Turkey's perpetually high current-account deficit -- which varies between 6 and 10 percent of GDP -- is a long-term structural issue for the economy. In order to finance the current account deficit, Ankara relies on both foreign direct investment (FDI) and short-term portfolio flows. But Turkey's long-term FDI has slowed, leaving the country at the mercy of portfolio flows and vulnerable to external shocks -- whether it be independent actions by the U.S. Federal Reserve or the European Central Bank, or domestic political unrest. The bottom line is that Turkey's dependence on speculative money -- which goes out as easily as it comes in -- puts the economy at risk.
In a worrying sign for the Turkish economy, money has recently begun to flee developing country markets for bonds in the United States. And while the retreat from investing in emerging markets began before the protests erupted in Turkey, the unrest has certainly called into question the country's political stability and hastened the monetary retreat from Turkish markets.
The capital flight began in late May, after Federal Reserve Chairman Ben Bernanke telegraphed his intention to taper the $85 billion in bonds that the Fed is buying each month. If the Fed does decide to slow down its stimulus plan and U.S. bond yields continue to rise, countries with high-current-account deficits -- like Turkey -- are particularly vulnerable.
Also worrying for the Turkish economy is the poor performance of its currency. In May, the Lira hit its lowest value against the U.S. dollar in 17 months. The protests have exacerbated this downward trend and eventually forced Turkey's central bank to intervene to prevent the Lira from depreciating further. On June 12, it auctioned off $250 million to Turkish banks to help prevent the further depreciation of the Lira. While the auction did manage to stabilize the currency, Turkey's capacity to intervene further remains limited. One potential option to combat this weakness is to raise interest rates, but Erdogan has remained steadfastly opposed to this option, maintaining that low interest rates are vital for Turkey's economic success.
Despite these difficulties, the Turkish economy grew at an annualized rate of 3 percent for the first quarter of 2013, though this is well short of the country's 4 percent growth target for the year. In reality, the economic picture is far more complicated than the economy minister -- or Erdogan -- would like Turkish voters to think. While blaming phantoms may appeal to some segments of the AKP's base, it papers over the political and economic conundrum now facing Turkey's leadership.
The protests have already dented Turkey's tourism industry -- a key source of revenue for financing the current account deficit -- and the combination of a slumping EU economy and the various crises in Middle East has made it harder for Turkey to export its way out of economic malaise. Ankara will therefore have to rely on domestic demand to fuel economic growth, which will inevitably increase the country's current account deficit -- in turn making it even more vulnerable to the whims of the U.S. Federal Reserve. While Turkey's economy is not going to collapse because the continued protests, the future is nonetheless gloomy. As a result, the AKP will most likely continue to focus on placing the blame elsewhere, rather than face the combined pressures of domestic unrest and central bank decisions abroad -- both of which may have a profound impact on the Turkish economy going forward. While Erdogan has no influence on the Fed, he could opt to try and mimic the protesters and stay silent, in order to at least dampen the growing feeling in some financial circles that he has lost touch with reality.