Turkey Watch – A most decisive moment

by: Nora Neuteboom

  • Turkey is set to hold two crucial elections soon
  • Economic issues and a well-organized opposition will make the outcome a close call
  • Our basecase scenario is that Erdoğan will win the presidency, …
  • … but the AKP will fail to gain a majority in parliament
  • This result will not be positive for markets and pressures on the lira will remain
  • The elections come at a tough moment as the economy is at a turning point…
  • … and during the economic slowdown, there is very little room for policy mistakes
180621-Turkey-Watch-A-most-decisive-moment.pdf (260 KB)

This publication has been written in cooperation with Barry Jongkees (SIM – Intelligence Specialist) Barry.jongkees@nl.abnamro.com

This report has been written with helpful contributions from Marc Guillit (Turkey reporter), Sena Dora (country risk officer, ABN AMRO) and Cagatay Yalcin (financial institutions risk officer, ABN AMRO).

Turkey is set to hold two crucial elections…

On 24 June 2018, Turkish voters will cast their ballots during simultaneous presidential and parliamentary elections. The outcome of these elections will have significant consequences for Turkey. Central to the election are the controversial 2017 constitutional amendments, which established a presidential system with few checks and balances on executive power. If sitting President Recep Tayyip Erdoğan is re-elected, he could theoretically remain in power for another decade without significant obstacles. Meanwhile, the opposition considers this election as its final opportunity to unseat Erdoğan and his Justice and Development Party (AKP) and undo their Constitutional changes.

…and there are three potential outcomes

When the president called early elections back in April, the overall consensus was that he would likely be able to secure a (relatively) straightforward victory. The opposition struggled to respond as they lacked candidates and even a clear electoral programme. Erdoğan may have also hoped that the early elections might enable him to pre-empt any negative impact on his popularity from a potential decline in Turkey’s economic performance. However, his constituency is already feeling the effects of the recent currency crisis and the clear signs of an overheating economy. As a result, the outcome may be more of a close call than previously assumed. In this report, we will outline the background of these elections and sketch three potential scenarios for how they might play out:

Scenario 1: Erdoğan and AKP gain a majority
Erdoğan wins the presidency (in the first or, more likely, second round on 8 July in the event there is no majority winner) and AKP wins a parliamentary majority

Scenario 2: Opposition candidate and opposition parties gain a majority
An opposition candidate wins the presidency and the opposition electoral alliance attains a majority in parliament

Scenario 3: Combination of scenario 1 and 2
Erdoğan wins the presidency but the AKP fails to gain a majority in parliament

The opposition has managed to rally…

Turkish opposition parties have managed to organise themselves after their initial struggle to respond to the early elections. The main opposition Republic People’s Party (CHP) put forward Muharrem Ince, a former teacher who is described as a highly spirited opposition speaker. Ince’s modest background and open practice of Islam is a clear break from the perception that the CHP was a secular elitist party that was out of touch with ordinary Turks, which inhibited its electoral appeal. His energetic speeches also illustrate something that has been largely absent from opposition campaigns since the AKP came to power in 2002: optimism and self-belief.

Another contender is Meral Akşener of the İyi (Good) Party, who split from the Nationalist Movement Party (MHP) in 2017. Like the CHP, she supports undoing the Constitutional changes and advocates for better rule of law. However, while the CHP has reached out to the Kurds, the Good Party is strongly nationalistic and has taken a more robust line. Rounding out the frontrunners is Kurdish opposition party leader Selahattin Demirtaş, who is campaigning from prison following his conviction for alleged ties to the Kurdistan Workers’ Party (PKK).

Breaking with past presidential elections, the opposition has decided not to put forward a single candidate in the first round. This may ultimately prove an advantage. In the past, the opposition has struggled to generate turnout for a compromise figurehead owing to their policy differences, to the benefit of Erdoğan.

