Turkey
Black Swans and the Surprise of 2007
May 24, 2007

By Serhan Cevik | London

Every election brings an unexpected result, but what will be the surprise of 2007? Just compare opinion polls before an election with the ultimate results, and you realise that every election has led to surprises and even to extensive restructuring of the political landscape. The 2002 election, for example, was such a turning point, with an unprecedented political consolidation that wiped out a range of established parties and brought a new party to power. However, until a month ago, we thought that the 2007 elections would be one of the least unpredictable votes, with the ruling AK Party receiving a decent enough share of the votes to form a majority government for the second term. In our view, even with the expected mean reversion in voting behaviour, the AK Party would enjoy popular support, thanks to economic normalisation and progress towards EU membership, and hence secure around 300 seats out of 550 in parliament. Unfortunately, nothing is straightforward in a country that is still in the midst of institutional convergence, as recent events have no doubt altered Turkey’s political dynamics. This is why uncertainty surrounding the voters’ reaction to political tensions is significantly higher and may well lead to a surprising outcome in the coming elections.

Turkey remains in a twilight zone of institutional and political uncertainties. Before dealing with election results and post-election scenarios, we will first face the challenge of institutional uncertainties introduced by the military’s venture into politics, the Constitutional Court’s decision to annul the presidential selection process and politicians’ response by introducing radical constitutional amendments (see Twilight Zone, May 8, 2007). As a result, there are now institutional and political risks that we thought would be unlikely to occur in today’s Turkey, negotiating to become a member of the EU. Unfortunately, although favourable conditions in the global financial markets have so far outweighed domestic anxieties, political dislocations are like ‘black swans’ — improbable events — that could have unexpected consequences (see Nassim Nicholas Taleb’s excellent book, The Black Swan: The Impact of the Highly Improbable, Allen Lane, 2007). Such an elevated state of uncertainty also affects the behaviour of politicians and voters. No wonder we have recently witnessed a series of unusual political manoeuverings, including mergers and alliances between centre-right and left parties.

All the parties are trying to move towards the centre of the political spectrum. Turkish society may be struggling to build concrete bridges between the centre and the periphery, but the voters have long favoured a centre-right stance in politics. And recent events will likely accelerate the shift towards the centre of the political spectrum, in our view, even against economic marginalisation among certain segments of society (see The Politics of Misery and Expectations, May 16, 2007). With that in mind, we need to be careful about political opinion polls and, given the 10% national threshold for parliamentary representation, the implication of even small errors on the distribution of seats in parliament. For the time being, the AK Party leads with a wide margin in opinion polls and is likely to come out of the elections as the leading grouping. However, unlike the 2002 elections when only two parties qualified for parliamentary representation, this time the number of parties in parliament is likely to be three (and possibly four). That means, even if it gets a greater share of popular votes, the AK Party would end up with significantly fewer seats in parliament and might even be challenged in forming a coalition government. Therefore, especially considering the possibility of having 20-25 independent members in the general assembly, the risk of a fragmented parliament is not negligible. Alternatively, of course, the AK Party could surprise on the upside, thanks to protest votes, and maintain its overwhelming control in parliament.

The economy is strong enough to absorb a political realignment, in our view. After decades of political and economic instability, Turkish voters have become ‘swing voters’ with no strong party affiliation. And that is exactly the main source of surprising election results and may well lead to a new realignment of politics this summer. Though financial markets never like uncertainty, one thing we are sure of is the strength of the economy and the desire of the majority of Turks for greater democratisation and openness.

 

Middle East/North Africa
Pumping Money
May 24, 2007

By Serhan Cevik | London

Petrodollars will keep shaping the global economy and financial markets. This was supposed to be a year of consolidation, but the global economy is still growing at a robust pace, despite the slowdown in America.  As a result, with strong economic growth around the world and supply constraints in the petroleum market, oil prices show no sign of easing. In fact, Morgan Stanley’s economics team recently revised up its oil price estimates to an average of US$63 a barrel in 2007 and US$59.2 in the next two years, just a bit lower than the peak of US$65.6 in 2006 (see A Higher Risk Premium on Oil Prices, Eric Chaney and Richard Berner, May 9, 2007). Of course, such a sustained real increase in oil prices means more windfall gains to oil-producing countries in the Middle East and Central Asia region, which already enjoyed a sharp increase in export revenues from US$251 billion in 2002 to US$786 billion last year. Therefore, with the cumulative current account surplus rising from 5.4% of GDP to 20% over this period, oil-rich economies remain in a position to pump money domestically as well as all around the world.

The abundance of liquidity will keep fueling growth across the Middle East. Real GDP growth in the Middle East surged from a disappointing average of 3.6% a year in the 1990s to 6.5% in the past five years, thanks to the oil windfall that has snowballed to US$1.5 trillion and given a boost to the development of non-oil sectors as well. With the continuing abundance of liquidity, these economies will experience a sustained increase in domestic spending and therefore a correction in current account surpluses through higher import growth. Indeed, the pipeline of investment projects — reaching over US$1 trillion in the Gulf region alone — could give a (selective) boost to equity and property markets. Nevertheless, despite increasing import demand, the accumulation of foreign assets will remain as the main channel for recycling petrodollars in the near future (see The Great Arabian Bubble, December 4, 2006).

Oil exporters accumulated net foreign assets at a rate of 1.9% of global GDP every year since 2000. We are possibly witnessing the biggest shopping spree in history, as oil producers keep accumulating foreign assets. And unlike the 1970s when the oil windfall was channeled into bank deposits, today’s oil riches are being used aggressively to build diversified holdings of assets and investment projects.  In addition to building entire new cities at home, oil exporters have channeled more of their earnings into new markets. 

As a result, the accumulation of net foreign assets reached an average rate of 1.9% of global GDP every year since 2000 and 3.2% last year.  From whatever angle you look at it, this is a massive liquidity injection that has contributed to the ‘conundrum’ of low long-term interest rates, higher growth and booming asset prices. Although opaque statistics do not allow us to pinpoint the exact composition of investments, the recycling of petrodollars has certainly become more diversified in recent years (see Tracking Petrodollars, February 13, 2007). Instead of just buying government bonds, oil-producing countries have started acquiring a variety of assets, ranging from GE Plastics (purchased by Saudi Basic Industries Corporation for US$11.6 billion) and a 2.2% stake in Deutsche Bank (purchased by the Dubai International Financial Centre for US$2 billion) to financial companies and real estate in emerging markets.

The latest trends justify the revaluation of oil-based currencies, in our view. The recycling of petrodollars has contributed to global imbalances, and thus needs to play a role in rebalancing as well. There are already signs of such a shift in underlying trends towards recycling via higher import demand (instead of financial channels that brought disproportionate benefits to the US economy).  However, the adjustment process also requires proactive measures (à la China) to help develop more flexible policies and address domestic economic imbalances, in our view.  Even though all the indicators justify the appreciation of oil-based currencies, the prevailing fixed exchange rate regimes keep currencies artificially undervalued and lead to distortionary imbalances that will no doubt make the planned monetary union extremely difficult.