Istanbul election re-run ‘prolongs recession and erodes Turkey’s credibility

The Turkish electoral commission’s decision to scratch the result of the Istanbul municipal elections, which Turkish president Recep Tayyip Erdogan’s AK Party lost at the end of March, will delay Turkey’s recovery and erode investors’ already shaky confidence in Turkey’s institutions, onlookers have told GlobalMarkets. The rerun is scheduled for June 23.

The move has caused the lira to weaken from TL5.96 to TL6.15 to the dollar — a level not seen since early October 2018, when the country was just beginning to recover from its economic crisis. Turkey’s credit default swap spread, another indicator of investor confidence in the country, has also widened 25bp to 465bp.

Erdogan’s AK Party won 51% of the national vote, but lost key races in Ankara and Istanbul. While it accepted defeat in Ankara, the AK Party blamed “organised crime and corruption” for the loss in Istanbul, with ineligible voters supposedly able to cast votes and polling station officials appointed without being approved. 

On Sunday, the Turkish official news agency reported that prosecutors investigating the election had uncovered illegal payments to 43 of the voting officials from associates of Fethullah Gulen — a cleric accused of inciting the 2016 coup attempt.

“Erdogan is just throwing everything he can at these people to see what sticks,” said an emerging markets portfolio manager. A second investor said: “This means another two months of election uncertainty. The country urgently needs costly economic reforms, and these have been postponed for another couple of months.”

Disruptive elections

Elections are typically extremely disruptive to Turkey’s economy, as Erdogan attempts to stage-manage the country’s economy into growing and providing a boost to his popularity. Ahead of the June 2018 elections, he strong-armed the central bank out of hiking rates, triggering the currency crisis that blew through the country last summer.

Ahead of the municipal elections, he intervened in the FX market, instigating a ban on Turkish banks lending the lira abroad. The ban caused a liquidity squeeze, propping up the currency’s value in the short term. But the locals have lost faith in the currency and are moving their savings to dollars. 

CB shock

Meanwhile, the central bank removed the line from its guidance including a provision for raising rates if necessary, causing a market shock.

“We’d been anticipating a rate cut in June, but after this, ideally rates will be higher for longer, but that will prolong and worsen the recession,” said Arvid Tuerkner, EBRD’s managing director in Turkey. “Of course, the question is how will the market react if Turkey cuts rates before the market thinks they’re ready to.”

While the currency and asset prices have both weakened the biggest casualty is Turkey’s credibility with international investors. “Turkey doesn’t have natural resources,” said a third emerging markets portfolio manager. “Keeping investor confidence is key. Rerunning elections in this obviously forced way is going to make FDIs very hesitant.”

Turkey is facing diplomatic as well as economic challenges. Its purchase of the S400 missile system from Russia has drawn the ire of the US. “Turkey desperately needs to find a solution to the S400 question, because more sanctions from the US would be disastrous,” said the second investor.

Turkey’s NPLs are climbing, with the final level yet to crystallise. The Turkish banking watchdog forecasts an NPL ratio of 6% by the end of 2019, but Tuerkner felt that might be optimistic. Although he was quick to stress that Turkey would not be facing an NPL shock of Greek magnitude, he added that “Turkey has acknowledged this problem, but not the full scale of it.”