Expect Turkey’s president to use his new executive powers to extract full benefit from Syria’s crisis and enrich an expanded personal network through mega-construction and energy projects, writes Jack A Kennedy.

Last summer, Turkish voters overwhelmingly rejected the ruling AK Party’s plan for a constitutional overhaul to boost the authority of the President. Five months later, they changed their minds.

The reason for this change? Most were spooked by terror attacks in their midst and wars on their borders. They chose stability over development.

Executing such a massive turnaround also highlights another factor: the extent of Recep Tayyip Erdoğan’s penetrating influence through informal networks.

Despite the limits of his office – constitutionally, for now at least, the President is supposed to be non-partisan – Erdoğan dominates an extensive system of patronage that marginalises Turkey’s Prime Minister, Ahmet Davutoğlu. It permeates the new Cabinet and particularly the team appointed to manage the economy.

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While economists the world over might raise eyebrows at the President’s theories that low interest rates reduce inflation, the new managers of Turkey’s economy are unlikely to have such qualms.

Zero Rates

Turkey’s push for low or zero interest rates, frequently expressed as a tenet of Islamic faith, is also central to maintaining the high level of borrowing that fuels the debt laden economy and mega-construction projects.

As a result, central bank Governor Erdem Başçı has been under constant pressure to keep rates low – omitting to raise borrowing costs in December, for example, a week after the US Federal Reserve did so.

Başçi’s closest government ally for a more orthodox monetary policy was his ex-classmate Ali Babacan, the former Deputy Prime Minister responsible for the economy and the man most associated with development progress under the AKP. Babacan, despite exceeding the AKP’s self-imposed term limit for parliamentary deputies, was re-entered as an AKP candidate for the November re-election. Intended to serve as a reassuring promise to voters of economic stability under the AKP, Babacan has been denied any significant policy-making position in the new government.

Former Finance Minister Mehmet Şimşek has also been effectively marginalised. While Şimşek has become Deputy Prime Minister, it’s a role that removes him from day-to-day economic management. Significantly, both Şimşek and Babacan were excluded from the AKP’s Central Decision and Administration Board (MKYK).

The absence of figures like Babacan may serve to validate the views of his opponents, such as Ziraat Bank’s Chief Executive Officer Huseyin Aydin, who has argued for looser banking regulations.

New Gatekeepers

The Economy Ministry is now headed by Mustafa Elitaş and the Ministry of Finance by Naci Ağbal – both members of Erdoğan’s inner circle and long-standing advocates for the government ceding authority to the presidency.

Joining them is Binali Yildirim, who had been replaced in the fallout from the December 2013 investigations into corruption surrounding Erdoğan. Yildirim is back as Transport, Maritime, and Communication Minister – a key position, with oversight for highways, railways and Turkcell, the national telecoms company.

These sectors will most likely receive the lion’s share of state investment. They form strategic components of the new “constructocracy” – an economy driven by ambitious construction projects deemed as being for the national good. Intercontinental bridges and tunnels, a third airport for Istanbul, an artificial waterway around Istanbul, the Istanbul Financial Center and a long-range missile defense system are among the big-scale plans discussed.

President’s Son-in-Law

But the clearest indication of Erdoğan’s expanding personal links to state projects came with the appointment of his son-in-law, Berat Albayrak, as Minister for Energy and Natural Resources.

Energy security and diversification is becoming a major economic priority for the AKP as diplomatic relations with Russia continue to deteriorate over the war in Syria. As a result, Turkey is looking to shift its natural gas dependence away from Russia. While these domestic projects won’t be large enough to replace existing Russian contracts, they demonstrate that Erdoğan is willing to invest time and money to enhance energy security..

No More Probes

With policy firmly in the hands of Erdoğan’s allies, it’s difficult to predict any significant improvement on the economic and business issues that most trouble foreign investors – such as the insipid tax collection that has been a hallmark of populist politics.

Crony elites that seek to benefit from preferential access to new state projects will do so without fear of being implicated in the corruption investigations that publicly disrupted elite patronage networks in 2013.

Erdoğan has forced through legislation ensuring that police chiefs must notify their immediate superiors of any investigations, handing oversight of covert corruption probes to Interior Minister Efkan Ala, another close ally of Erdoğan. It’s unlikely that any of the President’s inner-circle will be troubled by such an investigation, unless it’s at his discretion.

