Economic Uncertainty Likely to Continue After Turkey’s Elections

Ömer Taşpınar

Whoever emerges as the victor in Turkish elections on June 24, investors will remain nervous about the direction of the economy. With interest rates increasing in the West, global investors are losing interest in emerging markets. Countries like Turkey and Argentina that suffers from high inflation and growing current account deficits are under even more pressure with their embattled currencies. Turkey is heavily exposed to short-term private debt. It is also plagued by dysfunctional political leadership. Of all the emerging markets it seems to be most fragile and Recep Tayyip Erdogan’s expected re-election is likely to make things worse unless he rapidly changes direction.

The reason is simple. Erdogan has a strong grip over monetary policy and the central bank. He also has very unorthodox views about keeping interest rates low despite rising inflation. It doesn’t help that he is surrounded by sycophants who can’t speak truth to power. Last month, he shocked global investors during his visit to London when he spoke about a global conspiracy against Turkey and his willingness to exert control over the central bank after elections to keep interest rates low. Markets reacted immediately as the Turkish lira plummeted more than 10 percent on just one day.

As consumer confidence dropped and international investor began to flee Turkey, the prospects of losing the elections must have hit Erdogan. After all, his winning formula has always relied on economic performance. In the last few weeks competent hands have been engaged in damage control. First, the central bank raised interest sharply by 3 points to 16.5 percent. Then, a Turkish delegation composed of the finance minister and central bank governor travelled to London to calm investors. They promised wary investors that more interest hikes would come if inflation continued to increase.

The litmus test for credibility came on June 3 when the Turkish Statistical Institute released inflation figures that showed a 1.6 percent increase from the previous month – signaling inflation could average 15 percent for 2018. In a clear indication that Erdogan understood he could not win against the markets, the central bank hiked interest rates by an additional 1.25 points on June 7 with his grudging acquiescence. For now, the bleeding of the lira seems to have slowed down. Yet, there is still a sense that such monetary tightening came “too little, too late” to have a major impact.

This brings us to elections scenarios closely debated by Turkey watchers and investors. It is no secret that markets like predictability and stability. But lately, the kind of predictability and stability offered by Erdogan has not been positive. The economy did overheat because of Erdogan’s insistence on high growth amid low interest rates. This would have been avoidable if the central bank had been allowed to act independently and raise rates in 2017.

What is equally troubling in the eyes of investors is the loss of fiscal discipline. Despite growing unemployment and debt, Erdogan is still speaking about grand infrastructure projects to keep the construction sector and employment afloat. He has also engaged in major pre-election populism, with tax amnesties and raising wages for government retirees.

What the markets want is a strong government that will quickly engage in much needed structural reforms while cutting public spending and raising interest rates. Such fiscal and monetary tightening is never popular; it will cool off the economy and cause unemployment. But markets may welcome an Erdogan victory if they believe he will move in this direction with his new mandate and political capital. But here is the problem: he can ill afford major belt tightening because local elections are scheduled for March 2019. A downturn in the economy may cost Erdogan all the big cities.

Another electoral scenario is Erdogan winning the presidency but his Justice and Development Party, or AKP, losing the its majority in parliament. On June 24, voters will be electing simultaneously a new president and parliament. A divided government is therefore a real possibility. Most polls point in this direction: a cohabitation between Erdogan and a legislative body that will provide checks and balances against the office of the president. The potential for political deadlock may spook markets and investors who expect decisive action.

Under this scenario, Erdogan may wait until March 2019, when local elections are scheduled, to simultaneously call again for new parliamentary and presidential elections. According to recent constitutional amendments, parliamentary and presidential elections need to take place simultaneously.

A third scenario is an opposition victory: Erdogan losing both the presidency and his parliamentary majority. The main opposition candidate for the presidency, Muharrem Ince, is from the center-left Republican Peoples Party (CHP). Even if Ince wins the presidency, his party will have to rely on a coalition with two smaller parties with Turkish nationalist and Kurdish nationalist tendencies, in parliament. Markets have no clear idea about what to expect from an opposition victory, given the eclectic nature of such a coalition. An alliance of strange bedfellows in parliament and an untested name in the presidency may not augur well for decisive action and much-needed structural reforms. Ince is a gifted orator, but he is short on economic specifics.

Out of these three scenario, markets are probably hoping for the first, with Erdogan gaining a new mandate and acting quickly with a reformist agenda coupled with belt tightening. However, most polls point in the direction of the second scenario: a cohabitation between Erdogan as president and a parliament dominated by an eclectic opposition led by the CHP and a group of Turkish and Kurdish nationalists. The third scenario, of an opposition victory against Erdogan, will show that Turkish democracy still has a pulse, but creates more questions than answers for the economy.

Whatever happens, one thing is for sure: uncertainty about Turkey’s economic direction will continue.

Ömer Taşpınar is a senior fellow at the Brookings Institution and a professor of national-security strategy at the National Defense University in Washington.