Turkey's row with U.S. over Iraq may hit lira hard

By Selcuk Gokoluk - Analysis

ANKARA (Reuters) - A row between Turkey and its most powerful ally the United States over Ankara's plans to send troops into northern Iraq to fight Kurdish rebels could dent much-needed foreign investment and hit the lira hard.

The high-yielding lira has fallen 3.3 percent this week against the dollar from six-year highs due to the Iraq issue, but economists say it could drop much more if Turkey defies Washington and sends its forces across the border.

Turkey lured a record $20.1 billion FDI last year, and hopes to attract a similar amount this year.

Investors know an incursion into northern Iraq would further test relations with Washington, already strained after a U.S. Congress committee branded the 1915 killing of Armenians by Ottoman Turks as genocide, a view Ankara firmly rejects.

"If Turkey launches a large-scale operation, defying American opposition, then all markets will be hit by this... The markets believe the tensions are a good excuse to sell at the moment but the price of a serious clash will be higher," Fortis bank chief economist Haluk Burumcekci.

Emotions are running high in Turkey after a sharp rise in the number of Turkish soldiers killed in Kurdish rebel attacks. Parliament is due on Wednesday to approve a cabinet request to allow troops to enter Iraq if this is deemed necessary.

Washington's backing has been crucial for Turkey receiving International Monetary Fund loans to recover from a deep economic crisis in 2001 and for building energy pipelines that cut cross Turkey from the Caspian region to Europe.

Turkey in turn has served U.S. interests as a strategic partner in the turbulent Middle East region and as a model of stable democracy for the wider Muslim world. Washington relies heavily on Turkey for logistical support for its operations in Iraq and Afghanistan.

"If relations with the United States deteriorate permanently, then this could lower foreign direct investment. If this is coupled with a souring in global liquidity conditions, then Turkey will be hit harder," said Garanti Bank's head of research Ali Ihsan Gelberi.

A large balance of payments deficit leaves Turkey dependent on foreign investments.

It is not possible to predict the level of the lira in the event of a serious spat with Washington, economists said.

"The figures will depend on how many billions of lira foreigners will sell and more important than that, on how many dollars Turkish residents will buy," said Gelberi.

Traditionally, many Turkish savers keep deposits in foreign exchange to shield from sharp shifts in the lira.

A foreign exchange dealer said the lira may weaken to the 1.4-1.5 level at least if Turkey defies America over Iraq.

MANY STILL BULLISH