Erdogan Eye on ‘Crazy Projects’ Links Turkey Scandal to Builders

Erdogan Eye on ‘Crazy Projects’ Links Turkey Scandal to Builders

A tiny fishing village called Garipce holds a clue to understanding the largest corruption scandal in Turkish history. An hour’s drive north of Istanbul, two giant concrete towers straddle the Bosporus, one foot in Asia, the other in Europe. By 2015, a $2.5 billion suspension bridge will hang between the 322 meter (1,056 feet)-high towers. Nearby, a swath of forest the size of Manhattan is being readied for a $14 billion airport.The projects — the biggest of their kind in the world — epitomize a decade-long, $200 billion construction plan undertaken by Prime Minister Recep Tayyip Erdogan that has projected Turkey’s ambitions as a regional power and enriched his allies in the process. After a wave of arrests that targeted those new elites, the building sites now risk becoming emblems of the corruption and largesse that prosecutors say has permeated Erdogan’s designs for a new Turkey.

Executives from companies building the bridge and airport are among the 100 people who’ve been arrested, questioned or sought by prosecutors since news of a 15-month secret investigation broke on Dec. 17.

Also ensnared were the sons of three of Erdogan’s cabinet ministers, the chief executive of a state-run bank and a construction magnate who’s become one of Turkey’s richest men during the Erdogan decade. The three ministers have resigned.

‘Growth Miracle’’

There’s no formal indictment, though at least a dozen suspects remain in custody on charges ranging from taking bribes to rigging tenders. Many of the allegations target the massive public works program that helped Erdogan prop up the economy and bolster an Islamic business class kept loyal from the profits of audacious infrastructure projects.

“The growth miracle of Turkey was largely due to construction,” said Atilla Yesilada, an Istanbul-based analyst at Global Source Partners Inc., a New York economic advisory firm. “If these allegations have a single grain of truth to them, then it turns out that Turkey’s development model is not only skewed, but also corrupt. It’s really disturbing.”

Erdogan has said that the probe is an attempt to derail his transformation of the country.

Behind the probe, according to Erdogan and his allies, is Fethullah Gulen, a 75-year-old diabetic cleric based in Pennsylvania’s Poconos. From there, he runs an Islamist network that wields influence in Turkey’s police and judiciary, and collaborated with Erdogan in the past.

Their falling-out has scarred the premier’s third term, the one he promised would be his “master phase,” establishing a new and vibrant Turkey as one of the world’s top economies. Instead, Erdogan is fighting off accusations that growth on his watch was rooted in graft and favoritism, especially in the construction industry.

Not Involved

“The operations that started under the guise of corruption are an obstacle to building a new Turkey,” the prime minister told supporters in Sakarya, east of Istanbul, on Dec. 28 in one of six political rallies he held that weekend.

Gulen doesn’t have the “slightest involvement in or knowledge about” the graft inquiry, his lawyer Orhan Erdemli said last month. The cleric’s health problems mean he’s not able to discuss the issue, affiliated organizations, including the Journalists and Writers Foundation and the Alliance for Shared Values, said in response to e-mailed questions.

Favored companies of Erdogan’s new Turkey include Calik Holding AS, run until the New Year by Erdogan’s son-in-law Berat Albayrak, which has energy and construction interests from Kosovo to Iraq. Calik hasn’t been named in the probe. Cengiz Insaat is run by Mehmet Cengiz, who sits with Erdogan’s son on the board of a charity at a university named after Erdogan, and was helping build the new airport. The company says it has a $7 billion order book of contracts.

Second Wave

Cengiz’s name showed up on a list of people wanted for questioning in a second wave of arrests that was foiled when police officers refused to carry out orders from the prosecutors, Radikal newspaper reported on Dec. 27, publishing what it said was a copy of the list. Cengiz did not reply to a call or text message.

These companies exemplify a new business class, mostly from Turkey’s heartland of Anatolia and supportive of Erdogan’s Islamist values. It has emerged under the government of his Justice and Development Party, or AKP, to challenge the old secular elite of Istanbul.

