Imamoglu’s arrest raises numerous red flags

But the CBRT will respond in an orthodox fashion

News this morning that Ekrem Imamoglu, the mayor of Istanbul and the contender seen as most likely to run President Erdogan hard in the next election, was arrested raises red flags on many levels.

First, it raises obvious concerns around the direction of travel in terms of rule of law, democracy and human rights in Turkiye. The ruling AKP will argue that they are upholding the rule of law herein as they will claim that evidence of corruption by Imamoglu and those also arrested has been unearthed. They will also note that others have been arrested on similar claims, including some seen as a close to the ruling party, including the son in law of a well known Islamic scholar. Cynics will argue that the political coincidences herein are just too obvious - and argue that Erdogan wants to take out his closest political rival before elections. The Turkish authorities will have to reveal compelling evidence to dispel these fears.

Second, there must now be fears over political and social stability. Imamoglu is a revered figure in opposition circles and beat the ruling AKP’s candidate by a wide margin in last year’s local elections. He is popular and has a strong following. While a ban has been placed on demonstrations for 4 days, I think the fear is of large scale protests by the opposition this weekend with the fear therein that they could evolve into something Gezi like. Likely though we will also then see large counter demonstrations by pro AKP supporters and this could all end up in a scenario of duelling protests. The risks of demonstrations being mishandled is real.

Third, the market will be concerned how this all plays out with Western allies. Will Imamoglu’s arrest produce criticism, even sanction, from the US and Europe? I think therein it is unlikely that President Trump will feel inclined to come out strongly in support of Imamoglu. Trump seems to respect strong man leaders like Erdogan. Trump also needs Türkiye to deliver on his promise to pull US troops out of Syria, and Türkiye is an important player in the Russia - Ukraine peace process. I doubt that Trump would want to rock that boat. Plus also with rising U.S. tensions with Iran, and risks perhaps of a U.S. - Israeli strike on Iran, Türkiye could well prove to be an important security partner for the US on this particular front, given the presence of US military bases in Türkiye. Criticism from Europe is also likely to be muted, given the increased importance of Türkiye now both in the Russia - Ukraine peace process, where it is hoped that Türkiye might provide troops for a reassurance force, but also in terms of European defence Türkiye can provide military forces and access to its military industrial complex to help counter the threat from Russia. Understanding that the U.S. and Europe would be muted in response to Imamoglu’s arrest likely influenced the timing of the move this week. Events this week might though further delay progress in negotiating a new Customs Agreement between Turkiye and the EU.

Fourth, markets which had been positioned long lira (local and offshore) reacted badly, as expected, to today’s news. The lira dropped 14% at one point before recovering some of these losses. The concern then is obviously how this plays out in terms of the CBRT disinflation process, and could this undermine the CBRT’s relatively new found independence? Actually on this front I think it likely reinforces Simsek’s position as Erdogan will not want a financial crisis to run alongside a political crisis. I expect the response from the CBRT to be very orthodox and I think we have already seen that so far this morning. Initially the CBRT let the lira find its own level, hence the 14% fall on the unexpected news, then likely followed this through with intervention, which pulled the currency back from the lows of 42 to the dollar to 38+. I think the CBRT will likely further intervene verbally in defence of the lira - perhaps suggesting that all options, including rate hikes, are on the table in defence of macro financial stability. The CBRT certainly has plenty of FX reserve ammo to defend the lira at this stage, with gross reserves now of well over $150 billion. But I think if lira weakness sustains, I think the CBRT will respond with rate hikes. I think the CBRT has the mandate to act, given the realisation that inflation is a major political liability for Erdogan. Therein I would note that even after sidelining Imamoglu, if inflation remains high I think Erdogan will still struggle to win re-election which I think was one lesson from local elections last year. So the CBRT will act - literally doing whatever it takes to stabilise the lira and bring back the focus on fighting inflation.

Rule of law concerns will though persist and this will likely damage longer term foreign direct investment flows - which are already low - unless the AKP administration is able to produce a compelling case against Imamoglu, et al.

The AKP administration will likely respond to all this by focusing now on the good news around the Kurdish peace process, and events moving in Turkey’s favour therein in Syria. Clearly Erdogan sees an alliance with Kurdish parties as a means to secure constitutional reform so as to be able to run for another term in office, plus an alliance with Kurdish groups in elections might expose vulnerabilities for Mansur Yavas, the nationalist the mayor of Ankara lileky now seen as the mostly likely candidate to run against Erdogan as the CHP candidate in the next election.