Just when you think that Turkey has become an investable country again, its president, Recep Tayyip Erdogan, poured cold water on this idea. On March 19th, he orchestrated the arrest of Istanbul’s mayor Ekrem Imamoglu on corruption allegations. Imamoglu already faced charges of aiding a terrorist group and of committing financial crimes (bribery and rigging tenders for government projects apparently). Mr. Imamoglu’s biggest crime, in Erdogan’s eyes, probably is that he wants to be nominated as the CHP presidential candidate in the elections set for 2028 (political analysts believe Erdogan will bring the date forward and call for elections in 2027). A CHP primary to elect its leader was to be held on March 23rd where Mr. Imamoglu was the clear front-runner (and only candidate). Presidential candidates in Turkey are required by law to have a university degree. The day before he was detained, for good measure Mr. Imamoglu’s diploma was revoked, just in case.

Mr. Erdogan knows how to throw a party…

Imamoglu most likely is not Erdogan’s BFF. In last year’s local elections, the CHP got ahead of Erdogan’s AK party with 37.8% of the vote against 35.5% for AK, whereas Imamoglu bagged another term as Istanbul’s mayor. The election results were seen as a severe rebuke for Erdogan’s government, which, to everyone’s surprise, Erdogan seemed to acknowledge. Already in 2019, Erdogan had a run-in with Imamoglu after the latter one won Istanbul’s mayoralty elections for the first time. The win was by the smallest of margins (20,000 votes) pursuant to which Erdogan pressured the election authority to overturn the result and order a rerun. But Imamoglu won and even by a bigger margin. After he understandably called the election officials “idiots”, he was banned in 2022 from politics and sentenced to 2 years in jail, although these penalties were stayed pending appeal. So, no lost love between the two men (in Turkey, in any case, openly showing love for another man is not recommended).

After Imamoglu’s arrest (actioned by Turkey’s independent courts, independent at least in Erdogan’s fantasy), big street protests broke out. A violent crackdown on the demonstrations swiftly followed. More than 1,000 people, including pesky journalists, were detained and authorities banned public gatherings. Unfortunately, it is not likely that the protests will change the outcome, i.e. sidelining Imamoglu at the next presidential elections, as Erdogan is a master in utilizing suppressive instruments and controls the media. And the bureaucracy, including the police and the courts, is still behind him.

If not the action in itself, the timing of Erdogan’s purge may be surprising given that the presidential elections are still at least 2 years away. Clearly, Erdogan has good reason to see Imamoglu as a threat to his eternal reign of the Ottoman empire. Two factors could have been in play to strike now. Since the inauguration of Donald Trump in the Oval Office, the world’s attention has been drawn to a tsunami of sometimes rather outrageous executive decrees, where former allies are treated as enemies and former enemies are friends. Given the steady news flow from Washington, Imamoglu’s arrest is likely to vanish from the international newspaper headlines quickly. Given Trump’s appreciation for autocrats and his own disregard for democratic rights, Erdogan may get away with trampling the opposition, whereas the EU might not rock the boat as it may need Turkey’s help in Ukraine (e.g. as part of a peacekeeping force) as well as NATO and as a buffer against possible renewed migration flows from Syria. Domestically, Erdogan made overtures to the Kurdish PKK party and its jailed leader Abdullah Ocalan. The idea is that PKK would be disbanded, and Ocalan could be a free man. Subsequently, Erdogan may woo the main Kurdish political party, Peoples’ Equality and Democracy Party (DEM), to help him secure another term as president which requires an amendment of the constitution. Over the last decade or so, talks with the Kurds never came to fruition but maybe this time is different.

The price Erdogan may pay for his illiberal action against Imamoglu is in financial markets. After years of macro-economic mismanagement centered around the unique insight that by lowering interest rates inflation will disappear (see our blog “Cold Turkey” of December 2021), creating a very real risk of a balance of payments crisis, Erdogan abruptly changed track after his re-election as president in June 2023. He appointed Mehmet Simsek as minister of finance and Fatih Karahan as central bank governor (after a rather brief intermezzo by Hafize Gaye Erkan in that role), who reversed the macro-economic policies and increased policy rates stepwise to 50% to tame inflation (which peaked at 72% in mid-2024). Although the measures taken were (and are) very painful, foreign investors were enticed to return to invest in local government bonds, increasingly deeming Simsek’s new policies as both credible and enduring. Recent events will make foreign investors doubt about the future course of macro-economic policy in Turkey. The lira weakened from 36.69/USD to 37.98/USD due to capital outflows despite massive intervention by the central bank (reportedly USD 26 billion in 3 days). The key overnight interest rate was hiked to incentivize savers to keep their deposits in lira instead of converting to dollars. Cleary, further cuts in the central bank policy rate (42.5%) will be postponed (with maybe a low probability of a hike, depending on capital outflows). Local government bond yields rose by 3% for 2033 maturity and implied yields on 1-year forward rose from 37.1% to 46.3%. Of course, markets may settle down in the coming weeks, but the Erdonomics risk is on the table again, in our view, meaning that Mr. Erdogan may change macro-economic policies (lower rates, extend credit, increase minimum wage, etc.) to please his voter base (this would not be the first time). Turkey has large external financing needs whereas its private sector is heavily indebted in foreign currency. Financial stability now once again is at risk, which we assume will be priced in by investors (although many brokers seem rather complacent). The party seems to be over…