Media Wars

Some members have also become media moguls, and local coverage of the graft scandal is itself a portrait of a riven nation. Newspapers and television stations owned by Calik, like Sabah, have staunchly defended Erdogan since news of the probe broke. Meanwhile, in the absence of formal indictments, the allegations have dribbled out in leaks to anti-Erdogan newspapers, many of which are run by supporters of Gulen.

Newspapers Taraf and Zaman printed what they said were excerpts from surveillance video and text messages provided to them that purportedly showed economy minister Zafer Caglayan receiving a Patek Phillipe 5101G wrist watch, that retails for $380,000, from an Iranian businessman. Twitter lit up with pictures of the minister wearing the watch at public functions.

He said in a Dec. 17 statement that he had resigned to “spoil this ugly game” and “to allow the facts to come out.”

After the newspaper Radikal reported that shoeboxes stuffed with $4.5 million were found in a bank executive’s home, protesters started leaving empty shoeboxes on the bank’s automatic teller machines.

Macedonian Schools

Turkiye Halk Bankasi AS Chief Executive Officer Suleyman Aslan, who was detained during the probe, said the money found in his house was to be donated to build Islamic schools in Macedonia, according to Hurriyet newspaper. A court in Istanbul on Jan. 2 ordered that Aslan should be kept in custody pending trial.

Other companies in Turkey’s construction industry, whose biggest players include some of Erdogan’s main allies, have been drawn into the probe.

The Agaoglu Group, whose website lists more than 20 real-estate projects in the Istanbul area, said on Dec. 17 that Chairman Ali Agaoglu had been called in for questioning as part of a “wide-ranging investigation regarding public services.”

The publicly traded arm of the state housing authority, TOKI, said two of its board members had been questioned. TOKI allocates land — a precious resource in 15 million-strong Istanbul — and reports directly to the prime minister’s office. Calls to TOKI’s headquarters weren’t answered.

Muammer Akkas, the prosecutor who headed the probe, said Dec. 26 that he had been removed from the case by the government, which was obstructing the investigation.

Regional Power

“As Turkey grew to be a regional power, these mega projects were a sign of the new self-confidence and status symbols, and these are politically dominated building projects, with higher corruption,” said Lutz Roehmeyer, who manages $1 billion at Berlin-based Landesbank Berlin Investment, including $30 million in Turkish stocks and bonds. “Political shocks are always unwelcome, but when you invest in emerging markets, you have to expect something like this every day.”

The investigation has prompted a selloff in Turkish stocks. Since Dec. 17, the benchmark Borsa Istanbul 100 Index (XU100) has dropped 12 percent. As foreigners sold liras, the currency has lost almost 8 percent against the dollar since the investigation began, reaching a record low.

Even Erdogan acknowledges the audacity of some of his building plans. He routinely refers to one proposed effort, to cleave a $12 billion canal to connect the Black Sea to the Sea of Marmara to the south, as his “crazy project.”

Projects Underway

The building continued even as Turkey’s economy cooled. At least $102 billion of projects is under way, calculates Zeyno Ustun, a researcher at the New School for Social Research in New York. Ustun worked with an Istanbul-based collective called the Networks of Dispossession, which used publicly available information from company and government websites.

Much of the work is being done by companies that have prospered since the 2002 election and support Erdogan’s Islamic values, including allowing headscarves in the workplace, an incendiary issue in Turkey.

Cengiz Insaat is in the consortium that won the bid to build and operate Istanbul’s third airport for 25 years, then transfer it to the government. Mehmet Cengiz comes from Rize, the same Black Sea town as Erdogan, and was a founding member of a charity foundation at Recep Tayyip Erdogan University in that city, along with Erdogan’s son, Necmettin Bilal Erdogan.

Calik Holding expanded from a small textile firm in 1981 to post revenues of $2.9 billion in 2011, the last period available. It holds interests in construction, finance, media and telecommunications. In 2008, it bought Sabah newspaper, and a television channel, ATV, for $1.25 billion with $375 million in loans from two state-run lenders, including Halkbank.