Gülen Conspiracy

The zero-sum outcome of the failed 2013 corruption investigations has been a weakening of the judiciary and legal procedure, effectively purged dissident voices.

Much of the focus has been an on-going campaign of retribution against alleged adherents of Fethullah Gülen, the preacher living in exile in the US blamed by Erdoğan for conspiracies against him.

Turkey’s Supreme Board of Judges and Prosecutors (HSYK) has been comprised of presidential allies since elections to the board in October 2014. Over the course of the last year, the HSYK has been used to undermine the ability of the state to check any excesses of the President’s elite networks.

In September, for example, the HSYK established offices in courthouses to prevent any prosecutors from fleeing arrest. That decision was made after prosecutors Zekeriya Öz and Celal Kara – active in the graft probe investigations against Erdoğan’s networks in 2013, and subsequently accused of links to the Gülen Movement – escaped detention and fled the country.

The HSYK’s bureau collaborates with the Smuggling, Intelligence, Operation and Information Gathering Department (KIHBI) of the Interior Ministry, a sign that internal state security forces are being utilised as a tool to repress scrutiny rather than promote security.

Judges’ Judgment Day

Judges and prosecutors have been continuously reassigned by the HSYK throughout the year; 2,664 were shifted in June, and a further 156 were moved in October. These reassignments invariably involve the repositioning, if not outright dismissal, of opponents.

The October reshuffle included the judge who had accepted an indictment against Ethem Sancak, one of Erdoğan’s inner-circle of billionaire businessmen, distantly related to the President’s wife.

Beyond the judiciary, the state has become more brazen in its seizure of opposition business interests. Those with links – alleged or proven – to Gülen have been under the most significant pressure; Bank Asya, founded by Gülen affiliates, was taken over by the Banking Regulation and Supervision Agency (BDDK) in May after a year-long government campaign to discredit its reputation. Bank Asya’s parent company, Kaynak Holding, had caretakers forcibly appointed in November 2015 after a previously inconclusive tax investigation.

Manipulation of government regulatory institutions increased in pace and scope in the run-up to the November elections as the AKP sought to prohibit any dissent. The Finance Ministry’s Financial Crimes Investigation Board (MASAK) raided Koza İpek Holding – and despite failing to shed light on any illegal activity or transaction – placed the media-linked business under a trusteeship of the state. This allegedly followed a refusal by its CEO to join the President’s “pool media” – an informal network of businessmen who receive preferential access to state contracts in return for positive media coverage of Erdoğan and the AKP.

Investors will need to be mindful of an increasing disregard for property rights when political considerations intrude.

Syrian War

But the most obvious risk for most investors looking at Turkey is the escalating conflict on its borders.

With the Syrian civil war entering its fifth year, Erdoğan and Davutoğlu have persisted in following a strategy of non-negotiation with Bashir Assad’s regime, in contrast to every other regional actor bar Syrian rebel groups and Islamic State.

Ankara’s position cannot be separated from the deterioration in its own domestic security following the re-ignition of hostilities with the Kurdish separatist PKK movement in July. This conflict has massively disrupted the stability and economy of Turkey’s southeast regions; already suffering from loss of trade in Syria and Iraq, seven provinces have been placed under state curfew since mid-August. The cost is estimated to be in excess of $50 billion. It’s a price Turkey can ill-afford while struggling to finance the settlement of over 2 million Syrian refugees.

It’s the rise in geopolitical risk that’s behind the jump in yields in Turkey’s bond market. Turkey is officially part of the US-led coalition operating against IS in Syria and Iraq, but so far its involvement has been focused on supplying aid and ammunition to Syrian Turkmen groups fighting the Assad regime. Initial air strikes against IS targets in July 2015 were part of a token cover to distract attention from far more intensive action against Kurdish targets in northern Iraq.

The bellicose attitude of Turkey’s leaders towards the Syrian conflict had resulted in a laissez faire approach to Islamist fighters using the Turkish border as a transit point and an exceptionally lax application of regulation on illicit networks of finance and weapons trafficking into Syria.

Turkey has paid a heavy price. Islamic State-affiliated cells carried out suicide bombings in the country, killing a total of 135 people in July and October. The attacks – targeting Kurdish groups probably in retaliation for Syrian-Kurdish rebel groups in Syria – highlighted the wilful neglect of anti-terror operations against extremist groups in Turkey. This is of particular concern for residents of Istanbul, home to at least 5 million Turkish Kurds.

