In July, Turkey was hit by a series of attacks; the worst was the killing of 32 persons by alleged IS-linked militants in the Kurdish-majority city of Suruc. Following the attacks, police arrested suspected members of IS, the Kurdistan Workers’ party (PKK) and leftist groups, and the country launched a military airstrike in Syria against IS and PKK, both considered by Turkey as terrorist organisations. The country – which was reluctant to join the international coalition against IS before – opened its military airbases to the US. In addition, President Erdogan put an end to the peace process with the PKK that began in March 2013 alleging that the PKK threatens Turkey’s national unity.

Impact on country risk

Recent events took place in a context of ongoing negotiations between the Justice and Development Party (AKP) and other parties in order to form a ruling coalition after the inconclusive June parliamentary election. Indeed, for the first time since it came to power in 2002, the AKP has lost its majority. If no government has been formed in the 45 days after the election (which means by the end of August), early parliamentary elections must be held. Hence, there are doubts on whether President Erdogan’s ongoing dangerous nationalistic strategy aims to regain majority during potential early elections (likely to be held in November) rather than to fight IS. Indeed, Turkish stance toward IS is rather ambiguous as IS and the Kurdish militants are seen by some Turkish authorities as the same threat. Whatever the strategy, political uncertainty in Turkey is undoubtedly on the rise and the decision to break the ongoing peace process with the PKK is a step backwards as the ceasefire put an end to thirty years of armed struggle. The armed conflict started back in 1984 and has its roots in the demand for autonomy by the country’s Kurdish minority. Tens of thousands on both sides were killed over the past decades. The rising political uncertainty is likely to weigh on the economy. Since the beginning of this year, the Turkish lira, one of the worst performing currencies, has already lost almost 20% compared to the USD and is likely to remain under pressure. Indeed, Turkey is largely reliant on short-term capital flows to finance its large current account deficit. This leaves the country highly vulnerable to changing investor confidence. A rise in investors’ risk aversion could be provoked by external factors (e.g. the forthcoming increase in US interest rate or a spillover from the Syrian conflict) or by domestic factors (ongoing discussions about the formation of a coalition government or intensification of the insecurity risk). Last but not least, banks are increasingly exposed to the foreign currency risk as lending in foreign currencies to non-financial corporates has increased rapidly during the last five years. In principle, the banking sector’s credit risk arising from foreign currency lending is mitigated by a regulation that stipulates that foreign currency loans can only be granted to companies disposing of export earnings, financial hedges or foreign exchange collateral. However, figures are worrying as the Turkish lira is under continued pressure. rm-august2015 Analyst: Pascaline della Faille, p.dellafaille@credendogroup.com