Getting Contracts

“The relationship between the construction industry and the AKP is straightforward: They get the big government contracts,” said Oghuzan Dincer, a Turkish economist at Illinois State University in the town of Normal who studies corruption, via e-mail. “What is more important is their presence in Turkish media. These firms own the majority of the radio and television stations, and the AKP and Erdogan use these as propaganda machines.”

Sabah and other pro-government media call the probes politically motivated, rejecting any implications of corruption. Opinion pieces in the pro-Erdogan press don’t refute the allegations of corruption, arguing instead that these projects were awarded to speed up infrastructure investments, said Global Source’s Yesilada.

“This last point is so important that we feel the need to rephrase,” he wrote in a Dec. 29 note to clients. “The pro-AKP press does not deny the charges, but refuses to define them as ‘crimes.’”

Plot Accusation

Erdogan’s AKP also calls the investigation a plot to deny Turkey its destiny.

“Is it a coincidence that the businessmen who were building, or going to be building, the third airport and bridge were requested to be taken in?” asked party spokesman Huseyin Celik on his Twitter account. “Maybe the real goal could be sabotage? Because these ‘crazy projects’ in Istanbul have turned some circles inside and outside crazy.” He didn’t respond to a text message.

Erogan’s spokesman, Lutfullah Goktas, directed questions to Minister for European Union Affairs Mevlut Cavusoglu, whose staff said he wasn’t able to respond immediately.

Erdogan has overseen economic growth of more than 5 percent a year since 2002, while reducing inflation from more than 70 percent to 7.4 percent. In a New Year address to the nation on Dec. 31 he reiterated a goal of taking Turkey, currently the world’s 17th-biggest economy, into the top 10 by 2023.

Ranking Unchanged

The economy hasn’t moved upward in global rankings when measured by per-capita GDP, though. In the 10 years through 2013, Turkey remained 67th in the world by that measure, according to IMF data.

Erdogan wasn’t always a fan of mega projects. In 1995, as the mayor of Istanbul, he decried the plan to build a third bridge as “murder for Istanbul.”

“It is nothing but massacring the remaining green areas in the city’s north,” he said. “I hope the government will change without this murder being committed.”

The government did change. So did Erdogan’s mind. By the time he assumed power in an election in 2002, a year after he established the AKP, Turkey was opening up its economy. A financial crisis in 2001 led to reforms that boosted capital inflows, which Erdogan decided to use for infrastructure projects, said Mustafa Sonmez, a writer and economist who is the author of “Media, Culture, Money and Power in Istanbul.”

Istanbul Boom

Sonmez estimates that in the last 11 years, $583 billion has been spent in building and construction, citing data from the Turkish Statistical Institute. About $200 billion of that was generated from state-run projects, he calculated.

The results have transformed Istanbul, which generates 27 percent of the country’s GDP and a fourth of its tax revenues. Skyscrapers, malls and luxury apartments sprouted outside the historic city center. Nationwide, construction approvals by land area rose almost fivefold between 2002 and 2010.

“These mega projects, there are bottlenecks, and an opportunity for corruption in areas such as building permits,” said Sonmez. “And of course, if you are a friend of Erdogan, or a relative, there are some advantages. That’s where these investigations start from.”

Closed Envelopes

A planned second round of arrests was to include Erdogan-allied business people involved in the airport project and the bridge that’s under construction at Garipce, party spokesman Celik said in his Dec. 28 tweet. It didn’t occur after Erdogan fired and replaced hundreds of police chiefs.

Bidding for the airport, which will be one of the world’s largest, was switched from an open-bid model, where competitors and the public can see the entire tender, to a closed envelope model in the week before the May 2013 announcement, said Aykut Erdogdu. He is an opposition member of parliament who has worked as the chief comptroller for the Treasury, and overseen audits of state enterprises.

