By Sujata Rao
LONDON, Jan 6
(Reuters) - 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.
MISTAKE?
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.
RISK FOR TURKEY
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." (Additional
reporting by Simon Cameron-Moore. Reporting by Sujata Rao. Editing by Jeremy
Gaunt.
