Turkey - a critical election looms

For me these are really now defining elections for Turkey, for Europe and Western security and also for broader EM.

For Turkey, these could be the last real elections held under a fully Western liberal democratic system. Turkey is still just about a democracy, despite the erosion of democratic norms (over-concentration of power, erosion of checks and balances, arrest of opposition leaders) and the rule of law over years now by Erdogan. The political system has now been managed over years to the advantage of Erdogan and the ruling AKP – 90% domination of the TV media, new election law, opposition leaders barred from running or in jail – but votes are just about still counted, more or less fairly. Another win for Erdogan and I just don’t see a perspective for any opposition win in the future. Turkey will be a very different country, with no perspective of anything other than the ruling party/family – more Central Asian than European. Notable that over the weekend Erdogan welcomed Azeri leader Aliyev at an election rally and indeed the Azerbaijan model might be the future for Turkey with a very managed political process. 

For regional security, I think an opposition win could pull Turkey back in the Western/European orbit, away from Russia, and could see NATO strengthened. Indeed, if the opposition win I think we see a huge new reach out to Turkey by the West, a real love fest from NATO and the EU – as a snub to Putin. Suffice to say a win for Erdogan will be welcomed by  Putin, and the Gulf powers, seeing him as a useful counterbalance to the West.

And I think if Erdogan wins again I think we could see a crisis in relations with the West. The West has tried to stay out of these elections not wanting to show its real preference for the opposition for fear of gifting Erdogan a campaign nugget of saying the West is interfering in elections. No longer fearful of gifting Erdogan any advantage in the election I think the West will push a new Erdogan administration to chose between East and West with the first such pressure point being the decision on Sweden’s NATO entry. Added bite will likely be provided by a real risk of sanctions on significant Turkish entities in aerospace and logistics for sailing too close to wind in trade with Russia.

Broader EM? An opposition win opens the prospect of an actual bottom up, good news story in EM. I think we see a reform administration, re-aligning back with the West, and a wall of money coming back into Turkey as policy is normalised.

BUT – this election is the most difficult to call, in all the 23 years I have covered the country.

Erdogan is trailing in the polls still, but within reach of the opposition candidate, Kilicdoroglu. I recking it is likely going to be 44-48 to Kilicdoroglu in the first round, and its maybe 51-49 to Kilicdoroglu in the second round, but I have low conviction on anything here. But that’s at this point in time with a sense that momentum is moving in favour of Erdogan. The above ratios are hence fluid.

A few of factors:

• Parliamentary elections will be called first, on May 14/15, and likely this will see a hung parliament. If that happens, Erdogan will play the “you cannot trust a weak opposition leader in that scenario to stand up for Turkey, trust me, a strong leader”. 

• Actually if Erdogan takes it to the second round, that’s a win for him, as many people had predicted a Kilicdoroglu first round win. Erdogan will have momentum on his side.

• In the second round, Erdogan can play games to split the opposition and take off either Kurdish or nationalist votes – as he did between the June and November elections in 2015. A hung Parliament with the casting votes held by the HDP and supporting the opposition will be a gift to Erdogan as he will argue that only by voting for him in the presidency will rule by Kurds be avoided.

• Erdogan has lots of fiscal space still to bank roll, and he has done so much already with huge hikes in pensions, the minimum wage, benefits, and public sector salaries.

• Erdogan can still play the nationalist card – gunboat diplomacy somewhere, and Turks are pretty nationalistic when it comes to a range of issues – Kurds, Armenians, Syria, Greece, Europe, et al.

• Erdogan is already playing on Turks’ nationalist heart strings by running a campaign playing up industrial achievements like production of Turkey’s first aircraft carrier, unmanned jet fighter, electric car - TOGG, gas supplies flowing from the Black Sea, et al.

• Erdogan is just a brilliant campaigner, great public speaker, while Kilicdoroglu is not.

I find it near impossible to call this election, but Kilicdoruglu likely has his best chance to win in the first round, but if he fails, then momentum likely shifts to Erdogan in the second round.

What I am convicted in though is this is a binary market/macro outcome: 

1. Erdogan win – markets sell off, as BOP does not add up, Erdogan will not hike rates in defence of the lira, so its either a) call a friend (Putin, MBS, MBZ) to get more FX reserves to defend the lira; b) capital controls; c) let the lira sink. I think he does the latter and I think we see real macro-financial risks building here. Risk of bank runs, et al, before Erdogan relents and hikes rates. Lira sinks to 35+, Turkey credit back near record highs. Note also I expect a crisis in the relationship with the West, post election.

2. Opposition win, see above, I see a love fest with Turkey from the West – they do let the FX adjust to a more competitive level, say 25-30, but then hike rates to 40%, and we see a wall of portfolio money back into the Turkey game, CBRT meets that with intervention to rebuild reserves, but the lira holds relatively stable then at the depreciated level as above (25-30). But we see new FDI flows and “other investment flows” back into Turkey, plus reverse currency substitution. I see issues longer term around a six party ruling coalition, but not thru to the local elections next year. They hold their stuff together until then. They might even go to the IMF for a backstop.

And what about a contested election/cohabitation? These are negative scenarios for sure. But I don’t see them. Turkey is a presidential democracy and really whoever wins the presidency I think will see the parliamentary majority migrate to them thru defections from the rival camp. Contested election? Possible, but I think assurances have been given to Erdogan that he is safe from prosecution if he loses. If he contests it, then all bets are off and then his relationship with the  West is dead. I don’t think he would risk that – as is, he can retire, and still remain a political force, perhaps coming back in local elections next year or even early general elections. He might try tricks to acquire 1-2% of votes to win, but if we wake up and the vote is 51-49 to Kilicdoroglu, I think Erdogan walks.

Feedback very welcome.