The government had already revised the Public Tender Act 17 times, according to Global Source Partners, the advisory firm. In addition, more than 100 minor adjustments were added allowing ministries and municipalities more discretion in choosing winners and reducing transparency, Erdogdu said.

In April 2011, as Erdogan announced the Istanbul Canal, he joked in a televised press conference that Agaoglu of the Agaoglu Group might want a piece of the project.

Board Member

Agaoglu already had his hands full. He was building the $2.6 billion Istanbul International Financial Center, fulfilling contracts for TOKI and sitting on the boards of at least 24 companies. Agaoglu, whose net worth is $2 billion according to data compiled by Bloomberg, hails from Of, a town on the Black Sea that is also home to former Urban and Environment Minister Erdogan Bayraktar. He had overseen government construction projects as head of TOKI.

The media relations department at the Agaoglu Group didn’t return a phone call.

A transcript of a telephone call printed by Radikal newspaper on Dec. 23 says Agaoglu referred to Prime Minister Erdogan as “the big boss” when discussing a land deal.

On Dec. 17, he was among the first to be detained in the pre-dawn raids that kicked off the scandal. He was released on Dec. 21 and placed under a foreign-travel ban.

“Erdogan has always wanted to build new companies, a new elite, and to funnel public resources to these companies, and these building projects provide an opportunity to do that,” said parliament member Erdogdu. “This is just the tip of a very large iceberg. We maybe know 1 percent of what has happened.”

To contact the reporters on this story: Mehul Srivastava in New Delhi at msrivastava6@bloomberg.net; Benjamin Harvey in Istanbul at bharvey11@bloomberg.net

Corruption scandal complicates Turkish rate policy as lira slides

9:15am EST

By Andrew Torchia

ISTANBUL (Reuters) – A corruption scandal shaking Turkey’s government may delay for many more months a tightening of monetary policy that would stabilize inflation and stop the lira from plumbing record lows.

Across Turkish financial markets, there is a near-consensus that short-term interest rates need to be a lot higher – as much as 3 or 4 percentage points higher, some traders say – to be sure of relieving pressure on the sliding currency.

In recent weeks, this belief has strengthened as the global market environment has turned further against Turkey. The U.S. Federal Reserve’s decision last month to start cutting its monetary stimulus has hit a number of leading emerging economies, and means more pressure on the Turkish lira, which sank 17 percent against the dollar in 2013.

But the economic and political pressures created by the corruption scandal, which erupted in mid-December and forced the resignations of three ministers, make it harder for Turkey’s central bank to respond aggressively.

The damage which the graft investigations may inflict on business activity, particularly the construction sector, mean any interest rate increase could slow the economy yet further when it is already showing signs of losing steam.

The scandal has weakened the AK Party of Prime Minister Tayyip Erdogan just before local elections due in March and presidential polls in August. A rate rise, which would lift costs for Turkish home buyers and building firms, would be politically controversial.

“The central bank is more keen on supporting the economy rather than concentrating on inflation,” said Mehmet Besimoglu, chief economist at Oyak Yatırım, a top Turkish securities firm.

“It seems to be comfortable with 7 to 8 percent inflation – only inflation risks heading to double digits would make it tighten policy aggressively.”

Using unorthodox monetary policy, the central bank has guided short-term market rates higher in recent months. The average cost of funding for banks is at 7.17 percent, up from 4.52 percent in late May, but still below annual inflation which was 7.40 percent in December.

OUTFLOWS

Foreign portfolio investors shoveled cash into Turkey and other emerging markets while they were booming and global interest rates were soft. However, the Fed’s gradual withdrawal of help for the U.S. economy has raised the prospect of higher yields, encouraging investors to pull back from emerging markets including Turkey’s.

Central bank data suggests fund outflows undermining the lira may continue for some time. Non-resident holdings of domestic government debt securities sank to $52.7 billion on December 27 from a $72 billion peak in May; equity holdings fell to $55 billion from $82 billion.

These drops only take the markets back to levels seen in August 2012, when the boom was already well underway. A return to the historically more normal levels seen at the start of 2012 would bring foreigners’ holdings of debt and equities each below $40 billion.

