Turkey’s one-man regime denied confidence vote by markets(al-Monitor, July 18, 2018)

Turkey’s June 24 elections — which were held on an uneven playing field under a state of emergency and with few checks and balances in place — marked the country’s transition to a new model of governance that concentrates power in the hands of President Recep Tayyip Erdogan.

The new system, narrowly approved in a referendum last year, gave the president extraordinary executive and legislative powers as well as control over the judiciary. With parliament largely disabled, Erdogan began to issue decrees as soon as he started his new term July 9. The far-reaching decrees took effect directly with their publication in the Official Gazette, with no one in the 600-seat parliament aware of their content. Erdogan’s Justice and Development Party (AKP) is readying to lift the two-year state of emergency, but is planning legal amendments that would effectively make the emergency rule permanent.

The most remarkable member in Erdogan’s new Cabinet is his son-in-law, Berat Albayrak, who took the reins of the economy at a time of serious financial woes. Erdogan chose to sideline Mehmet Simsek, the hitherto czar of the economy who enjoyed credibility among local and foreign investors; he then attached the Treasury to the Finance Ministry and handed the portfolio to Albayrak, who was previously energy minister. Regulatory boards overseeing the banking sector and capital markets, public banks and even the central bank — though in an indirect way — were all placed under the control of Albayrak’s ministry, meaning the 40-year-old is now single-handedly in charge of the economy.

The abrupt transfiguration of the Turkish state, which marks a sharp departure from the modern governance norms of the Western world, has added new layers to Turkey’s economic frailty. Financial actors, both local and foreign, have so far denied a confidence vote to the new political system and its cadres, compounding worries over the already serious risks and fragilities in the economy.

Ahead of and after the elections, Al-Monitor had pointed to a key problem plaguing the Turkish economy: a confidence crisis among investors and ordinary citizens. Judging by the behavior of domestic and external actors since the elections, the problem continues unabated. Economic actors have remained reluctant to put their money in the Turkish lira, bring in funds to Turkey or make investments. As a result, the depreciation of the currency has continued.

Inflation is the biggest risk stemming from this state of affairs. Turkey’s current account deficit, i.e., its foreign-currency gap, is growing, while the external funds needed to close the gap are not coming and the existing ones are depleting. Ankara’s pre-election spending significantly exceeded its revenues, leading to a big deficit in the central government budget.

The 7.4% growth rate in 2017, secured through lavish government incentives, had inevitably created anomalies, and the economy is now beginning to pay the price. A slowdown has been tangible since the first quarter, raising the prospect of contraction. This is evidenced by the seasonally adjusted unemployment rate, which hit 10.3% in April, and the 1.6% decline in industrial output in May.

Inflation looms as the biggest headache for the one-man rule in the short run. In June alone, consumer prices increased 2.6%, bringing year-on-year inflation to more than 15%, while producer prices rose more than 24% from the same period last year. The increase in producer prices stems mainly from the dramatic depreciation of the lira, which has made imports more expensive. Turkey’s annual imports amount to about $250 billion. Every imported item creates cost inflation, which pushes up producer prices and then retailers’ consumer prices. Amid Ankara’s failure to rein in foreign-exchange prices, the growing costs will continue to push prices up, with inflation likely to reach 20% at the year-end. Among Turkey’s emerging-economy peers, Argentina is the sole country with such a high inflation and, ominously, it ended up in a stand-by deal with the International Monetary Fund last month.

In the face of mounting inflation, hard currencies — mostly the dollar and the euro — have become a safe haven for savings holders and entrepreneurs who scramble to preserve the value of their assets. Interest rates involving the Turkish lira have failed to keep pace with inflation, despite the central bank’s recent rate hikes, which totaled nearly 5 percentage points in a month.

High inflation means risk and uncertainty for foreign investors in particular, leading them to shun the Turkish stock market or to withdraw existing investments with minimal loss. This aggravates the problem of financing the country’s $58 billion current account deficit. The latest current account data show that there was no inflow of external investments in May and the deficit was covered through reserves and capital inflows of unknown origin. In other words, the ammunition at home is depleting.

All those downsides bear on the country’s credit default swaps, which reflect risk premiums. On July 16, Turkey’s risk premium hit a record high of 328 basis points, having fluctuated below 300 basis points before the new Cabinet took office.

According to central bank data released July 17, the external debt Turkey has to roll over in the next 12 months amounts to about $181 billion. Add to this a current account deficit of roughly $50 billion, and Turkey’s 12-month external financing needs exceed $230 billion.

Things are no better on the public finances front. The central government budget deficitswelled to nearly 47 billion liras ($9.8 billion) in June, up from 25 billion liras in the same period last year.

The high inflation and unemployment rates, the gaping current account deficit and the accompanying budget gap are all reflected in the reports of credit rating agencies, which serve as warnings to investors. On July 13, Fitch sent Turkey’s sovereign debt rating further into junk territory and rated its outlook as “negative.”

Moody’s, for its part, said in a July 16 statement that it expected problem loans at Turkish banks to exceed 4% of loans over the next 12-18 months compared with a low of 2.9% in May.

This gloomy outlook is keeping the price of the dollar at more than 4.8 liras as of mid-July. All eyes are now on the central bank’s July 24 meeting, the first under the new government. A reluctance to hike interest rates could easily send the dollar above the psychological mark of 5 liras. Could the one-man regime show flexibility to win over the markets? It’s anyone’s guess.