…but faces several hurdles

While the opposition therefore presents a more formidable challenge to Erdoğan than in previous contests, the scales are still very much tilted towards the incumbent. For starters, the extensive state control over the media results in highly uneven coverage, both in terms of time accorded to the opposition/Erdoğan as well as the slant of reporting. Secondly, past elections saw reports of intimidation at voting booths and alleged ballot stuffing. Thirdly, the ongoing state of emergency (in place since the July 2016 coup attempt) has led to the location of voting booths at great distances from Kurdish population centres in the southeast. Fourthly, although there are growing signs of opposition to Erdoğan and his policies, he remains the country’s most popular politician and still enjoys significant support, particularly as he has branded himself as the sole leader capable of defending Turkey from its many (real or imagined) domestic and international enemies. Over the last year, Erdoğan’s popularity increased substantially in the wake of the military operations in Syria. Therefore, there is a risk he will launch similar actions against the Kurds in Northern Iraq just ahead of the elections.

It will be very tight, but scenario 3 is the most likely outcome

The introduction of electoral alliances will play a key role. Under this system, parties that fall under the 10% electoral threshold will still gain seats in parliament if they are part of an alliance. The CHP and Good Party have aligned themselves with the Felicity Party (which has the same Islamist roots as the AKP) and the Democrat Party. This is likely to dilute the number of seats gained by the AKP, as it has benefitted in the past from snapping up the seats gained by those parties failing to breach the threshold. The HDP falls outside of the opposition alliance and will therefore still have to attain 10% of the vote. As such, all depends on whether the HDP reaches the 10% electoral threshold (it is not part of the opposition alliance and therefore still subject to this hurdle). If it does, AKP will not have a majority in parliament. It is expected that the Kurdish turnout will be high regardless of the large distances to voting booths, as most will be keen to vote given the widespread belief that Demirtaş was (in their view) unjustly imprisoned by the current administration.

As local reports suggest that some opposition voters are strategically choosing to vote HDP, we assume that the AKP will not gain a majority in parliament, nor will there be a majority for any specific presidential candidate. This will result in a second round of the presidential elections, to be held two weeks later on 8 July. Although the opposition electoral alliance has few links other than their rejection of the constitutional changes and desire to unseat Erdoğan, it will be still be hard for them to collectively rally behind a single opposition candidate in the run-off second round vote. Some of the constituency of the İyi party in particular may feel more closely associated with Erdoğan than, for instance, Ince. Combined with the aforementioned factors favouring the incumbent, Erdoğan will be the most likely winner in a second round, resulting in scenario 3.

Both scenarios 1 and 3 result in a continued weak rule of law…

If Erdoğan wins the presidency and retains a majority in parliament (scenario 1), we can expect a continuation of the president’s policy trajectory from the past years, in the absence of any noteworthy checks and balances. In this case, the media and courts are likely to remain under significant state control. Although we anticipate that President Erdoğan will likely slightly ease repression after a secure win (for instance by lifting the state of emergency or revising some decrees issued thereunder), Turkish society will remain polarised and tensions are unlikely to fade in the foreseeable future. Likewise, Ankara’s relations with its allies in Europe and the United States may be expected to remain tense, particularly if there are indications of electoral tampering.

Scenario 3 would underline the enduring popularity of Erdoğan as a leader, but this would be coupled with a signal that the public seeks to somewhat curb his power. The president has indicated that he would not tolerate a hung parliament, stating that he would call snap elections akin to the situation in 2015 when it appeared that the AKP needed to form a coalition. Yet this carries significant risks for Erdoğan. The economy may well continue to worsen in the meantime, and a rerun of parliamentary polls also requires a new presidential vote. Yet even if the president were to agree to ‘cohabitation’, an opposition-led parliament could not significantly oppose him unless they won a two-thirds majority (which is highly unlikely). Without such a majority, he can continue to issue presidential decrees on numerous policy issues without parliamentary approval.

