Political risk in Turkey is rising up the agenda of investors as elections approach and the president grows more autocratic.
“The dogs bark, but the caravan rolls on,” according to a blunt Turkish proverb, which economic policy-makers will be hoping applies to the outcome of elections on June 7.
The meaning of the saying is clear – suggesting that no matter how much noise is made by critics of the country’s economic policies under the ruling AKP Party, they are unlikely to change their direction.
But rising political risk heightened by signs of growing autocracy under the architect of Turkey’s transition, President Recep Tayyip Erdogan, suggest the country’s once successful economic caravan may now have reached a crossroads.
“Turkey’s risk premium now is a more pertinent issue for global investors, especially in a political climate that is increasingly volatile and uncertain; populism is also now a greater driving force of economic policy in Turkey rather than policy stability and market-friendly reforms,” said Fadi Hakura, manager of the Turkey project at the Chatham House foreign affairs think-tank in London.
Politics has risen steadily up the agenda as the economic stability that has been the hallmark of 12 years of AKP rule has faltered: while Turkey enjoyed growth in the region of 9% when it last went to the polls in 2011, by 2014 this had fallen to about 3%.
Multilateral agencies have been warning since late last year that without a change in policies and structural reform, Turkish growth is expected to slow to about 3.5% in the medium term – potentially ensnaring it in the notorious “middle-income trap” of emerging economies.
Short-lived relief
Cheaper fuel prices may have relieved the pressure on the current account deficit – set to fall to about 5% of GDP by the end of this year – and on inflation, which is likely to dip in H1 to around 6% before picking up, but the positive benefits of lower oil prices have waned as political risk has increased.
Economist Murat Ucer, Turkey adviser for Global Source, said: “The window of opportunity offered by cheaper oil is definitely gone. It was a fragile bet in the first place. The way the dollar has been going, the euro environment, Greece, the political uncertainties that people are starting to think about post-June 7 – all these mean that all of a sudden the oil factor is more than compensated for by several other negative shocks.”
Against this backdrop, the behaviour of Erdogan has become a focus of scrutiny as signs of growing authoritarianism have been accompanied by a tightening of the screw against critics and opponents.
One observer IFR spoke to said Erdogan’s autocratic turn was not easy to explain, adding: “There has been this incredible hubristic transformation plus a sort of paranoia.”
“Turkey’s risk premium now is a more pertinent issue for global investors, especially in a political climate that is increasingly volatile and uncertain; populism is also now a greater driving force of economic policy in Turkey rather than policy stability and market-friendly reforms”
Nervousness among investors about stability under Erdogan has grown since the AKP government’s heavy-handed response to protests in Turkish cities in 2013.
Hakura of Chatham House said: “There are clear signs that Erdogan is trying to concentrate more and more power in his hands – he has recently granted sweeping powers to the police to conduct searches more easily, detain protesters and quell demonstrations; international media watchdogs have indicated that Turkey’s global standing on freedom of the media has declined precipitously; and Turkey’s competitiveness and measures on accountability and combating corruption, etc, have either stagnated or regressed.”
Creeping autocracy in Turkey may reflect a trend found in other emerging markets such as Russia and Hungary.
“Across emerging markets often you seem to get this drift towards authoritarianism after about 10 years in power, you could say the same perhaps about [Vladimir] Putin in Russia; once one party and particularly one leader has been in power for a long time, it is possible that it goes to their head and I think policy-making becomes much more short-termist and it’s much harder to break with previous policies,” said William Jackson, senior emerging markets economist at Capital Economics.
Nonetheless, a key question is the underlying motive for Erdogan’s polarising ambition to reform Turkey’s political system by establishing a strong executive presidency.
Ucer of Global Source said: “Frankly, I think Erdogan wants to have control over all levers of policy-making, period. Now, how compatible this is with sustainable growth is a big question. I do believe that strong institutions with proper checks and balances and sustainable growth kind of go together not the other way around.”
Jumpy investors
A clear sign that Erdogan is making investors jumpy came in February when he launched an extraordinary series of attacks on two economic policy-makers seen as pillars of stability by investors – Erdem Basci, the governor of the central bank, and his ally Ali Babacan, deputy prime minister responsible for the economy. Erdogan’s very public demands for a cut in rates hammered the lira, which hit an all-time low against the dollar.
Bruna Skarica, an economist at independent emerging market research provider Trusted Sources, said: “The comments made in February definitely weighed down on the positive investment sentiment that existed in the last quarter of 2014 when the oil price started declining. They translated into currency weakening and political risk and had a very strong effect on the lira, and in turn the weaker currency translated into higher inflation as well.”
