyzing the psychological makeup of individual judges. However many analysts suggest that there are two or perhaps three judges on the Constitutional Court who start out with a disinclination to ban AKP. Thus if the Ergenekon dossier produces some sort of epiphany in two or three of the secularist judges – who as a result start questioning assumptions and principles that they had never questioned before – then perhaps it could push the anti-closure vote up to the five needed to save AKP.

But I am certainly not predicting anything like this. I think that nine or ten of the judges will stick to the plan and disappoint the markets.

Best regards,
Laurent Ruseckas
Director, Eurasia Research
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