Turkey's economy: The mask is off A SENSE that things are sliding out of control has gripped Turkey since prosecutors launched a series of investigations into bribery and corruption close to the government in mid-December. Even if official charges and convictions never materialise, enough has come out to unsettle foreign and local investors. It casts serious doubt on the independence of the country's police and the judiciary, and their ability to enforce the law. Turkey suddenly looks more like the country it was trying to leave back in the shadows a dozen years ago. Inflation is running at over 7%, the currency is sliding and the current-account deficit is around 7% of GDP. Private savings, foreign investment and exports are shrinking. What is to be done? Ask any orthodox economist and he will probably say, "first raise the headline interest rate," which Turkey's central bank has held obstinately below 8% since last March (see chart). The central bank's lending rate should be a good 11%, calculates Murat Ucer at Istanbul Analytics, a consultancy. Extraordinarily, however, this vital tool of monetary policy is not one that the central bank is prepared to use at the moment. It prefers an alternative technique, known as the reserve-option mechanism. This allows Turkish banks to keep part of their reserve requirements in foreign currency rather than in Turkish lira. When foreign money was flooding into the country this was a good way of relieving upward pressure on the lira. But with the currency weakening it makes little sense - except as a way of unsettling investors. Exasperated economists blame Recep Tayyip Erdogan, the mildly Islamist prime minister, for this aversion to raising the interest rate. He is on record as saying that banks" interest frates should be the same as the rate of inflation, but no more. The central bank is not independent enough to gainsay him. Most forecasters predict that Mr Erdogan's distaste for higher rates will prevail at least until after local elections to be held on March 30th. In the meantime the central bank is using other means to combat speculation against the lira, in particular buying it with dollars to prop up its value. On December 24th it announced minimum daily auctions of $450m until the end of the year, followed by daily auctions of $100m to the end of January. But at some point the central bank's war chest will be exhausted unless confidence is restored that politics and the economy are under better control. The auguries are not good. A few former ministers and their offspring are under investigation for corruption, as are some businessmen, considered close to the government, whose assets have been frozen. At best that will paralyse some investment projects and their access to finance. More important, it raises questions about Turkey's economic model, which only a year ago seemed an example for other industrialising countries to emulate. Yet impressive GDP growth, which reached an annual 9% in 2010 and 2011, was largely driven by debt-fuelled private consumption and property investment, which included awarding big contracts to fast-growing and highly leveraged Turkish construction firms. Investment in industry, on the other hand, has languished. The government has shown little interest in encouraging the building of new plants and attracting big industrial investment from abroad - which should be meat and drink to a land with industrial ambitions. Instead, profits made by established industries and by banks have been subject to sudden capricious taxation. What is more, too much easy money (thanks to America's "quantitative easing") flowed into Turkey. Quicker returns were to be had in financing infrastructure and property than from investing in industry. Superficially, the country modernised rapidly, observers say, but underneath the old habits of government-by-favour, which Mr Erdogan had once opposed, seemed to wheedle their way back. A chastened prime minister could still put the economy back on a better trajectory, say even some of those who oppose him. But he would have to make peace with the grassroots Islamist movement which helped him into power and lately has sought to undermine him. He would also have to apply economic orthodoxy, allowing an interest-rate rise and some austerity, and let the judges do their work. In late November the country's financial watchdog announced measures to curb consumer lending for electronic goods and some luxury items, including expensive cars, but that hardly seems enough. What could push Mr Erdogan to go further is the danger that his grand projects will founder without a robust legal system and economic stability. His ambition to establish an international financial centre in Istanbul to compete with Dubai's already seems a non-starter. Financial firms have little incentive to come to Turkey for more than Turkish business: international investments can be caught by a 35% capital-gains tax; cash settlement of commodity futures is prohibited; and commercial law is not geared to international contracts. A €22 billion ($29.8 billion) project to build a third airport for Istanbul and a $10 billion canal to relieve the congested Bosphorus are also vulnerable. Both need international financing - which is much harder to come by when investors are worrying and ratings agencies pondering whether to downgrade the country.