Turkey: Victory for Erdogan mitigates short-term political risks, but severe economic uncertainty remains
June 27, 2018
In presidential and parliamentary elections held on 24 June, incumbent President Recep Tayyip Erdogan won over 50% of the vote, while his Justice and Development Party (AKP), together with its coalition partner the Nationalist Movement Party (MHP), won an absolute majority in parliament. The result reduces political uncertainty in the short term; with the parliament under control, Erdogan is unlikely to call fresh elections soon. However, the future direction of fiscal and monetary policy—and by extension the evolution of the lira and the risk of a hard economic landing—is less certain.
Regarding the fiscal position, even with elections out of the way the government may not sharply tighten its expansive stance in the near term, despite economic overheating concerns and a bulging current account deficit. Around USD 40 billion in extra stimulus measures were announced in the runup to the vote, including a private-sector debt restructuring program, extra support to businesses and payments to pensioners. In addition, Erdogan could be tempted to continue with fiscal largesse to shore up political support before important local elections in March 2019.
Analysts at Nomura state, “It is not obvious to us that the policy focus will shift from growth to rebalancing. The most realistic scenario […] [is that] fiscal and quasi-fiscal policies remain loose.” Economists at UniCredit concur: “Economic policies are unlikely to tighten in the run-up to local elections.”
Concerning monetary policy, President Erdogan suggested in May he could take more direct control following the elections, and he has long professed his dislike of high interest rates. However, as the lira began to depreciate sharply, the Central Bank tightened its stance on 23 May. With the lira still down markedly since the start of 2018, pressure on firms with foreign-currency denominated debts intensifying and inflation well into double-digits, the Bank has little room to reduce rates. Any such move would further undermine the CBRT’s credibility, likely see a renewed run on the currency and cause the corporate external debt burden to become crippling. This would risk tarnishing Erdogan’s reputation among voters as a strong economic helmsman; as a result, Erdogan is unlikely to take wholesale charge of monetary policy, although such a possibility cannot be entirely ruled out.
Fiscal and monetary policy will have a key bearing on the vulnerable external position—the current account deficit has ballooned so far this year and is being financed largely by short-term capital inflows—and the vulnerable Turkish lira. According to Nomura, “the lack of tightening of the overall policy mix would pose upside risks on the current account deficit and inflation, which would keep TRY under pressure against the backdrop of QExit. So, unless we see a significant reorientation of macroeconomic policies towards rebalancing, we expect the currency to remain vulnerable owing to large external financing requirements.” Analysts at UniCredit paint a similar picture: “The TRY and government bonds will remain under pressure, with occasional brief periods of stability afforded by eventual rebounds in global risk appetite or seasonal FX inflows. Inflation will stay deep in double digits, with monetary policy aimed at damage control.”
An important insight into the future direction of economic policy will come from the minister Erdogan appoints to lead the powerful new ministry in charge of economic affairs. The ministry, which was announced before the election, will likely be an amalgamation of the previously separate finance, economy and treasury ministries. The current deputy prime minister, Mehmet Simsek—a trained economist who played a key role in soothing market jitters following May’s sharp currency depreciation—would likely be a choice well received by markets, as would current finance minister Naci Agbal. Both are regarded as adhering to economic orthodoxy, and could serve as an important counterweight to Erdogan’s more unconventional views.
Erdogan’s win ushers in a new system of government, with the role of prime minister abolished and the president awarded wide-ranging new powers. The president will now be able to bypass parliament and rule by decree, unless a majority of MPs vote to explicitly overturn his laws, which is unlikely given the parliamentary arithmetic. In addition, Erdogan will be able to appoint ministers and senior members of the judiciary, dissolve parliament, and declare a state of emergency.
Although Erdogan’s AKP won the most seats in parliament, it relies on the nationalist, right-wing MHP for a parliamentary majority, allowing the MHP to wield influence over the legislative agenda. The party could encourage a more belligerent stance towards the EU and the U.S. and is staunchly against the prospect of Kurdish autonomy, which could make it difficult to reach a lasting solution to the conflict with the PKK affecting the south-east of the country.
Author: Oliver Reynolds, Economist