Erdogan only appears to have backed down after apparently reconciling with Basci amid the market backlash, relieving some of the pressure on the lira.
“The pressure to cut interest rates seems to have faded a bit, but that’s mainly because the financial markets really took fright from the amount of pressure that the central bank was under and what it was doing for monetary policy, and how this wasn’t aligned with what the economy needed. That eventually forced Erdogan to tone down his demands, but it took a sell-off of the currency and concerns about financial stability and inflation for that to happen,” said Jackson of Capital Economics.
Most analysts do not believe that this marks the end of pressure on the CBRT, and say that behind the political theatre the real question is what will happen to its governor after June 7.
Central bank independence
Marcus Svedberg, chief economist at East Capital, said: “What Erdogan is doing is negative but may not be disastrous or have long-term consequences. Despite bashing the central bank governor with very public criticism, it is likely that private negotiations between them have been much less emotional. Some of this is political theatre but then there is a serious underlying element: the real question is whether governor Basci will stay, and that is worrying – especially as the independence of the CBRT has been questioned over the years.”
Attacks on the CBRT’s independence are highly symbolic given its role in Turkey’s economic success story, and provide evidence of what Hakura at Chatham House says is a “much more populist style of policy-making” that in turn raises questions about what policies will look like after June 7 – and whether the AKP’s established liberal economic team will survive.
Ucer of Global Source said: “The question of economic management is pretty much in everyone’s mind right now. There is big uncertainty as to what economic policies will look like after the general elections. Turkey has had a solid performance, especially until the global crisis, but it’s quite obvious that we are not going to have the same kind of ride or stability for a number of reasons.”
Speculation about Erdogan’s motives has inevitably suggested that he needs to set up a blame narrative about the ailing economy in a period of intense electioneering. While the AKP is likely to win the polls, the president needs a large majority to amend the constitution in order to create an executive presidency – a task complicated by the economic slowdown.
The parliamentary arithmetic is such that much will depend on the performance of the party of the Kurdish minority in parliament, the HDP, whose ability to exceed a 10% electoral threshold will determine the AKP’s room for manoeuvre.
Skarica of Trusted Sources said that if the HDP passed the 10% threshold to enter parliament, this would make the Kurds “king-makers” – a factor not yet priced sufficiently into political risk calculations.
The currency row also draws attention to differences between Erdogan and his hand-picked successor as prime minister, Ahmet Davutoglu. Talk of rifts within the AKP has grown, and Hakura of Chatham House believes that if the ruling party is unable to achieve a sufficient majority to introduce a powerful executive presidency, the relationship between the president and ministers will become “increasingly challenging and testy”.
There is therefore now considerable speculation about the likely outcome of the June 7 vote. Although the polls bring to an end a busy two-year electoral cycle, political campaigning over the presidential system is likely to cut short any relief for investors.
Jackson at Capital Economics has outlined three scenarios: Erdogan “sees the light” and changes tack, realising that his aggressive rhetoric has damaged the economy; growing authoritarianism, whereby the AKP strengthens the president’s powers, fuelling authoritarian tendencies, and the central bank governor is replaced with a loyalist inclined to lower interest rates; and the continuation of status quo – the most likely scenario – which implies little reform and an economy stuck in weak growth of 2%–3%, high inflation and tight monetary policy.
Either way, believes Skarica, if Erdogan’s attempts to consolidate executive power coincide with Kurdish discontent if the HDP fails to enter parliament, political clamour could beat down Turkish equities once again.
One thing is clear, given the scale of Erdogan’s ambitions, any slowdown challenges his position at the head of Turkey’s caravan.
The complicated mathematics of elections
The last few elections went by without a hitch, leading to clear AKP victories, despite the warnings of political uncertainty. June 7 general elections, though, could be very different, with a rising pro-Kurdish party likely to nab a large chunk of the vote and deny the AKP enough seats to rewrite the constitution and hand president Erdogan more power. What then – who will be in charge? And will this create a genuine period of investor-worrying uncertainty?
For Turkey’s politicians, it’s yet another year of living uncertainly. Elections have come thick and fast in recent years, each one fostering a sense of anxiety in everyone, from politicians to corporates, and investors to an increasingly vote-weary populace. Two national-level polls last year were analogous in that they were preceded by dire warnings of political unrest.
