Turkey: Failed military coup fuels political turmoil and economic uncertainty
July 28, 2016
Political turmoil erupted in Turkey following the short-lived 15–16 July military coup. Immediately, the government started to crack down on the coup plotters, but the backlash against the putschists expanded rapidly and affected around 50,000 people including military and police officials, judges, journalists, teachers and governors. The main targets of President Recep Tayyip Erdogan were people with alleged links to Fethullah Gülen, a Muslim cleric exiled in the United States. While the Gülen movement has denied any involvement, Erdogan accuses the group of infiltrating the government and fomenting the coup. The extent of the purge raised concerns about Erdogan’s intentions and many local political parties and international institutions warned that Erdogan was trying to suppress all dissent.
Although it is too early to fully calibrate the impact of the crisis on the economy, Turkey’s strong economic fundamentals should shield the economy against a sharp downturn. That said, spillovers will mostly be felt through the financial markets, business confidence and politics.
Uncertainty following the military coup and the subsequent purge drove the Turkish lira to fall to an all-time low. On 20 July, the lira traded at 3.09 TRY per USD, which was 6.3% weaker compared to the same day in June. On an annual basis, the lira was down 14.5%. Shockwaves also reverberated across Turkey’s stock markets and the Borsa Istanbul 100 Index fell markedly in the post-coup week. Against this backdrop, on 20 July, S&P Global Ratings slashed Turkey’s credit rating from BB+ to BB with a negative outlook. On 18 July, Moody’s put Turkey’s credit rating under review, which paves the way for a downgrade. This situation could further encourage capital flights and threaten Turkey's ability to meet its sizeable external financing requirements. On top of the country’s relatively large current account deficit, it has to repay around USD 197 billion in external liabilities this year.
Turkey’s fragmented political landscape and rising security threats will undermine business sentiment. Fragile investor confidence will weigh on fixed investment, which had already contracted 0.1% annually in Q1. Political uncertainty will also have an impact on tourism. The sector was already under severe stress due to a series of deadly terrorist attacks and the economic sanctions imposed by Russia following Turkey’s shooting down of a Russian jet over Syria last year. According to the Tourism Ministry, the number of foreign visitors took a nosedive in June, falling around 40% on an annual basis.
The failed military coup will likely strengthen Erdogan’s case to change Turkey’s governmental architecture from a parliamentary system to an executive presidency. Erdogan does not have the necessary support in Parliament to launch a constitutional reform. However, in the wake of his triumph over the military, he could push through a referendum on a presidential system or call a snap general election. According to polls, the country is deeply divided between supporters and critics of Erdogan. Therefore, if called, the new elections or the constitutional referendum promise to further polarize the Turkish society and increase political uncertainty.
The waves of the political crisis in Turkey also reached the European Union and the United States. While European officials condemned Turkey’s coup bid, they fiercely criticized the government’s decision to partially suspend the European Convention on Human Rights and warned that Erdogan’s intention to re-introduce the death penalty will end Turkey’s EU accession plans and economic assistance. Turkish officials, including Erdogan, have also criticized the recent EU-Turkey deal to stem the flow of refugees to Europe and threatened to back away from the agreement. The United States’ refusal to extradite Gülen without evidence of his involvement in the plot has triggered an irate reaction from Erdogan, who accuses the U.S. of not standing firmly against the failed military coup.
The economic consequences of the political crisis in Turkey are expected to be limited due to the country’s strong fundamentals, the government’s bold fiscal support and the Central Bank’s accommodative monetary policy. However, declining tourism and a fall in business confidence look set to negatively impact growth. Further instability in the financial markets, along with Turkey’s large external financing needs, could lead the country to a balance of payments crisis. In the long-run, the main risk is a deterioration in Turkey’s relations with the U.S. and the European Union.