Politics 1 July 2013 Will investors flood out of Turkey? Depends who they are. Print HTML If we needed another reminder that geopolitics rather than economics has become the barometer of investor sentiment look no further than Turkey. The recent protests in Istanbul and Ankara have revealed a degree of domestic discontent not appreciated externally. The investor unease this created has been compounded by the harshness of the crackdown against the demonstrators and Prime Minister Tayyip Erdgoan’s intransigent rhetoric, which are reminiscent of Turkey's authoritarian past. Turkey used to be viewed as a modern Muslim nation. Not an Islamic state. When Kemal Ataturk established the Turkish republic in 1923 he sought to transform the Ottoman Empire into a modern, secular European nation. Prosperity and peace in Turkey has derived from this. When Erdogan was first elected in 2003, the heads of the Turkish army visited him as is the custom. It was a very short meeting in which the generals warned him not to interfere with the secular nature of Turkish government. This was a stark warning to a man whose wife wears a head scarf. Gradually Erdogan has eroded the power of the military and sought to outlaw liberal behaviour with restrictions on the sale and consumption of alcohol and "immodest" public behaviour. This has created a backlash amongst those who wish to secular nature of Turkish society to be respected. Turkey's foreign policy as a bridge between east and west has been derailed by the government's handling of events in Syria. Erdogan’s credibility as a critic of President Assad of Syria has been undermined by the speed with which he resorted to force in an attempt to quell the protests orchestrated by his own people. Rubber bullets and tear gas are incommensurate with the western image of liberal democracies. He has undermined Turkey’s democratic credentials and complicated links with the EU at a time when investors are seeking the elusive "safe haven". Will investors leave? It really depends on who they are. For the Gulf sheiks Turkey remains a safe investment haven and it is Arab money that has flooded into the country, fuelling a financial bubble and high inflation. These investors are unlikely to be concerned about the tactics Erdgoan employs to quash protests and will continue to view Turkey as a safe investment haven after the Arab Spring as they are wary of investing in Western countries because if unrest breaks out, their assets could be frozen. Western investors have a different view - partly driven by concern over returns - and partly by the reputational risk that could arise from investments in Turkey if protests escalate and Erdogan instigates another crackdown against them. The financial outlook is also worrying. Turkey has seen its risk premia narrow in recent years. Capital inflows have almost offset the current account deficit which has narrowed to some 6 per cent of GDP from the alarming 9.6 per cent recorded in 2012. The banks are in good shape and, despite incoherent use of monetary policy tools, the financial system is stable. Inflation has receded, to some 6 per cent from over 9 per cent last year, though unemployment has only nudged lower, and remains high, at 9 per cent, as GDP growth is still only moderate, albeit stronger than last year's feeble 2.2 per cent. With its favourable structural dynamics of a growing middle class and a young, decently educated workforce, observers had reappraised the outlook and after Turkey secured two investment grade ratings, many were expecting another ratings upgrade. Political stability played a part in this improvement, but recent events have undermined the optimism, leaving the economy vulnerable at a time when the liquidity emerging economies have benefited from as a result of quantitative easing in the US, may be coming to an end. The absolute size of the current account deficit and its majority financing by portfolio inflows makes the lira vulnerable to shifts in market sentiment. Protests continue and the state continues to round up those it considers responsible. Intimidation of journalists has risen from an already high level – Turkey imprisons more journalists than Iran. This will further harm relations with the EU at a time when the organisation has already postponed the latest round of membership talks with Ankara to October. Across the Atlantic the violent response to the protests is souring the close relationship Erdogan enjoyed with President Barack Obama, as it becomes increasingly difficult for Washington to defend Turkey’s prime minister after abandoning long time ally Hosni Mubarak in the face of protests and a brutal response. The prospects of Turkey winning the right to host the 2020 Olympic Games has also receded with all of the economic benefits that could bring. › How to be a powerful woman: be ambitious Photograph: Getty Images JLT Head of Credit & Political Risk Advisory Subscribe from £1 a week Subscribe More Related articles UK equities: A logical proposition The case against TTIP There is radical potential in revitalising adult education – why are we letting it disappear?