Diplomatically, Turkey has moved on from its previously heralded ‘zero problems with neighbours’ policy, a flagship strategy of Davutoğlu. Turkey has no embassies left open in Egypt, Syria or Libya. Its privately negotiated energy trade with the Kurdistan Regional Government (KRG) has increasingly aggravated relations with Baghdad. Acrimonious accusations have been traded with Iran throughout the past year.

Poking the Bear

But the most significant casualty of Turkey’s Syria policy has been diplomatic relations between Ankara and Moscow. Erdoğan and Vladimir Putin maintained cordial personal and economic interests throughout much of the AKP’s 12 years in government. Although the two leaders disagreed on Syria, the issue was largely kept separate from business interests. In September, Erdoğan accompanied Putin for the opening of Moscow’s largest mosque.

But this relationship has been over since the Turkish Air Force shot down a Russian jet in November 2015 over an alleged incursion into Turkey’s airspace. Russia continues to insist that it was operating entirely in Syria and imposed trade and travel sanctions on Turkey in response. These measures will severely disrupt the Turkish tourism sector; Russian business is worth $4 billion annually.

While Russia has increased it’s military footprint in Syria, without a shift in strategy Erdoğan risks losing any stake in a meaningful role for post-conflict reconstruction.

Diversifying Energy

For Turkey, the deteriorating relationship with Russia has necessitated an enhanced scrutiny of its energy security. Turkey imports 98% of its natural gas consumption, and Russia accounts for 56% of this and 30% of oil. This figure was set to increase to 70% if the proposed TurkStream pipeline was completed, but that project is now indefinitely on hold. Erdoğan, both politically and economically, cannot afford for Turkey to be held to ransom by a threatened gas supply – as Ukraine was in 2009.

This threat has motivated a concerted effort to diversify energy relationships across the region and internally. In December, Tosyali Holding, Turkey’s largest private steel manufacturer, announced plans to invest in the production of oil and gas pipes with a target of 500,000 tons for 2016.

Turkey has signed Liquid Natural Gas (LNG) import contracts with Qatar, and accelerated gas pipeline construction projects with Azerbaijan and the Kurdistan Regional Government for operation in 2017. Negotiations to normalise frozen relations with Israel began in December – opening the possibility of joint development of Tel Aviv’s offshore gas reserves.

The government also appears to have re-prioritised relations with the European Union. Although out of diplomatic necessity rather than policy reform, Turkey agreed in November to a $3.2 billion aid deal to halt refugee flows to Europe, with the added assurance from Brussels that it would unfreeze Turkey’s accession negotiations. At the same time, Erdoğan is notoriously dismissive of the EU, dimming chances for any positive reform or real engagement.

Meanwhile, Turkey faces mounting challenges economically. Public banking and institutional debt estimated at over $170 billion is due to be paid in the coming year. Of this, 53.8% is in dollars and a further 29.9% in euros. Any further increase in the US Federal Reserve’s interest rates will negatively impact the cost of this debt.

Without assurance of stability, the prospects for foreign direct investment rushing back to the Turkish market look negligible.

2016 Watch Points:

Without meaningful participation in a comprehensive settlement of the Syrian civil war, the conflict will continue to impact Turkey’s regional integration and domestic security. On the positive side, resolving the Syrian crisis would contribute to a negotiated cease-fire of the on-going Kurdish insurgency.

If the central bank continues to exhibit signs of external pressure from decision-makers close to Erdoğan, there is little prospect of foreign investor confidence returning to the Turkish market. Inflation will remain high and the lira will continue to weaken against the dollar.

Worsening relations with Russia necessitates broadening energy relationships. Expect this to be driven by members of the President’s family and his close network of business allies.

The author is Jack A Kennedy, lead Middle East & North Africa analyst at West Sands Advisory Ltd. An Arabic speaker, Jack has travelled the wider region and last worked in the Middle East in 2014 with the European External Action Service.

West Sands Advisory Limited is a business intelligence, investigations and political advisory firm that has, since 2006, helped clients identify opportunities and reduce risk in emerging and frontier markets (http://www.westsandsadvisory.com).