How political risks wreck Turkey’s economic prospects (Al-Monitor, Februrary 3,2017)
Summary Turkey has lost its investment grade status with all top three credit-rating agencies, falling…
The June 23 rerun of the mayoral election in Istanbul ended in a big debacle for the ruling Justice and Development Party (AKP). Ekrem Imamoglu of the main opposition Republican People’s Party (CHP), who ran for the CHP-led Nation’s Alliance, beat the AKP’s Binali Yildirim by more than 800,000 votes, a huge increase from his original winning margin of some 13,000 votes. Analysts said many AKP supporters irked by their party’s refusal to recognize Imamoglu’s March 31 victory switched sides, contributed to his resounding victory in the rerun.
The contest for local dominance in Istanbul, Turkey’s biggest city and economic hub, became also a vote of confidence in the AKP in a sense; hence, the defeat is widely seen as a sign that the party’s political might is on a general decline.
June 24, the day after the Istanbul vote, marked the first anniversary of President Recep Tayyip Erdogan’s election as Turkey’s first head of state under a new governance system concentrating power in the president’s hands. The one-year record of his executive presidency, which many see as a “one-man regime,” is hardly flattering, especially in economic terms.
The March 31 local polls, coupled with the rerun vote in Istanbul, have only increased pressure on Erdogan’s government, which has been grappling with economic recession and then crisis since last summer, when it assumed its new powers.
Erdogan failed to deliver on his pledges to pull down inflation, interest rates and foreign-exchange prices, which he made in his campaign in the June 24, 2018, presidential and parliamentary elections. As a result, the local elections took place amid economic gloom, marked by an inflation hovering around 20%, a joblessness rate approaching 15%, a Turkish lira that has lost nearly 30% of its value and steep declines in purchasing power. Voters in big urban centers, in particular, penalized Erdogan, with the CHP winning the key mayoral races in 21 provinces that account for 63% of Turkey’s gross domestic product (GDP).
Unable to stomach the March 31 defeat in Istanbul, which alone contributes 31% of the country’s GDP, the AKP and its ally, the Nationalist Movement Party (MHP), piled pressure on the election board and eventually had the result canceled only to fare far worse. The AKP’s debacle in the rerun was delivered by voters whose grievances over the government’s failure to resolve economic problems were compounded by a sense of injustice over the denial of Imamoglu’s win.
What challenges will the executive presidency system face following a dismal performance in its first year and especially after the Istanbul rout?
In his first postelection speech at the AKP’s parliamentary group June 25, Erdogan stressed that the next elections were four years away, meaning that the government has ample time to work free of electoral strains. Yet those four years could prove difficult to complete amid the groundswell of pressure building up among an increasingly frustrated electorate. Can Erdogan’s government fix the economy, given its declining political might and lackluster record over the past year?
Economic indicators remain gloomy. The economy contracted 2.6% in the first quarter and is expected to close the second one with a similar result. Leading indicators suggest that the crisis continues. Unemployment remains the primary social problem, standing at more than 14%, with 4.5 million people jobless.
The Turkish economy is desperate for foreign funds, which had been abundant in previous years and served as the linchpin of economic growth. As a result, however, the economy is saddled with $450 billion in foreign debt accumulated under 17 years of AKP rule. According to April figures, nearly $18 billion in foreign funds fled Turkey over a year, in a sharp reversal from the previous 12-month period, which saw the inflow of $45 billion in foreign funds.
The scarcity of foreign funds means that hard currency becomes more expensive and the Turkish lira depreciates. The average price of the dollar stands at nearly 5.9 liras in June, up by more than 27% from 4.64 liras in June 2018. Efforts to prop up the lira, in turn, have pushed interest rates up to about 25%.
The figures have gone up and down under the impact of global economic trends. Rate cuts and expansionary monetary policies in global powerhouses are good for emerging economies such as Turkey by boosting their prospects of attracting foreign funds. Such capital inflows have a curbing effect on foreign-exchange and interest rates. Turkey, however, has come to benefit less from such external tailwinds because of a whopping increase in its risk premium.
Turkey’s credit default swaps, which indicate the country’s risk premium, have long decoupled from those of other emerging economies such as Brazil, India, Mexico, Russia and South Africa. On June 24, 2018, Turkey’s risk premium stood at 275 basis points. It shot up to 575 basis points in August amid a spike in political tensions with the United States. Since then, the risk premium has eased, but still hit as high as 440 basis points this week. In contrast, Russia’s risk premium stood at 112 basis points in the same period.
The factors pushing Turkey’s risk premium up are not only economic, but also political and geopolitical. Standing out among them are ongoing tensions with Washington over Ankara’s resolve to acquire S-400 air defense systems from Russia. Despite Washington’s threats to slap sanctions on Ankara in the coming weeks, Erdogan has maintained the deal with Russia will go through, stoking the prospect of a crisis with uncertain consequences for the economy.
A damaging showdown with the United States, hot on the heels of the Istanbul rout, could further weaken the AKP government. Moreover, the AKP faces the risk of fracture, with Erdogan’s former economy supremo Ali Babacan bracing to form a new party, backed by former President Abdullah Gul. Meanwhile, some observers believe that the MHP, emboldened by its success in winning over some of the AKP’s disgruntled voters in the local polls, might eventually undo its alliance with the ruling party under a strategy focused on forcing early elections.
In sum, Erdogan’s government is under mounting strains on multiple fronts, while the CHP and its allies are highly energized, boosted by their victories in the local polls. The mounting pressure, reinforced by other possible setbacks down the road, could well boil down to early elections in 2020.