Trip note: Turkey’s most important election in recent history
Reza Karim discusses his recent trip to Turkey, where he met several government officials, local political experts and pollsters ahead of the upcoming election.
Whatever the election outcome, the winning party will have the colossal task of managing Turkey’s economy. However, with positioning in Turkey currently very light, a market-friendly outcome could result in notable inflows into the economy. As a large population economy, which is often viewed as the gatekeeper to Europe, the outcome of the election could have significant geopolitical implications too.
Over 200 regulations have been introduced by the current government to manage capital flows, and if the opposition party won, they would likely unwind these regulations, albeit slowly. While the Turkish economy would be expected to enter a recession following monetary policy tightening, if the coalition party could successfully restore confidence, Turkey could still print positive growth for the year despite an economic contraction in the second half, which would be considered a good result. The main challenge for the opposition party would be to keep the coalition of six parties.
A win for the party would likely be well received by markets, as long as they moved quickly to appoint a new central bank governor and hike interest rates.
The banking system would need to recapitalise immediately if rates were hiked, which would be manageable considering that fiscal policy has been prudent historically. Erdogan has handed out early retirement to 2.2m people at the age of 42, costing about 1% of GDP; in addition, the recent earthquake will add around 2% of GDP costs to this year’s budget. Lower gas bills have helped, but the cost of unwinding the FX-protected schemes would also impact GDP. All in, Turkey is looking at a deficit of close to 6% this year, which we believe would be manageable.
However, the adjustment period looks ugly as the currency could depreciate, making inflation quite sticky, which could result in further FX depreciation. Given how dollarized the Turkish economy is (the US dollar is heavily used for saving and transactional purposes, given the lira’s instability), local expectations are that even a slight reversal of FX moves would make the adjustment period short-lived. Nevertheless, we believe there is a strong possibility that the economy would be able to muddle successfully through this adjustment period.
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