Turkey at a crossroads and evergreen solutions to economic crises

Published 13.06.2018 23:05

Bloomberg's poll commissioned last week signals good news for incumbents in Turkey. The Foresight Danismanlik poll, released yesterday, returns the Justice and Development Party (AK Party) to Parliament with a majority for their coalition government and returns President Recep Tayyip Erdoğan to the capital, having won the presidential election with a majority in the first round of voting. The poll was conducted June 7-11 with a 3.5-percent margin of error. While the methodology of the poll is questionable, should the results hold, Turkey may forego months of political uncertainty as it did following the 2015 parliamentary elections.

The kryptonite of investors, uncertainty, is always the worst possible outcome. While the majorities Bloomberg predicts the AK Party to win fall within the margins of error, the data is far better for the current government than earlier polls that had put the AK Party-Nationalist Movement Party (MHP) coalition at under 50 percent. The biggest question mark in these polls has been how the Peoples' Democratic Party (HDP) will perform. The HDP hasn't aligned itself with any coalition going into the election and therefore is vulnerable to falling below the 10 percent minimum threshold to be seated in Parliament. Should that happen, the second place finisher in each district gets the seats the HDP would have received. The AK Party would benefit the most from such a scenario as it is the HDP's main rival in districts where the HDP has support.

The worst possible outcome for investors would be a hung government. This means the president and government would be from opposing coalitions. In this election, President Erdoğan is practically guaranteed to win in the second round of voting even if Bloomberg's predictions of a first-round win do not materialize. This is a factor of the fragmented opposition comprised of parties from polar opposites of the electoral spectrum. Should the opposition parties' coalition plus the HDP, pull off an upset, then it's anyone's guess as to what will happen. Should the parties not agree on a coalition, as was the case in the June 2015 elections, the president would call for new elections that would take place in the late fall. In this election the president would also stand for reelection. This would cause months of uncertainty in the run-up to the elections. Expect a major sell-off if this is the case.

Turkey's electoral fate, ironically, is as much a factor of domestic voter sentiment as it is the Federal Reserve's statement to be released after the conclusion of the Federal Open Market Committee (FOMC) meeting held Wednesday. As this column will go to print before the 9:30 p.m. announcement (Istanbul local time) of the Fed's decision, I can only speculate as to what Fed Chairman Jerome Powell will say. Any indication that Wednesday's Fed hike, which the Fed has all but guaranteed, will be followed by two more hikes before the end of the year, will cause a major rally in the U.S. dollar.

Turkey's central bank has already raised rates 500 basis points in the last two months making any further rate hikes unlikely in the near term. Borrowing costs have sky-rocketed and continued dollar strength would be devastating both for Turkey and the broader emerging market economies. Should the U.S. dollar index spike following aggressive tightening talk from Powell, the Turkish lira would fall to new lows against the dollar. This would cause dollar denominated energy prices to spike on the eve of the Eid-al-Fitr holiday in Turkey invalidating any predictions pollsters have made in recent weeks. The AK Party wins elections on the back of strong economic performance and any weakness in the economy would put this record at risk.

Historically, Turkey's inability to become energy independent and its reliance on foreign imports make it, like nearly all other emerging markets, dependent on the strength of the dollar and dollar-denominated commodities. The only solution to avoid economic crises in Turkey going forward, whoever wins the upcoming elections, is to focus on energy independence and reduce reliance on foreign currency denominated imports.

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