Tuesday, 26 March 2013

Cyprus Badly Misplayed Its Hand

Cyprus has just learned a very old lesson the very hard way – nations don’t have friends, they only have interests. Assuming protection for the last decade from its membership in the European Union, the Euro zone, and close ties to Russian oligarchs Cyprus tried to remake itself as a global financial service center and a significant regional political player. Whatever productive businesses it had were wound down in favor of a service-based economy. Cypriot politicians mistakenly thought their consistent support of Russian stances on issues like Kosovo and Syria would earn them Russian protection when times got hard.  Wrong.

Cyprus just learned a hard lesson
These delusions were brutally punctured when a remorseless European Union led by Germany forced a complete restructuring of the island’s unsustainable banking system in return for helping rescue the country’s battered finances. This restructuring will lead to failed businesses and large losses for many savers, including thousands of Russians who thought Cyprus was a safe place to stash their funds protected by the notoriously incurious Cypriot financial regulators. Essentially, the island’s economy is back to Square One.

Cypriots were ‘shocked, shocked’ that their fellow EU members would do this to them. They were even more shocked when the Russians, demonstrating a bit of real politick, showed they valued their relations with the EU more than their Cypriot ties and refused to help, leaving the island nation well and truly in the lurch.

This plea fell on deaf ears
The Cypriots badly misread their presumed support from the EU. The reality was that many EU countries deeply resented Cypriot membership in the first place and were increasingly annoyed at the lax financial regulation on the island. In 2004 Greece essentially threatened to veto the entire EU expansion project unless Cyprus was included. Greece and Cyprus won the short-term game, but lost longer term support. No one likes being blackmailed. The Germans in particular did not want to accept a country that was divided by the break-away Turkish Republic of Northern Cyprus in the north and the Republic of Cyprus in the south.

The Cypriots did not help their reputation when they overwhelming rejected a plan to unify the island just before they were admitted to the EU. Cyprus further overplayed its hand by consistently blocking any closer relations between the EU, NATO and Turkey. What began as a major victory for Hellenism in 2004 has sadly turned to dust as both Greece and Cyprus, largely through their own doing, are now little more than wards of the humourless northern Europeans.

In a twist that only the gods could arrange, Cyprus’s implosion has coincided with major strides forward by its arch-enemy Turkey. While Cypriots leaders were desperately shuttling between Nicosia, Brussels and Moscow seeking bail out money Turkey not only made a major breakthrough in the peace process with the Kurds but succeeded in amending its torn relations with Israel. At a stroke, the geopolitics of the Middle East changed. Turkey, whose economy is humming along quite nicely, re-established itself as a credible, powerful force in the ever-changing dynamics of the Middle East.

The implications of these developments for Cyprus are mixed at best. Israel now could be much more interested in shipping the gas from its offshore field to Turkey rather than Cyprus. Turkey has long protested that Cyprus should not develop its own gas fields without taking into consideration the Turkish population of the island. Now that Turkey is finally living up to its potential as a regional power more countries and major oil companies could be willing to consider the Turkish position before doing more work on the offshore Cyprus gas fields. Certainly countries like Germany and Russia have many more strategic interests in Turkey than they do in Cyprus. And they most likely would not like to jeopardize those interests for the sake of Cypriot gas.

Cyprus is in a tough neighborhood
There is at least one step Cypriot leaders could take that could restore their credibility and possibly lay the foundation for recovery. They could think the unthinkable and work out a deal to re-unify the island. After nearly 40 years of division following the Turkish military incursion this will by no means be easy. One of the more thankless jobs for any diplomat since 1974 has been to seek peace between the two sides of Cyprus. The best chance came in 2004 when a plan supported by former United Nations General Secretary Kofi Annan was overwhelmingly supported by the Turkish side and just as overwhelmingly rejected by Greek Cypriots after a vigorous ‘No’ campaign led by former president Tassos Papadopoulos.

Such reunification talks would undoubtedly be challenging. Much has changed over the last several years on the island and the two sides no longer have much in common. Cyprus also would be negotiating directly with Ankara rather than with just the Turkish Cypriots. Touchy issues include the presence of the Turkish military that by now has built up a substantial infrastructure on the island, restitution of Greek Cypriot property seized in 1974, the status of the thousands of immigrants from the Turkish mainland that have been settled on the island, and many, many others. But Turkey has reasons of its own for wanting a settlement. Currently it spends about $600 million a year to support the Turkish part of Cyprus, money it can ill afford to spend. It has been unable to get a single country to recognize the Turkish Republic of Northern Cyprus, and its negotiations with the EU have been hindered by Cyprus for several years. Also, the Turkish military is in a much weaker position than it was in 2004. It is no longer in a position to block a settlement and pretty much does whatever Prime Minister Erdoğan says.

