Turkey’s June 24 presidential and parliamentary elections, held 16 months ahead of schedule, produced no remarkable change in the country’s political topography. On the economic front, the climate of uncertainty that the elections had created is over, but economic visibility has not improved and the risks have not eased. For both domestic and foreign actors, the Turkish market remains fraught with unknowns, prone to surprises and far from inspiring confidence, as evidenced by vital indicators such as hard currency prices, interest rates and the risk premium for foreign investors.
The price of the dollar, which measures the pulse of the Turkish economy, was about 4 Turkish liras in mid-April, when President Recep Tayyip Erdogan called the early elections. Under the impact of both domestic and external negative factors, the dollar climbed to 4.9 against the lira in May, forcing the Central Bank to hike interest rates despite Erdogan’s longstanding pressure for lower rates.
In two months’ time, rate hikes totaling 5 percentage points brought interest rates to nearly 18%, but savings holders continued to shy away from the lira amid an unrelenting inflation that hit 12% in consumer prices and more than 20% in producer prices in May. More importantly, lack of confidence in the government has persisted among domestic and foreign actors alike, sustaining hard currency as a safe form of keeping savings.
The trend has changed little since the June 24 polls. The dollar’s price closed the first week after the elections at about 4.6 liras, reaching 4.7 liras occasionally during the week. This price is no different from the pre-election levels, suggesting that the polls and their outcome have contributed little to improving confidence among economic actors.
The same result can be observed on the risk premium front. Turkey’s risk premium, reflected in credit default swaps, had risen above 320 basis points ahead of the elections, exceeding that of Greece, and remains above 300 basis points after the polls. The risk premiums of other emerging economies such as Brazil and Russia stand respectively at about 270 and 140 basis points. The risk premium is important in determining the interest rate that Turkey pays for external borrowings. In other words, when borrowing from abroad, Turkey has to shoulder the rate shaped by its risk premium, atop the rate of 10-year US bonds.
The amount of foreign funds that Turkey needs to secure over the next 12 months is $233 billion — now with the added burden of higher interest rates. This total includes the rollover of $183 billion in external debt and $50 billion to finance the country’s annual current account deficit.
Erdogan and his Justice and Development Party (AKP) may have a renewed mandate of five years, but this does not mean the funds will be easily available. Besides the problem of confidence among foreign actors, the global financial climate is no longer in favor of emerging countries such as Turkey. The US Federal Reserve’s ongoing normalization of monetary policies and rate hikes, coupled with tightening monetary policies in the European Union, have already curbed the flow of hot money to emerging economies and even led to occasional flights. US President Donald Trump’s trade wars and the oil tensions with Iran are also negatively affecting countries such as Turkey. Given Turkey’s dependence on foreign energy supplies and its massive oil and gas imports, each increase in energy prices adds to the country’s current account deficit and further fuels inflation.
Moreover, political uncertainties in Turkey are far from over, despite Erdogan’s victory in the presidential polls that entitled him to far-reaching executive powers. Erdogan’s party finished first in the parliamentary vote, but fell short of an absolute majority in the legislature. The AKP is now dependent on the support of its ally, the Nationalist Action Party (MHP), which is hardly a promise of political stability. The possibility of the MHP using its critical position to obtain political benefits or even for political blackmail is a major factor sustaining the confidence problem.
The reports of international credit rating agencies have become even more important for foreign financiers after the elections. Moody’s has already voiced its misgivings. “Even if the current account deficit narrows in the second half of the year due to the impact of the weaker lira and a slowdown in domestic demand, the deficit will remain large in absolute ($50 billion) and relative (6% of Gross Domestic Product) terms,” the agency said in a June 26 statement.
“Notwithstanding the growth of the economy in recent years, Turkish authorities have made only limited headway in addressing the structural economic problems that ultimately give rise to its persistent external deficits. Increasingly expansionary fiscal policy has stimulated growth to unsustainable levels, whereas longer-term economic reforms intended to raise potential growth on a sustainable basis have been largely sidelined,” it added.
Referring to the sweeping presidential powers under the new governance system, the agency said, “Executive presidency model confers broad powers — both political and economic — on the president. The macroeconomic policies that Mr. Erdogan’s government adopts will ultimately determine whether Turkey will be able to reverse its rising external vulnerability, which has been exacerbated by expansionary fiscal and monetary policy in the last two years.”
In other words, Ankara is expected to quickly tighten fiscal and monetary policies. This would mean a complete reversal of pre-election steps that served to enlarge the budget gap such as tax facilities on fuel or bonuses for pensioners.
Turkey’s biggest business group, the Turkish Industrialists and Business Association, has voiced similar expectations. In a June 28 television interview, chair Erol Bilecik called for fiscal discipline and an economic program that “would reduce inflation to single digits and then to below 5%.”
An increasing number of observers believe Ankara will end up running for help from the International Monetary Fund (IMF) unless it shifts to belt-tightening policies. According to former Central Bank Governor Durmus Yilmaz, now a lawmaker for the opposition Good (Iyi) Party, “Turkey today is a few steps away from the IMF’s door. Urgent measures are required. Comprehensive reform is a must.”
What experts mean by “reforms” is essentially measures to narrow the gap in public finances, which comes atop a chronic current account deficit. It would effectively amount to an IMF program without the IMF, but the prospect of such austerity steps remains unclear.
Will the AKP’s strategic ally, the MHP, stand behind a belt-tightening program that will embitter the electorate? Municipal elections scheduled for March 2019 are seen as a major factor deterring Ankara from braving the bitter pills. Moreover, the construction and housing sector, a key driver of economic growth under the AKP, is already in a highly fragile state. Austerity measures would push the sector further into a crisis — a prospect that makes belt-tightening moves all the more difficult for Ankara.