To counter the effect on the lira, the central bank has supplied foreign currency to the market; it had spent about $15 billion by late December and central bank governor Erdem Basci said it would spend a further $6 billion by the end of January.

Market intervention in these volumes is proving enough to slow the lira’s drop but not to halt it – and with net foreign exchange reserves of under $40 billion, the central bank cannot safely spend much more.

“The big picture is Turkey doesn’t have enough reserves to spend on defending the currency,” said Manik Narain, emerging markets currency strategist at UBS in London.

That leaves interest rates as the one way to stabilize the lira. But with Turkish rates still below inflation, they will remain a recipe for currency weakness unless they rise much more sharply – something other emerging economies have already learnt.

“The lesson from places such as Brazil and Indonesia is that you have to tighten very aggressively to have an impact when the market is going against you,” Narain said.

POLITICS

This is why the timing of Turkey’s corruption scandal, which involves inquiries into government procurement and prompted the ministers’ resignations when their sons were among dozens of people detained, is economically unfortunate.

With the rise in companies’ financing costs, analysts think economic growth could drop to as low as 2 percent this year, pushing up unemployment. The scandal may disrupt the government’s ability to approve big building projects and extend contracts, which have been a motor of the economy.

Murat Yetkin, a columnist at leading newspaper Hurriyet, said the government had responded to the scandal by starting a “cleansing operation” against its political opponents in the bureaucracy, while prosecutors of certain affiliations were opening inquiries against civil servants with other affiliations.

“Expecting a civil servant to sign a document, any document, will be more risky and difficult than before,” he wrote.

Besimoglu said the central bank would have to factor the construction sector into monetary policy. While an interest rate rise would help construction firms with foreign debt if it stabilized the lira, it could also curb their access – and that of their customers – to domestic funding. “Lending rates in that sector are critical,” Besimoglu said.

Erdogan has to some extent politicized monetary policy. Last year he railed against a “high-interest-rate lobby” of speculators who he said were trying to engineer higher rates, and called for real borrowing costs of zero percent.

The central bank is technically independent of the government, but Basci was appointed with the approval of the AK Party. Few Turks believe he can ignore the political implications when deciding whether to tighten policy before this year’s elections, which because of the scandal could be the toughest test for the AK Party in its 11 years of rule.

DELAYS

The upshot is that the central bank, which is due to hold its next monetary policy meeting on January 21, may delay any significant tightening of policy until after the March elections – and conceivably the August polls as well.

Emre Deliveli, a local economist and columnist who has worked at the central bank as well as international institutions such as the World Bank, said the central bank would probably wait until after the elections, unless a sudden, sharp drop of the lira forced it to take emergency action.

If the central bank moves, it is likely to tighten a little, perhaps by 1 to 1.5 percentage points at most, rather than the 2 to 3 percentage points which would be more certain to quell market jitters, he said.

Basci has shown no sign of blinking. He insisted on December 24 that the central bank would continue its policy of intervening in the foreign exchange market and adjusting lira money market liquidity with routine operations – though he did not totally rule out policy change. “The current policy stance is sufficient. We could take moderate steps if needed,” he said.

Many investors would like the central bank not only to raise interest rates, but to abandon the unorthodox monetary framework adopted by Basci and return to more traditional policy-making.

It uses frequent market operations to manage banks’ cost of funding in a band, the ceiling of which is its overnight lending rate, now at 7.75 percent; as the lira has weakened, the central bank has brought market rates up near the ceiling.

This approach helped authorities to cope with massive fund inflows into Turkey during the boom years, and was once seen as a possible model for other emerging markets. Now, many investors yearn for orthodox policy based on a single benchmark rate, which they feel would send a clearer signal that the central bank aimed to support the lira.

Besimoglu said the central bank might start removing parts of its monetary policy framework this year, as it became evident they were redundant in an era of tighter global markets. But there is no sign of a complete return to orthodoxy.