London - The unprecedented arrest and jailing of a former Turkish army chief has left the country's financial markets unmoved but adds to a steady rise in political risk that foreign investors could be ignoring at their own peril.
Ilker Basbug, who retired in 2010, is the highest-ranking officer to be caught up in the government's long-running crackdown on the powerful military and secularist establishment. His arrest came hours after several Turkish journalists were put on trial over alleged ties to an ultra-nationalist movement accused of anti-government conspiracies.
Such an escalation in political risk would in the past have triggered an aggressive response from the military, sending shock waves through Turkey's financial markets. Yet on Friday, Istanbul's stock market rose, taking its cue from gains on Western European bourses while the currency also firmed.
“It is a staggering event in various ways. But I don't think it will become, at least in the short term, a negative catalyst for the market,” said Wolfgango Piccoli, who heads Turkey coverage at the political risk consultancy, Eurasia Group.
One reason, according to him is that Turkey's economic boom in recent years has won the ruling AK Party a pro-business reputation at home and abroad. An election last year gave Prime Minister Tayyip Erdogan's party nearly 50 percent of the vote.
Fast economic growth and booming investment returns of the last half decade contrast starkly with Turkey's 20th century history of financial crises, much of it down to the power of the military which dominated politics for 40 years.
So with GDP likely to have expanded 8 percent or more last year, an 80 million-plus population and rising incomes, investors seem to be keeping their eyes firmly on the numbers.
“What concerns me a bit is that we have never had such a high-ranking army official put in prison so this may cause some upheaval in the political space,” said Dilek Capanoglu, CIO for emerging markets at RCM, part of Allianz Global Investors.
Capanoglu says she will watch the issue but is overweight Turkish stocks nevertheless, contrasting the country's inherent strength with other regional emerging markets.
But some say investors should not be too sanguine.
First, Turkey's economic miracle has already run into trouble, with central bank policy mistakes seen behind 10 percent-plus inflation. The currency is down 18 percent in the past year and Turkey's ability to defend it from further falls is limited.
Foreign investors have also in recent months cut back their positions in Turkish stocks and bonds, fearing that loose monetary policy is fuelling an explosive inflation shock.
Second, Piccoli and others note that Basbug's arrest is the latest in a stream of negative political news from Turkey. These include deadly conflict with Kurd rebels, tensions with Iran, civil war risks in Syria and planned constitutional amendments that are set to considerably increase the AKP's powers.
Many see political risks escalating in 2012 as the government tries to amend the constitution to boost the presidency's powers and potentially pave the way for PM Erdogan to assume that role in future.
All this could result in more unpredictable foreign policy in a volatile region, and exacerbate the conservative-secular divide in Turkey, said Manik Narain, a strategist at UBS.
“There is a risk investors are not paying enough attention to political uncertainty in Turkey. These stories tend to be ignored by markets until they reach tipping point,” Narain said.
“We saw that in Hungary where we have had controversial policies since 2010 but investors failed to see for 19 months that the government was developing an authoritarian streak.”
Hungary's financial markets have suffered an enormous capital exodus this week as new laws have put the government on a collision course with international lenders and raising risks that it will have trouble repaying its debt this year.
Turkey, with a current account deficit of around 10 percent of GDP, cannot afford to risk damaging investor sentiment. That's especially so in a crisis-hit world where all emerging economies now are in intense competition for investment.
Simon Quijano-Evans, chief EEMEA economist at ING Bank says political risk tends to have greater ramifications for longer-term, foreign direct investment (FDI).
As of mid-2010 Turkey had received a total of $180 billion in FDI, United Nations data shows, up from less than $20 billion in 2000. But flows have slowed, with 2011 levels less than half of what was received in 2007.
“Although markets are seeing this (arrest) as neutral it does drive sentiment of FDI investors,” Quijano-Evans said. “Political worries.. is one of the reasons why FDI into Turkey has been holding back of late.” - Reuters