Recep Tayyip Erdogan finally got what he wished for. On June 24, the Turkish leader got to keep his position in an election that completed the country’s transition to a presidential form of government, the ground for which was laid by a constitutional referendum last year. The election gives the president sweeping powers and greater control over national policy, and the success of the June 24 exercise lessened the political uncertainty in a country that has been in a state of emergency for nearly two years.
But the coast is not all clear for Erdogan to pursue his agenda. Despite the victory of his coalition, the People’s Alliance, in the concurrent parliamentary vote, his party, the AKP, lost its majority in the legislature, so he will have to navigate deal-making with coalition partners. The election had been characterized by rising support for the opposition, and the population remains polarized, so reconciling conflicting views will remain a challenge for his government.
And despite the greater powers that the president now has – he can appoint cabinet members, craft the budget, and issue executive orders – parliament retains legislative authority and will serve as a check-and-balance when it comes to ruling by executive order. The AKP’s weaker showing means the other dominant party, the nationalist MHP, will hold sway in the lay of the land, with possible influences in fiscal and foreign policies.
To be sure, the election is positive in the short term in that it has definitively created a government that can now begin to tackle Turkey’s various challenges. In the medium to longer term, however, the new government is unlikely to receive the benefit of the doubt from financial markets, as seen from the lackluster performance of Turkish assets after the election.
Also, investors have a number of concerns about the economy. After a blistering, stimulus-fueled 7.4 percent GDP growth last year, we estimate this year’s expansion will slow to around 4 percent. Inflation is running at a double-digit rate, above 12 percent in May. And the Turkish lira has plunged since the start of the year, pressuring the central bank to aggressively raise interest rates to 17.75 percent. While the move has eased capital outflows, the market has begun to doubt the independence of the central bank and its willingness to lower inflation.
Meanwhile, Turkey’s large and persistent current account deficit, at 5.5 percent of GDP last year, keeps the economy dependent on foreign capital inflows, and the corporate sector’s foreign-denominated debt is a key vulnerability. This leaves Turkey in a precarious position in an environment where global investors are becoming risk averse amid tighter US monetary policy, broad-based US dollar strength, and rising trade war concerns.
With its economic fundamentals deteriorating rapidly, Turkey needs decisive action, specifically a more restrictive fiscal policy, in our view. However, the AKP will be keenly aware of its electoral loss, and Erdogan needs to build public support to further consolidate his power. With municipal elections scheduled for next March, we expect the government to continue catering to its voter base, reducing the outlook for significant fiscal reforms.
Several possible measures could make us more positive on Turkey’s outlook – a commitment to central bank independence, a credible fiscal consolidation plan, and the appointment of a pro-market cabinet. A positive turn in the global environment – such as Europe’s recovery from its soft patch and an easing of trade tensions – will also be positive for the performance of Turkish assets.
For now, in our emerging market strategy, we advise investors with large positions in Turkish assets to use any period of near-term strength to gradually reduce exposure. The direction of economic policy choices will be crucial to how we assess the risk-reward of Turkish assets in the months ahead.
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