Local elections held in March 2014 were widely expected to be a de facto referendum on the ruling AKP, yet despite a flagging economy and rising inflation, it secured a comfortable victory. Five months later, Recep Tayyip Erdogan, still the AKP’s – and the country’s – most powerful and wily politician, was ushered in as the country’s 12th president after securing a simple first-round majority, despite expectations of a tighter race and an ensuing political bun-fight.
Mollified, investors returned in force to Turkish assets. Yet general elections slated for June 7 could turn into a far nastier affair, fomenting the sort of uncertainly erroneously predicted in each of the past two polls.
Here, the mathematics are complex; the outcome, nigh on impossible to predict. If the AKP secures 367 or more seats in June, a two-thirds majority, it will seek to rewrite the constitution, transforming Erdogan from a ribbon-cutting, Germany-style president into the commander-in-chief version found in the US. If it wins more than 330 seats, it can launch a national referendum to settle the issue – though current polls suggest the electorate would vote against any constitutional change.
Complicating the issue is the pro-Kurdish Peoples’ Democratic Party (HDP). Once scattered and incoherent, tending to run candidates as independents, the HDP is now an organised political force, unified in its opposition to the AKP. If it gains more than 10% of the overall vote in June, as is widely forecast, it will win enough seats to thwart Erdogan’s ambitions.
This creates a quandary. Ever since Erdogan ran for president last year, his intention has been clear: secure office and flip the power switch, channelling all the power to the presidential office. Many say it is he, and not the current, unelected premier and former foreign minister, Ahmet Davutoglu, who continues to pull the economic strings. So if Erdogan fails to secure a mandate to rewrite the constitution in June and remains a ribbon-cutting president with little or no power to wield, it raises the question: who is really in charge?
Any outcome is possible, even the admittedly unlikely scenario of the AKP losing power. A far more likely result involves the AKP falling short of its secondary target of 330 seats, leaving an economy in limbo and a dwindling group of fretful investors.
“It would be nice to say that post-elections things would be clear,” said Gabor Ambrus, emerging markets analyst at RBS markets and international banking. “I hope they will, but most of the polls point to a period of uncertainty in June.”
There are those that hope a poor result for the AKP – bad enough to leave it struggling to form a government – would prove to be a silver lining. Inflation is rising along with the rate of national debt, even as the economy flags.
The pace of reform has slowed markedly over the past four years, and the upcoming election will, said Timothy Ash, head of emerging market research at Standard Bank, “determine the way Turkey goes”; forward, in the direction of much-indeed industrial and capital market reforms; or backward, into the easy embrace of a static government, embedded corruption, and a cosy oligarchy.
Then there are the increasingly troubled relationships between government and key institutions. Erdogan’s increasingly bitter attacks on the central bank earlier this year, in which he blamed inflation and rising unemployment on high interest rates, forced governor Erdem Basci to snip the overnight lending rate.
These “growing tensions” at the heart of government, said Guillaume Tresca, senior emerging market strategist at Credit Agricole, point to rising “concerns about the independence of the central bank” in the months leading up to an expected rate hike by the US Federal Reserve.
That has left some wondering if the AKP remains a force for good in Turkey, and whether a spell in opposition would in fact do everyone the world of good.
“A strong victory [in the June polls] suggests that the AKP and Erdogan will consolidate power even more and try to change the constitution towards a presidential system,” said Marcus Svedberg, chief economist at East Capital.
“This would be market-negative. Another risk is that some of the reformist economic policy-makers are replaced by more nationalistic politicians. We, and the market overall, are cognisant of these risks and will therefore analyse the election very carefully.”
A contrasting belief is that everyone will fare better if the ruling party wipes the floor with its rivals. Recent elections have, after all, been “pretty straightforward” affairs, which “the AKP tends to win and that in turn tends to be good for the market”, said Standard Bank’s Ash.
And while many view Erdogan’s convoluted power grab with disquiet, a clear victory would at least offer the AKP a chance to push through much-needed economic changes.
“With a four-year window between elections coming up, this is a golden opportunity to push through much-needed reforms, and to focus on boosting competitiveness through innovation and efficiency rather than relying solely on lower labour costs,” said Bojan Markovic, economist for Turkey at the EBRD.
“The government recently launched a national development plan [which] outlines what it wants to achieve in the years ahead, and it is important to implement this plan.”
June’s election is likely to come down to the wire. Even after the poll, Turkey’s retail, commercial and political worlds may remain in the dark, possibly for months, as a new government is formed, and the president’s future is clarified and calibrated. A clear victory for the AKP, while favourable to some investors, is unlikely. More probable is a growing and gnawing level of doubt at all levels in what is already proving to be yet another year of political uncertainty.
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