Turkey: Erdogan Appears Willing to Trade Economic Risk for Political Gain

(Stratfor)
The Big Picture

A number of converging events recently have increased the risks to economic and political stability in Turkey. Even so, as Stratfor’s Third-Quarter Forecast pointed out, the Turkish government will maneuver among its numerous domestic and external problems, calculating that it can withstand the pressure from both its own constituency and foreign powers.

Representatives from each of the European Union’s members met July 10 to discuss the bloc’s options for sanctioning Turkey after it decided to send a second drillship into disputed waters around Cyprus on a hydrocarbon exploration mission. They considered possible actions including suspending some $150 million in EU funding earmarked to pave the way for Turkish accession to the bloc, suspending some European Investment Bank programs in Turkey and canceling high-profile meetings between EU and Turkish officials. On July 15, EU foreign ministers are expected to make a formal decision over which, if any, of those options to exercise. According to Cypriot media, the government in Nicosia sees these sanctions as a starting point and warned that new measures (such as targeted sanctions against companies and individuals) could be taken in the future.

Why It Matters

The threat of impending EU sanctions comes at a time when a number of other blows could damage Turkey’s already creaky economy. The European Union is Turkey’s most important trade partner, and Ankara values maintaining productive economic ties with the bloc. Despite that, Ankara is tempted by the economic value of any oil and gas discoveries the ships might make. Besides, the exploration itself serves to solidify Turkish claims to the Eastern Mediterranean waters that it alone recognizes and, in its defiance of international norms, appeals to nationalist sentiment in Turkey. In turn, that will shore up domestic political support for embattled President Recep Tayyip Erdogan, who is still trying to recover from the surprising defeat that opposition parties inflicted on his Justice and Development Party (AKP) in some former AKP strongholds in the recent municipal elections. Turkey’s relationship with the United States faces a similar risk of sanctions over the impending delivery of S-400 air defense missile systems from Russia. But neither threats that U.S. sanctions could be imposed against the Turkish defense industry nor that Turkey could be kicked out of the joint development program for the F-35 fighter jet have changed Ankara’s mind about acquiring the Russian hardware. Despite the threats from Washington and the damage the purchase would cause to its relationship with other NATO allies, Turkey calculates that the boon to its diplomatic sovereignty and the technology transfer rights that come along with the S-400 purchase will be worth it.

With Erdogan’s political popularity in danger, he has apparently made the calculation that his need to solidify support among his political base is worth the economic risk.

Erdogan’s unorthodox approach to monetary policy has given rise to another threat to the Turkish economy. He had long pushed for Turkey’s central bank to cut interest rates to boost economic growth, no matter the effect on the lira, and this week, he moved to make his wish a reality. After the president of Turkey’s central bank spurned Erdogan’s entreaties to slash the country’s prime rate yet again, the president fired him and named a compliant loyalist as a replacement. He now has a team in place at the bank much more likely to bow to his wishes, despite the chance that rate cuts could send Turkey’s fragile currency value down (in turn adding to the private sector’s sizable debt picture). The move has stirred anxiety among the foreign investors and the domestic industries on which Turkey’s economy depends.

Finally, there is a more distant threat of potential future penalties that Turkey could face if it has been found to have had dealings with Iran or Venezuela in defiance of the current U.S. sanctions regime. After all, a Turkish bank aided Iranian oil-smuggling efforts under Obama administration sanctions. If it comes to light that Turkish entities have repeated that history, economically damaging punishment could certainly follow.

Context

Certainly, Turkey has taken actions in the past to strengthen its own sovereignty and nationalist policies. With Erdogan’s political popularity in danger, he has apparently made the calculation that his need to solidify support among his political base by pursuing strongman policies in the Eastern Mediterranean, with the United States and at home is worth the economic risks. Former AKP loyalists are now openly discussing a splinter party that could threaten Erdogan’s hold on parliament, giving this strategy to staunch the bleed of domestic political capital a new urgency. Turkey’s rate of inflation has improved somewhat in recent months after the country entered a recession in the last quarter of 2018.

Dates to Watch

July 15: Expected EU decision on sanctions and penalties on Turkey. Countries along the Balkan migration route, including Hungary, Bulgaria, Croatia and Slovenia, could be reluctant to authorize tough sanctions on Turkey out of fears that Ankara could retaliate by withdrawing from the immigration agreement it reached with the European Union in 2016, unleashing a flood of refugees bound for Europe.
July 25: The Turkish central bank holds a monetary policy committee meeting. Considering the recent changes in bank leadership, an interest rate cut is widely expected.

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