Nicholas Birch in Istanbul -

Fighting for its political future after a top court decided on March 31 to hear a closure case against it, Turkey's ruling party looks unlikely to have the time or inclination for reforms aimed at strengthening the country's still-flawed democracy and advancing its bid for EU membership.

The result of one of the bitterest bouts yet in a 50-year war pitting popular governments against the secularist establishment, the court case as yet shows no signs of triggering the economic crisis pessimists have been predicting for months. Instead, after five years in which Turkey's economy grew an average 7% per annum, it appears to have set the seal on a slowdown that will be difficult to shake off.

"We are in a new era", says Mehmet Besimoglu, Oyak Securities' chief economist. "Turkey's economy is strong enough now not to fall into the boom bust of the 1990s, but this slowdown looks set to be pretty permanent - two years at least."

In line with other Turkey-based brokers, Oyak revised macro-economic estimates downwards in a strategy paper. It now forecasts year-end inflation at 10%, up from 7%, growth estimates for 2008 and 2009 down from 5% to 4%, and dollar/lira up from 1.25 to 1.4. Turkey's Statistics Institute announced that 2007 GDP growth was 4.5%, the lowest level since the 2001 crash.

Briefly up to 1.15 against the dollar late last year, Turkey's overvalued lira was one factor in growing imports that have pushed Turkey's current account deficit up to $45bn this year - one of the world's largest in real terms and roughly 7% of GDP. The currency adjustment most analysts expect isn't likely to be enough to pull the deficit down, though. "Devaluation won't be big enough for that," says Abdurrahman Yildirim, an economist. "What it will do is make financing more difficult, and that will come back as slower growth - it's a vicious circle."

Banking on FDI

After a bumper year for foreign direct investment last year, the government is expecting a further $22bn this year. And that's not just wishful thinking - FDI in the first three months of 2008 totaled $7bn, and the projected privatisation of Halkbank, Turkey's second biggest state lender, could provide a windfall later this year.

Yet, while international investors have so far remained mostly loyal to Turkey's equity market (their share of the market has dropped just slightly from 72% in January to 69% today), the signs are there that political turmoil is beginning to put some investors off. "Two REITs we were advising had made a decision to invest EUR1bn in Turkey this year," corporate lawyer Tevfik Gur told the business daily Referans today. "They were due to come to Turkey this week to start looking for investment opportunities. Now, they've put everything on hold. Everybody is on stand-by, waiting to see what happens."

It's a sensible decision, and not just because the construction sector - blessed with double-digit growth in the five years after 2001 - all but ground to a halt in the fourth quarter of last year.

As is so often the case in Turkey, the crucial issue remains politics, and more specifically how the government will react to what many analysts see as an organised campaign to close it down. Falling like a bombshell on a party that came to power in 2002 and was re-elected with 47% of the vote last summer, the March 14 indictment followed two foiled coup attempts in 2004 and a veiled threat of military intervention last year.

Turkey's business leaders spent last week calling - somewhat mysteriously - for compromise, but the ruling AKP shows few signs of listening to them. Speaking a day after the indictment, Prime Minister Tayyip Erdogan called it a "move against the national will" and - apparently alluding to the prosecutor - cited a Koranic verse that compares unbelievers to "beasts."

Deeply sceptical of secularists' intentions and aware that no Turkish party has yet escaped a closure case against it, the government made clear this week that it was planning to change the constitution within two months to make it more difficult to close political parties down.

With secularist politicians warning the move would spark "a regime crisis," analysts think the move is legally dubious and politically very dangerous. Any referendum that would ensue if AKP failed to get enough votes in parliament would risk being interpreted, in today's poisonous political atmosphere, as a referendum on secularism. "If AKP goes it alone, there will be hell in this country," warns Cuneyt Ulsever, a prominent political commentator. "Anything could happen, even military intervention."

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