The economic and political benefits of a unified island just might push the parties toward the negotiating table. Now that the former Cypriot economic model is broken beyond repair the political leaders might be willing to re-think the unification issue. This would require leadership and statesmanship that so far have been in short supply. But in this case necessity might just the catalyst for welcome change.

Monday, 11 March 2013

Challenges To Long Term Economic Success

Deputy Prime Minister Ali Babacan of Turkey never spoke truer words. Whether the words will ever be translated into action is another matter. But for the moment, the words are welcome.
Regarded as an economic technocrat in a government of zealous ideologues, Babacan is widely credited for Turkey’s recent strong economic performance. 

He has kept a tight rein on the country’s financial management since the Justice and Development Party swept to power in 2002. He has often warned his countrymen against taking on too much debt, and once famously compared running the Turkish economy to driving a truck down a steep, winding road in a thick fog.  Perhaps most importantly he has kept economically illiterate politicians from wrecking the budget with their pet projects or handouts to favoured groups.
Deputy Prime Minister Ali Babacan
In a recent meeting hosted by theFoundation for Political, Economic and Social Research he said that Turkey needs a “predictable rule of law” to improve its investment climate. “We must certainly create a more rapid and consistent judicial process,” he told the audience. “We are not at an ideal point regarding fundamental rights and freedoms. We need more judicial reforms. To become a country where there is a functioning (italics are mine) democracy and the rule of law is our sine qua non.”

Welcome words indeed to those hundreds of people incarcerated in prisons for long periods without being brought to trial. Then he got to the heart of the matter.

“Without political reforms, economic success cannot be maintained . . . development based on economic growth alone falls short of satisfying people.” Never were truer words spoken. I wonder what the Chinese would make of them.

He continued by stating the obvious about Turkey’s education system. “Our educational system is not very pleasing. The average number of years of schooling for adults is 6.5 years. With this kind of education level it is hard to achieve a target of $25,000 per capita GDP. We can achieve this goal with a better education level,” he told the group. It is a measure of Babacan’s importance to the government that he felt free to make such comments. Most other ministers with the temerity even to hint that there was any risk whatsoever to Turkey’s economic growth would quickly be transferred to supervising car parks near the Iranian border.

His comments come on the heels of the Global Competitiveness Report that showed between 2006 – 2012 Turkey’s justice system declined from 56th place to 83rd place. The country’s tax regime declined from 95th to 117th, and the education system fell from 58th place to 74th place. With this kind of performance Babacan’s concerns about Turkey’s economic success are well founded.

Problems in the legal and judicial system that hurt Turkey’s growth are not limited to criminal cases. Recently there was a closely contested bidding procedure for the privatisation of the country’s toll roads and bridges that attracted three bids and was won by a consortium of Turkey’s largest conglomerate Koç Group and the Malaysian UEM Group with a bid of $5.7 billion. The process followed Turkey’s complex privatisation regulations to the letter. The winning bid was far above what the other competitors were willing to pay, and was considered very rich by other market participants. Despite this, Prime Minister Tayyip Erdoğan complained that the winning bid was too low and that he would be ‘accused of treason’ if he permitted the privatisation to be completed at only  $5.7 billion. The prime minister did not reveal how he arrived at this conclusion.  Predictably, the bid was cancelled. Nothing has been said about compensating the winning bidders for the considerable investment they made merely to make the bid.

Abrupt cancellation of the bidding process when the government is unhappy about the results is, unfortunately, nothing new. A few years ago a client of mine won a small bid for a property containing deposits of a low value industrial mineral. Two weeks after the bid the client received a two sentence notification from the Ministry of Energy saying the bid had suddenly been cancelled. No explanation, no reason was given. I made several fruitless trips to the ministry seeking some sort of explanation. Various officials had the grace to be embarrassed, but said there was nothing they could do. “It’s out of our hands,” they said.

This lack of transparency has plagued Turkey for decades. With its massive electoral mandates Turkey’s ruling Justice and Development Party has had the perfect opportunity to make long overdue and fundamental reforms to the country’s governing institutions – the very ones that Babacan talked about. By focusing instead on expanding his own authority, emasculating the military, and creating vote-gathering construction projects the prime minister has missed an excellent opportunity to make these fundamental changes that would transform Turkey’s recent economic growth into lasting economic and social progress.