Last month, Recep Tayyip Erdogan called early presidential and parliamentary elections, now scheduled for June 24th instead of the original timing of November 2019. We believe that the main reasons for bringing forward the elections are the growing economic stress in the Turkish economy and, to a lesser extent, increasing political opposition.

In the run-up to the elections, which will formally crown Mr. Erdogan as Turkey’s ruler should he win (under a state of emergency act imposed after a failed coup attempt in 2016, he effectively already is ruling by absolute decree), the economy got an extra stimulus in 2017 to mask the country’s problems and to increase the likelihood of an Erdogan victory (although there are other, less legitimate, means to reach this goal). The government increased infrastructure spending, amongst others by constructing a new airport in Istanbul catering for 90 million passengers per annum (increasing to 150 million in a few years’ time), temporarily reduced taxes, offered 7% first-loss credit guarantees to banks willing to lend to (SME) companies and relaxed bank provisioning requirements and certain rules related to household lending. In the belief that providing jobs will win votes, Mr. Erdogan continued with his distorting policy of employment incentives and subsidies with the aim to reduce the high unemployment rate (11%). Mr. Erdogan also instructed the nominally independent central bank to keep interest rates low.

Rebuilding the Ottoman empire…

Last year, the economy grew by a Chinese-like 7.0% after posting a disappointing 3.2% the year before. However, the limits of growth are reached as inflation is running at nearly 12% per annum and the current account deficit increased to 5.5% last year (higher oil prices clearly didn’t help). The lira predictably softened (or, more precisely, plunged) from 3.85 lira per euro a year ago to nearly 5 lira per euro now, a depreciation of more than 20%. With a high dependency on foreign capital to fund the current account deficit, last month the central bank had to increase its effective funding rate to 13.5% (the central bank advertises a policy rate of 8% but banks can’t borrow at this rate). This will lead to softening in economic growth. Most analysts expect growth for 2018 to slow to 4.0%-4.5%.

Turkey’s vulnerability is specifically visible in the private sector, where especially medium-sized companies have indulged in foreign currency borrowing, resulting in relatively high leverage and open foreign exchange positions. Two large conglomerates, Yildiz and Doğuş, already had to restructure their debt piles this year. Moreover, external debt is rising (now 51% of GDP from 41% 5 years ago) and requires significant annual refinancing, estimated at around 20% of GDP. Turkey is not facing a solvency crisis (although the government’s contingent liabilities from credit guarantees and infrastructure public-private partnerships are not fully captured in its relatively low gross debt figure of 28.5% of GDP), but a liquidity crisis is quite possible (and probable if and when global markets sell off), also because the country’s net international investment position (the value of foreign assets owned by the private and public sector of Turkey minus the value of Turkish assets owned by foreigners) is far from rosy (-53% of GDP) and the real interest rate is too low to entice foreign investors to keep mum under adverse market conditions. So, it should be no surprise that rating agencies downgraded Turkey (Moody’s to Ba2 in March and S&P to BB- this month).

Thus, Mr. Erdogan has decided to hold elections when the economy is still chugging along. He doesn’t need much time to prepare as his AK Party operates in a continuous election mode and opposition remains fragmented and feeble (or jailed, as in the case of many pro-Kurdish HDP politicians, including its leader Dimirtaş). Further, AKP-unfriendly press has been swept away, so it is difficult to hear a dissonant voice nowadays. However, the opposition seems to have gained some strength since the constitutional referendum of April 2017, which sealed the change to a presidential system (refer to our blog “Turkey’s Supreme Sultan” for details). Erdogan won the referendum with the tiniest of margins (51%) and most likely only after a ballot-box stuffing exercise (made possible by a lenient Supreme Electoral Council). Now he is facing an enemy from within, Meral Akşener, a former minister of interior with an “iron lady” reputation, gained after she stood up against a military’s attempt to topple the government in 1997. Not for nothing is she called Asena, a mythical she-wolf, by her supporters. Ms. Akşener split from AKP’s long-time ally MHP (National Action Party), a center-right party, after she fell out with its leader. Her new Iyi (Good) party could clear the 10% threshold hurdle, taking votes from both the AKP and MHP. She may convince Turkey’s largest opposition party, the secular CHP, and two smaller parties to join her in a coalition to make a fist against Erdogan. She already persuaded 15 MPs to join her party. In that case, should Ms. Akşener not meet the 10% threshold, votes for her party will go to the coalition party that does meet the hurdle. The Kurds may hold the key but they are unlikely to support Akşener, who is even more of a hardliner than Erdogan. We believe there is a low likelihood that Erdogan will not emerge as winner of the elections but he may need to polish his ballot-stuffing skills, just in case (which is not without risk, though).

Not exactly a wolf in sheep’s clothes…

Assuming Mr. Erdogan will prevail, the big question then is if he will disengage from his unsustainable macroeconomic policies. This is not a given. There are local elections in March of 2019 and Erdogan surely wants to win those as well. In any case, a severe deterioration in the economy could unleash latent dissent against Erdogan’s undemocratic behavior (just look at what happens in neighbouring Armenia). He may not have an option to continue stimulating the economy or else he might have a wolf knocking on his door…