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Turkey's standoff between government, protesters could cause trouble for economy

The escalation in the clashes between Turkey's government and protesters could hurt one of the world's recent economic success stories, spelling uncertainty for a country that has become a source of growth and stability in a region hit by recession and unrest.

At first, the 12-day protests, which were sparked by plans to bulldoze and redevelop a park in central Istanbul but have widened to incorporate concerns over the government of Prime Minister Recep Tayyip Erdogan, were largely peaceful and limited in size and scope. They weren't very different from the Occupy Wall Street protests in New York.

However, clashes between riot police and the demonstrators on Tuesday have heightened tensions and raised fears that a key regional power could be destabilized. Water cannon and teargas were used against the hundreds of protestors in Taksim Square, Instanbul, many of whom have fled into a nearby park.

Here's a look at the Turkish economy and the risks it faces.

HOW BIG IS TURKEY'S ECONOMY?

Turkey's economy has grown quickly in recent years. Annual gross domestic product in the country of about 75 million people is around $800 billion, putting it on a par with wealthy countries like Switzerland or the Netherlands.

Its neighbors, by contrast, are almost all in the midst of economic turmoil. Greece and Cyprus have been embroiled in Europe's debt crisis and fallen into deep recessions, while many of its neighbors to the east — Iraq, Syria and Georgia — have seen their economies shattered by war and popular uprisings.

Though impacted by the developments around its borders, Turkey has managed to blaze a trail. Following an economic crisis at the turn of the millennium, the country has seen its economy grow at a little over 5 percent a year. In 2010 and 2011, when much of the global economy was trying to recover from recession, Turkey was growing by over 8 percent, more or less the same rate as China, the world's second-largest economy.

Turkey's economic performance has enhanced its political profile in the world. As a member of the Group of 20 leading industrial and emerging countries, it has a voice in discussions on the world's biggest issues.

Though annual growth slowed to 2.6 percent in 2012, the International Monetary Fund has projected that growth should accelerate to around 3.5 percent this year and 3.75 percent next. It credited the improvement to recovering demand for its exports and to an increase in capital flows that it can use for investment.

Figures Tuesday showed that the Turkish economy was in relatively rude health in the period preceding the protests — the economy grew by 3 percent year-on-year in the first quarter from 1.4 percent in the previous three-month period. The increase was also higher than expected — the consensus in the markets was for a more modest 2.3 percent rise.

What has impressed many analysts over the past 10 years is the broad nature of Turkey's economic development. The industrial and services sectors have expanded alongside tourism. Inflation, which had been high for decades, hitting 90 percent as recently as 1999, has come under control. The IMF predicts a fall in inflation to 6.6 percent this year from 8.9 percent in 2012.

HOW HAVE INVESTORS REACTED TO THE UNREST?

Not well. Markets fell sharply during the first days of protest and government clampdown and have remained volatile since, suggesting the international investment community is on edge.

Despite gains Tuesday in the wake of the growth figures, the main stock index is still down around 10 percent this month, while the national currency, the lira, has dropped about 6 percent against the dollar, to about 53 cents per lira.

The interest rates on government bonds have risen sharply, indicating foreign investors are more worried about lending money to the Turkish government. The benchmark 10-year yield has risen from 6.2 percent to 7.3 percent. Because economic growth and inflation are relatively high — helping to erode public debt — the government is expected to be able to keep borrowing at these rates. That means it's unlikely to need to call on the IMF for a bailout, like neighboring Greece.

But it is nevertheless a bad sign for a country whose economic growth has depended heavily on investment from beyond its borders.

WHAT ARE THE RISKS TO THE ECONOMY?

The biggest threat is that political turmoil scares foreign investors into pulling their money out of the country. One of the reasons Turkey has become such an attractive place for investors is the relative political stability the country has enjoyed over the past decade or so. Erdogan's government has been in power since 2003.

Turkey has launched a series of massive infrastructure projects, such as a huge new airport outside Istanbul, a third bridge across the Bosporus straight that divides Istanbul, and oil pipelines that cross the country. To pay for these works, the government and major corporations have been issuing bonds that investors in the U.S. and Europe have been eager to buy because they potentially yield better returns than many of their financial assets back home.

Political turmoil increases the risk that such investments might not be repaid. Some investors could opt to pull their money out and place it in a more stable country.

"The risk now is that a renewed period of political uncertainty dents confidence and causes investment flows to reverse," said Neil Shearing, chief emerging markets economist at Capital Economics.

Although some have made comparisons between the Turkish protests and the Arab Spring uprisings that have toppled governments in several Mideast countries, the similarities are in fact few. The government was voted in democratically and still enjoys strong support. So there is no immediate risk of the same kind of violent uprising.

"The demonstrations have not been on the scale that would bring about the kind of economic dislocation that has occurred in parts of the Arab world in recent years," said Paul Rawkins, a senior director at Fitch Ratings.

A marked increase in the unrest could also deter tourism. About 37.7 million visited Turkey in 2012, making it a top ten destination globally. Tourists are not cancelling any trips so far, mainly because the protesters are not targeting visitors and the main sites — palaces, markets and beaches — are still accessible. But any sign that the protests are becoming a more violent and widespread confrontation would likely have an impact.

WHAT TO WATCH OUT FOR?

Besides a nasty turn in the protests, a particularly big risk factor for the Turkish economy, like other emerging economies, could come from beyond its shores — the U.S. Federal Reserve. Experts say that the Fed's policy of stimulating the economy with a bond-buying program has lowered returns for assets like U.S. Treasuries and encouraged investors to look for higher returns in other markets, like Turkey.

Moody's vice president Sarah Carlson said the protests come "at an inopportune time" for Turkey if the Fed does reduce the amount of new money it is creating as part of its monetary policy.

The Turkish government would hope to have sorted its political standoff by then.