In five short years, Turkey has experienced a whirlwind of political events — from popular upsurges to changes in the political system, war within and outside the country, and bombing attacks. In fact, the nation has been under an official state of emergency since a failed coup in July 2016. Complicating matters, Turkey’s economy is on very shaky ground, just as the country is bracing itself for general elections which could prove pivotal in the long-term.
As it is, Turkey is on the verge of a currency crisis. The lira is down 24% against the U.S. dollar year-to-date driven by a confluence of factors. These include Turkey’s weak economic fundamentals, aggravated by double-digit inflation, reliance on foreign funding in an environment where rising U.S. interest rates are making dollar-denominated debt more expensive, and the fact that Turkey’s Central Bank and President fundamentally disagree on Turkish interest rate policy. Rising oil prices have also weighed on the lira, as Turkey is a net oil importer and must sell liras to buy dollars to pay for its oil.
Moreover, the country’s economic model appears to be unsustainable. While Turkey has experienced high nominal GDP growth for several years (7.4% in 2017), that growth has been heavily financed by dollar-denominated investment. Few economists expect a decrease in the current account deficit, which is on trend to exceed 6% of GDP. Even consumer and business sentiment have turned pessimistic about inflation, wages, employment growth, and investment spending.
RECENT CURRENCY MELTDOWN
Paradoxically, Erdogan is to blame for the lira’s most recent freefall. While the Central Bank of the Republic of Turkey (CBRT) has been calling for higher interest rates to combat Turkey’s surging inflation, the president has advocated for lower rates instead. This month the lira dropped 16% after President Erdogan indicated he wanted to take control of setting interest rates from central bankers. That sent investors rushing out of the lira, driving the currency to a record low of about $0.20 USD per lira.
To stem the panic, the CBRT implemented an emergency 300 basis point rate hike last Wednesday, raising its late liquidity window lending rate to 16.5% from 13.5%. Judging from the lira’s continued fall the next day, the CBRT’s move was deemed to be too little too late, and some economists predict another rate increase to around 19.5% in early June.
The combined effect of a plunging currency and an 11% inflation rate means things are getting more expensive every day in a country that imports hundreds of billions of dollars’ worth of consumer goods. And this is unfolding at an inopportune time for Erdogan.
Elections are scheduled to be held in Turkey on June 24, nearly a year-and-a-half ahead of schedule. Although President Erdogan has been widely expected to win, his polling numbers have suffered with the escalating currency crisis. With the opposition gaining traction, there could be a surprise election outcome.
Thanks to recent changes to the electoral system, presidential and general elections are now held together, and parties are allowed to form electoral alliances. If an alliance garners more than 10% of the vote, all parties participating in that pact will be awarded seats in parliament.
Motivated by this new electoral rule, MHP (aka “Nationalist Movement Party”), which risked falling short of the 10% threshold if it entered the election on its own, has formed an electoral alliance with AKP (aka “Justice and Development Party”), Erdoğan’s ruling party. Together, the AKP-MHP pact form the People’s Alliance, uniting under Erdoğan’s candidacy.
Opposition parties have thus far been unable to unite behind a single candidate that would weaken Erdoğan. However, three parties – the İYİ Parti (“Good Party”), CHP (centrist secular “Republican People’s Party”), and SP (conservative-Islamic “Felicity Party) – have also formed an electoral alliance. Together, the İYİ-CHP-SP pact comprise a right-wing anti-Erdoğan bloc. The only left-wing party with a chance of passing the requisite 10% is the pro-Kurdish Peoples’ Democratic Party (HDP).
The final presidential candidate slate is as follows:
- Erdoğan, supported by the AKP & MHP (the“People’s Alliance”)
- Meral Akşener under the İYİ
- Muharrem İnce under the CHP
- Temel Karamollaoğlu under the SP
- Selahattin Demirtaş of the HDP
Candidates İnce and Aksener are thought to have the best chance to make it to the second round to contest Erdoğan. Demirtaş, who ran for president in 2014, has been imprisoned since November 2016 after being swept up in Erdoğan’s post-coup crackdown.
Some analysts believe an opposition win could spark a sharp rally of the lira, similar to the South African rand’s appreciation when Cyril Ramaphosa took over from Jacob Zuma. Whether that comes to be remains to be seen.
What is more certain is that, if Erdogan retains power, the country’s current troubles could erupt into a full-blown economic crisis. Unless he introduces some long-term reforms and switches monetary policy. The fact that private sector external debt totals more than 25% of the country’s GDP, and some of the biggest conglomerates have to restructure debt are indicative of deeper-rooted problems within the economy. As the currency drops to new lows every day, that may precipitate a debt and insolvency crisis. In March, ratings agency Moody’s cut Turkey’s sovereign credit rating, which was already in “junk” territory, citing the country’s growing fragilities.
Rising U.S. interest rates have caused a general selloff of Emerging Market equities this year, but Turkish equities have fared much worse. The Turkey ETF (TUR) is down more than 28% YTD, while the Emerging Markets ETF (EEM) is down just 3.5%. Ahead of the lira’s slide, Turkey was one of the most attractive emerging market plays for investors, thanks to the high yields of Turkish assets. Now, investors are carefully watching this election for a change in political dynamics that could boost appetite in Turkish assets.