Make No Mistake About It: The Storm Has Hit in Turkey

Last week we took you through an emerging crisis in Turkey that will set the investment terrain for 2014. This week, we feel the subject warrants another installment as Prime Minister Erdogan, the Justice and Development Party (AKP) and the business elite attached to them become targets of a very focused corruption scandal that Erdogan may not survive-and that should shake investor confidence to its core.

A series of raids and 60 arrests have Erdogan thinking that he is the real target of the corruption probe-and he is not mistaken. This is what happens when you take on the Gulenists as we noted last week.

The corruption probe is targeting Erdogan's allies first-those AKP fellows in key ministries, and key dynasties with whom Erdogan and the AKP are close to.

A day after the raids and arrests Erdogan reshuffled his Cabinet, replacing 10 ministers.

Erdogan's reshuffle has only fueled the fires-similar to those that burned all last summer in the form of the Gezi Park protests-with the opposition accusing him of trying to create a secret "deep state" of authoritarian rule. Indeed, Erdogan is hoping that the new Cabinet will be solidly loyal during the ensuing probe.

The Scandal

The scandal is the culmination of a two-year investigation into bribery, corruption and gold-smuggling-and the timing is highly significant.

The Iran angle is getting the most international attention because it has more mass appeal at a time when the Obama administration is trying to bring Tehran back into the fold. Though almost anyone doing business in Iran and following basic due diligence procedures knows to look out for potential entanglement in Turkish banks, or the groups connected to them, who are helping Iran get around sanctions, this has suddenly become an issue inside Turkey due to Erdogan's attack on the Gulenists.

An Iranian businessman, Reza Sarraf, was among those arrested, accused of bribing the Minister of Economy for the coordination of $120 billion in transactions from Iran.

But the real action has less to do with Iran. Three ministers resigned on Christmas Day after their three sons were arrested in the probe.  The three sons of ministers were questioned regarding alleged illicit money transfers to Iran and bribery related to construction projects, a sector the AKP has its hands in quite deeply. Two of them were later arrested on bribery charges.

The resigned ministers include Economy Minister Zafer Caglayan, Interior Minister Muammer Gular and Urbanization and Environment Minister Erdogan Bayraktar. Bayraktar's resignation was the most dramatic. A long-time ally of Erdogan, Bayraktar made it clear he wasn't going to go down alone and resented what he claimed was the prime minister's attempt to get him to make a statement acquitting Erdogan of any involvement when he stepped down. Instead, he called on Erdogan to resign as well. Thus we see the ranks of the AKP fracturing before our eyes.

Among the some 60 people arrested was the head of Turkey's biggest private real estate partnership, Emrullah Turanli, a friend of Erdogan's who has amassed great wealth thanks to the AKP. Also arrested were the chief executive of state-owned Halkbank, Suleyman Aslan, and Turkish billionaire construction magnate Ali Agaoglu.

What Next?

The corruption probe is the single largest and most vehement the AKP has ever witnessed. Police officials are being reshuffled and special prosecutors have been assigned to the cases to ensure that no one gets out of this one unscathed. The Turkish media has cited sources saying that Erdogan was being wiretapped during the investigation and the run-up to the raids and arrests. This in itself-if true--should give us a better idea of where this is going and what Erdogan's chances of survival are.

For investors who have opted into deals with one of Turkey's family dynasties, the lines are clearly drawn in the sand, in some cases, but there are complex blurs in others. Koc Holding, the country's largest business family, is sitting this one out on the sidelines, after a nasty showdown with Erdogan, whom the family head publicly criticized last summer and sparked the prime minister's ire. After responding with a tax raid and other threats, Erdogan is now himself under fire, and Koc Holding is not likely to be involved in any of this. It will be sitting on the sidelines, though, anxiously monitoring what is to come next. For Calik Holding, which is also involved in some key energy deals, things are bit more complicated.

(For reasons of discretion and security we refrain from going to deeply into the positions of the dynasties in this newsletter. Our intelligence-gathering and strategic analysis wing, OP Tactical, has its own networks on the ground in Turkey and is closely monitoring the situation to provide private clients with intelligence and insight into the direct and indirect targets of the corruption probe and the probably fall-out).

Though we are still in the early days of this crisis, it will climax soon, and what is definitively clear is that the marriage of convenience between the Gulenists and the AKP has ended, and right now, Erdogan is dealing with some very formidable divorce lawyers.

The markets are necessarily nervous, and investors should be doing some very serious due diligence and damage control at this point. Stocks are scared and the Turkish lira has fallen to a record low of 2.1025 to the dollar.

Contact us for assistance with your strategic intelligence and analysis requirements in Turkey.