Turkey’s Economic Enemies: Corrupt Politicians and the U.S. Fed

Turkey’s economy was already in a shaky place, thanks to decisions by the U.S. Federal Reserve that could make it harder for Ankara to sell its goods and borrow cash overseas. A widening corruption scandal in Turkey could turn things from bad to worse. 

Twenty-four people, including relatives of officials and high-level executives have been arrested so far, in a corruption investigation that is creeping closer to Prime Minister Recep Tayyip Erdogan. As the political crisis has intensified this week, top officials have resigned, others have been dismissed and Erdogan has been called to resign. Protesters took to the streets Friday in Istanbul and were met with police tear gas, the Associated Press reported.

The growing unrest has already taken a toll on Turkey’s currency, which hit a record low this week before rebounding somewhat on Friday. If the flight from the Turkish Lira is followed by long-term investors also deciding to leave the country, Turkey’s economy could be hit hard.

"If the instability and this crisis continues, then I suspect there’s also going to be pressure on the country’s growth prospects as business people from Turkey or outside Turkey will become less willing to invest," said Kemal Kirisci, a senior fellow with the Brookings Institution. 

Kirisci said the investigation is recognition of what many people had suspected behind closed doors — companies with close government ties were more likely to benefit from large development projects than companies without them. He said the extent of the damage to Turkey’s economy will depend a lot on how deeply democratic institutions like the separation of powers and rule of law are damaged as the political scandal unfolds.

"No business in a capitalist environment is going to feel comfortable in a situation where the judiciary is compromised," Kirisci said.

The instability comes at a sensitive time for the Turkish economy, which analysts see as vulnerable to a recent decision by the U.S. Federal Reserve to pull back on its stimulus program. The Fed announced earlier this month that it would start scaling back its bond-buying program in January. In an effort to help the U.S. economy, the Fed had been buying bonds in order to hold down borrowing costs and encourage banks to lend and, in turn, businesses and individuals to spend. But now the Fed sees the U.S. economy as recovering, so it plans to reduce the number of bonds it buys every month.

The Fed’s decision to buy fewer bonds, which will likely increase the value of the U.S. dollar, could hurt emerging market economies like Turkey. While the value of the U.S. dollar and interest rates have been low, investors sought bigger returns abroad.  The Fed’s decision to "taper" its bond-buying program could lead to rising interest rates that could prompt investors to shift their money back to American investments. 

Tim Ash, chief economist at Standard Bank Group, said Turkey is particularly vulnerable to the Fed’s tapering because of its reliance on borrowing money from abroad.

"This comes at a tricky time for the Turkish economy and markets," Ash said in an email. He said he doesn’t see the political crisis resolving quickly, which could mean that investors will continue to want to sell Turkish Lira, further driving down the value of the currency.

While instability doesn’t bode well for the short term, Turkish-American business consultant Elmira Bayrasli said long-term investors are less likely to be scared off.

"There’s a political earthquake going on in Turkey, but at the same time it’s a fairly stable country," Bayrasli said. She said the government is not likely to collapse and the crisis could even prove the strength of the government’s institutions, if they can weather the political tumult.

Still, the ongoing investigation could keep new investors from jumping into the Turkish market in 2014. Bayrasli, who is writing a book on global entrepreneurship, said Turkish start-ups should be ready to answer some tough questions about the impact of the political crisis if they’re seeking money abroad.

"I just don’t think there’s going to be a whole lot of new money going into Turkey," Bayrasli said. That could mean a tough year ahead for Turkish businesses.