…and this will not be positive for markets

As Erdoğan has generally pursed market-unfriendly policies by seeking lower interest rates, the market will likely not react positively to either scenario 1 or 3 (although some of this has likely already been priced in). Moreover, Erdoğan’s comments inferring he will take greater control of the economy after snap elections have deepened investors’ worries. Therefore, much depends on Erdoğan’s stance after the elections. If he continues to put pressure on the central bank and to hide behind the high growth numbers without dealing with the increasing imbalances, investors will become more bearish on Turkey. Furthermore, scenario 3 will only further increase uncertainty given that Erdoğan, as President, may use his executive powers in some areas while other regulatory bills will bog down in a parliamentary deadlock.

Further pressure on the lira will remain

As Turkey is highly dependent on foreign capital inflows and thus investor confidence, both scenarios have the potential to push Turkey further down the road towards another currency crisis. Turkey’s annual external financing requirement – reflecting the current account deficit and maturing debt – sits at USD 200bn. FX reserves are around USD 80bn (liquid reserves are estimated to amount to only around 50% of the total reserves). The external financing requirement has so far largely been covered by volatile portfolio flows. However, if Erdoğan remains president (with or without a parliamentary majority for the AKP) and investors become more risk averse on Turkey, these portfolio flows can easily be withdrawn, putting further pressure on the lira (See: Turkey Watch: Turkey in crisis – Q&A on our different crisis scenarios for Turkey). Therefore, we do not exclude the possibility of another currency crisis if the outcome is scenario 1 or 3.


Scenario 2 will have positive effects on rule of law

Alternatively, it is possible that an opposition candidate (likely Ince) will win against Erdoğan in the second round, and that the opposition coalition will attain a parliamentary majority. In this scenario, we expect the new president to implement measures to undo the constitutional changes, as well as some of the reforms that have curbed judicial independence and media freedom. However, the coalition’s internal policy differences are likely to cause friction beyond these points of agreement. Notably, restarting the Kurdish peace process will prove difficult. Given the extent of polarisation in Turkish society, the coalition would also struggle to reach out to ardent Erdoğan supporters. In terms of foreign policy, the new Turkish government may be expected to moderate its assertiveness towards its Western allies.

Investors would be generally relieved by scenario 2, as the opposition presidential candidates are expected to pursue investor-friendly policies. Furthermore, they would clearly be comforted by a better relationship between Turkey’s leaders and the West.

However, none of the scenarios will save the economy from spiralling downward…

In all three scenarios it will be difficult for Turkey’s leaders to redirect Turkey to a more sustainable growth trajectory. The internal and external imbalances that have been building over time are difficult to reverse. Clear signs of overheating have appeared as Turkey posted 7.4% GDP growth over the course of 2017. Credit growth contributed around 1.5%-2% to GDP growth in 2017 on the back of the relaxation of macro-prudential policies (lowering provisioning requirements for loans), the set-up of the Credit Guarantee Fund (CGF) and loose monetary policy. The first cracks in the system are already visible. Property prices are declining in real terms. A broader definition of impaired loans – including restructured credits and NPLs sold to third parties – currently stands at 8% of all loans, signalling deteriorating loan quality. Furthermore, according to the latest article IV report by the IMF, there are clear indications that most of the outstanding CGF-backed loans has been used for working capital and rolling over existing debt, instead of productive investment. The combination of higher interest rates (one-week repo stands at 17.5%) and the CGF almost depleted, credit growth will slow substantially, leading the way for slower growth, regardless of the outcome of the elections.

… and there is very little room for policy mistakes

Turkey must recalibrate its macroeconomic policies in such a way that they reduce the aforementioned vulnerabilities and drive the economy towards a ‘managed slowdown’, rather than pushing it into a serious crisis. This will entail cautious monetary and fiscal tightening, in combination with structural reforms aimed at improving Turkey’s competitiveness. While not impossible, such a ‘managed slowdown’ strategy requires delicate economic policymaking, which may prove difficult in the midst of high domestic political polarisation in this geopolitically unstable region.