Turkish Prime Minister Recep Tayyip Erdogan. Picture: REUTERS
Turkish Prime Minister Recep Tayyip Erdogan. Picture: REUTERS

Istanbul/Ankara — When Turkey’s president called early elections, most analysts figured they knew why: there was financial trouble ahead and he couldn’t risk waiting.

The gambit worked. Recep Tayyip Erdogan was returned to office with sweeping new powers, after running the economy hot for more than a year. Now, preventing a meltdown is probably his most immediate and difficult task.

"The election result doesn’t solve the most important question the Turkish economy faces: how to avoid a hard landing," said Inan Demir, an economist at Nomura International in London.

On the campaign trail, the president could boast about growth rates that surpassed China’s last year — but only because he’d engineered them. Cheap money and government incentives helped plough billions of dollars into the economy following the coup attempt in 2016.

Turkish companies have borrowed extensively in dollars and euros, debt that’s now more expensive to repay after the lira’s 20% slump against the dollar this year

Yet even before the weekend vote, cracks were forming in his growth-at-all-costs strategy: months of rebounding inflation and a widening current-account deficit triggered a run on the currency as foreign investors fled.

Unorthodox views

Most economists agree that Erdogan’s policies caused the rout. They say interest rates have consistently been too low, a byproduct of the president’s meddling in central bank affairs with his unorthodox views on how to fight inflation. The budget deficit, while small by past Turkish standards, is still too big for an economy at risk of overheating.

Turkish companies have borrowed extensively in dollars and euros, debt that’s now more expensive to repay after the lira’s 20% slump against the dollar this year. The central bank has made domestic credit costlier too, by raising interest rates 500 basis points since April — a move green-lighted by Erdogan, after initial resistance, in a desperate bid to shore up the currency.

On the first trading day after Erdogan’s double victory in Sunday’s presidential and parliamentary elections, there were signs that such risks were weighing on investors’ minds. Turkish assets posted initial gains, as various scenarios — including a challenge to ballot results in the courts or the streets — were removed from the table. But the benchmark stock index closed 1.9% lower, led by banks, while the lira reversed its election-night advance.

Many vulnerabilities

"Any period of respite is unlikely to be sustained," JPMorgan Chase analysts, including Yarkin Cebeci, wrote in an e-mailed note. "The list of vulnerabilities is a long one."

An early sign of how Erdogan plans to tackle them could come in the next couple of weeks with the appointment of a new economic team. Deputy prime minister Mehmet Simsek, a former Merrill Lynch analyst who headed the outgoing administration’s economic team, is the name many market-watchers will be looking out for. "If he isn’t kept on, it would send a worrying signal to investors," said Jason Tuvey, an emerging-market economist at Capital Economics in London.

The government announced a stimulus package worth about $5bn two months before the election, having done something similar in the run-up to a referendum last year. Simsek and finance minister Naci Agbal had signaled that fiscal tightening would come after last weekend’s vote.

‘Not likely’

Turkey is running a budget deficit of about 1.6% of GDP and that’s likely to widen past 2% by year-end, JPMorgan estimates.

In pre-Erdogan Turkey, governments regularly posted much larger shortfalls. Fiscal discipline has been two of the ruling AK Party’s watchwords. Still, spending that’s often directed toward consumption, combined with cheap money at the central bank, has contributed to Turkey’s imbalances in many economists’ eyes — especially to a current-account deficit ratio that’s one of the world’s largest.

Tuesday June 26 2018
Tuesday June 26 2018

But Erdogan may not be inclined to the kind of fix that his technocrats were flagging, according to Nomura’s Demir. "He cannot or will not cut personnel, social security or military spending. And he would not want to starve his mega-projects of funding. Rebalancing through fiscal tightening is not likely."

In a Bloomberg interview weeks before the ballot, Erdogan promised to take more direct control over interest-rate decisions — a prospect that alarmed many investors and accelerated declines on Turkish markets.

The president has repeatedly clashed with a string of central bankers, who began their terms feted as AK Party protégés and ended up being reviled.

An obvious way for Erdogan to "regain some credibility" would be to "stop interfering with the central bank and allow it to take appropriate action to bring down inflation," said Tuvey. But Demir, referring to the president’s pledges in the Bloomberg interview, said "investors should take Erdogan for his word on this. He will likely exercise stronger control over monetary policy."

Erdogan campaigned hard on Turkey’s long-run economic performance on his watch, pointing to rising welfare standards as output grew at an average pace close to 6% a year. It’s a record that compares favourably with many developing-economy peers.

‘Mesh with reality’

However, the early-Erdogan boom was achieved in an era when liquidity was flowing freely to such countries. The problem for the president now is that the opposite condition prevails, said Erinc Yeldan, a professor of economics at Ankara’s Bilkent University.

The US Federal Reserve is raising US interest rates, and Turkey hasn’t been the only country under pressure in recent weeks. Brazil and SA have also seen currency wobbles.

Amid the general emerging-market malaise, Turkey has a special feature, said Yeldan: a government that’s "stuck on the belief that you have to lower interest rates, that’s how the economy thrives, that’s how companies can roll over their debts. But that doesn’t mesh with reality."