Not too long ago Turkey was one of the world’s best-performing emerging markets. Under the leadership of Recep Tayyip Erdogan, first as prime minister and more recently as president, the country made impressive economic progress. Coming to power in 2002, he tamed inflation and ushered in a period of sustained growth. Turkey became a major exporter and tourists flocked to its accessible Mediterranean resorts.

But the gains tailed off after the first decade of Erdogan’s rule, with the economy experiencing a marked downturn over the last year. The stability that underpinned Turkey’s prosperity has been rocked by security, political and diplomatic crises. These appear to have been exploited by Erdogan to tighten his grip on the country and weaken his political opponents. All of which has alarmed investors and trading partners alike.

The origins of the downturn can be traced back to 2015 when Erdogan was suspected of sparking renewed conflict with Kurdish separatists, the PKK, in order to undermine support for a popular pro-Kurdish party, the HDP, which threatened to deny his AKP party a majority in parliament. At the same time, Turkey’s increased involvement in the US-led coalition fighting Islamic State in Syria prompted the Islamic militants to launch waves of bombings in Turkey. Then Ankara and Moscow engaged in a damaging eight-month trade war after Turkish forces shot down a Russian bomber that had strayed into Turkish airspace.

The turmoil culminated in the failed attempt to overthrow Erdogan in July last year. In the aftermath, the president declared a state of emergency, targeting those suspected of links to Fethullah Gulen, the US-based cleric alleged to have masterminded the attempted putsch. At least 30,000 people have been detained and over 100,000 military personnel and civil servants sacked or suspended.

Erdogan’s increasingly autocratic rule was lent legitimacy in January. Parliament backed changes to the constitution granting him sweeping powers that will be put to a referendum on April 16. If approved, the reforms would enable him to issue decrees, veto bills passed by parliament and appoint senior officials.

The instability and Erdogan’s creeping authoritarianism appears to have contributed significantly to the current economic slump. The lira lost 17% of its value in 2016, and has continued to fall this year. Growth shrank nearly 2% in the third quarter of last year – the first time the economy has contracted since 2009. Inflation is forecast to rise to 8% by the end of the year, with the central bank governor, Murat Cetinkaya, warning that there is a risk it may even reach double figures. Turkey’s tourism revenue – key to financing the country’s current account deficit – fell by 30% in 2016.

Taking fright

Foreign investors have in the past been drawn to Turkey because of its substantial domestic market, low taxes, skilled and competitive labour force, and location at the junction of Europe and Asia. But many appear to have taken fright at Turkey’s instability and the course Erdogan has set. Foreign investment amounted to $8.62bn in the first 10 months of 2016, down nearly 45% on the same period the year before. Leading credit rating agencies have all issued downgrades.

Investors have been shaken by the detention of hundreds of businessmen and the seizure of more than 600 companies – with assets in excess of $10bn – suspected of Gulenist sympathies. As well as concern that prospective partners may face the same fate, investors are also likely to be worried about rising corporate sector debts, as the fall in the lira may leave Turkish companies facing difficulties repaying dollar-denominated loans.

Foreign investment could also be hit by uncertainty about Turkey’s EU integration process. Foreign companies take advantage of the country’s customs union with the bloc to export to Europe. But in November the European parliament voted overwhelmingly to halt talks with Ankara on membership over the ongoing political repression. While only EU governments have the authority to suspend the accession process, and for now are unlikely to do so, Brussels officials have warned that ties with the EU will be put at risk if the purges continue. However, there are plenty of indications that Erdogan will not be ridden off his authoritarian response to the coup attempt by threats to the accession process.

The Turkish press has reported that Gulf money could soon flow into the country to make up for any shortfall in investment should the shift to an executive presidency damage economic relations between Turkey and the West. But some analysts are sceptical of the reports largely because the Gulf countries have been relatively minor investors in Turkey in the past and the fall in the oil price has depleted their foreign exchange earnings.

Employing a tactic he used in the first decade of his rule to fuel an economic boom, Erdogan looks set to spend big to try to stimulate growth. He is building up the country’s sovereign wealth fund, set up in August, with billions of dollars’ worth of government stakes in some of the country’s top companies in order to finance large infrastructure projects. But some point out that the country would be better off paying down its sizeable foreign debt.

With the referendum approaching, Erdogan and his supporters are urging voters to get behind the proposed constitutional changes in order to stabilise the country. An executive presidency, they argue, would free the country from fractious coalition governments and, in so doing, allow Erdogan to arrest the economic slide. But others are concerned that granting him unfettered powers at a time when checks and balances have already been eroded would deepen divisions in the country and further unnerve foreign investors.

Yigal Chazan is an Associate at Alaco. Alaco Dispatches is the business intelligence consultancy’s take on events and developments shaping the CEE/CIS region.