Turkey election Q&A

A foreign investor perspective

Turkey Q&A

With elections looming in Turkey on May 14, I thought it useful to update my views, giving a foreign observer/investor perspective.

I always find it easier to write these things in a Q&A format, so here goes, but these are the things I am typically asked.

Q? So who is going to win the election?

Answer: I thought I might as well cut to the chase, as that’s what you all really want to know.

Opinion polls have long been suggesting a 60-40 probability of an opposition win, but my bias has tended to think, it’s Erdogan, he never loses elections. He is an absolute election machine. He loves campaigning. He is a great, energetic public speaker. And he still has so many rabbits he can pull out of the hat. Turkey still only has a public sector debt/GDP ratio of less than 30%, and the budget deficit was less than 3% of GDP last year, so he can engage in massive lamb barrelling this side of the election. And we are already seeing that with huge hikes in public sector salaries, benefits and pensions, the minimum wage, et al. His low interest rate policies are also being used to pump prime credit to key sectors of the economy and keep unemployment relatively low. He can also play the nationalist card/gunboat diplomacy - he has already done that by stalling on Swedish NATO membership.

And then there is the opposition, with a candidate from the Table of Six (TOS) opposition alliance, in Kemal Kilicdaroglu, who could not be more different from Erdogan - a much weaker campaigner and public speaker, who has a poor track record in elections. His added vulnerability is his Alevi heritage, which might cost him a few, and perhaps critical, percentage of votes from the majority Sunni voters.

True we have seen the greatest show of opposition unity against the ruling AKP for any time over the past 21 years. Incredible indeed that six different parties from very different traditions, from centre left, to nationalist, to former Islamist centrists, are coming together to ally against Erdogan. Even the ethnic Kurdish HDP, albeit not formally part of the TOS, seems to have given the nod to the oppoistion coalition by agreeing not to field its own presidential candidate.

If ever the opposition has/had a chance of beating Erdogan it is now - a unified opposition, a broader desire I think for change after 21 years of rule by Erdogan and the AKP, and a failing economic model of high inflation, a depreciated currency and stop go economic cycles - with the cycles getting ever shorter. Under Erdogan, in the latter years of his rule, and at least for the past decade, Turkey always appears on the edge of economic crisis. Surely the population will now vote for change? And then add in here the question as to whether the electorate will penalise Erdogan and the AKP for the earthquake response, and indeed failings before the earthquake in planning which might have worsened its impact and death toll?

Well maybe, or maybe in an uncertain world, with the war in Ukraine and threats to Turkey from Syria, Russia, the Med, difficult relations with the West, and a strong inherent nationalist/socially conservative core of voters, that they will again vote for what they know. And with Erdogan they know he will strut his stuff on the international stage, batting for what he, and many of them, will view as Turkish national interests.

Will voters opt for the “devil you know” in Erdogan or an untested broad coalition which could easily splinter after elections? And therein Turkey has a poor history of government by coalition - remember the 2000/01 crisis which was to a large extent the result of years of failed coalition government and political patronage resulting from that?

And yet in recent weeks it has felt as though the momentum is with the opposition - the fact the TOS eventually put all their differences behind them and anointed Kilicdaroglu as their join presidential candidate, and the HDP opted not to field its own candidate gave a new found sense of confidence and optimism to the opposition.

But then do we, as foreigners, just get most of our Turkey views thru the prism of typically secular, anti AKP English speaking sources and journalists? And we know Turkey is so polarised and the two communities - secularists and socially conservative Sunni Turks - don’t really talk much to each other. Are we operating in an opposition echo chamber here. Perhaps.

And then I wonder how the image of the TOS with one joint presidential candidate but now SEVEN anointed vice presidential candidates will go down with the electorate. Either the electorate view it as too diverse, complicated and suggesting division and indecision once elected, or eight now political heavyweights campaigning with Kilicdaroglu will just pummel Erdogan thru the campaign.

I am beginning to shift my view, to one where I think Kilicdaroglu can and will win. His chances though suffered a blow with the former CHP candidate in the 2018 presidential election, Ince, opting not to join the TOS and run independently. That likely means Kilicdaroglu cannot secure a first round win, and will go into a head to head run off with Erdogan on May 28. That gives Erdogan a longer campaign which is to his advantage (more time for the lamb to stick) and the ability to cut deals with other political players, even potentially slicing off some of the legs from the TOS - could he offer Aksener a position of prime minister/first PM in a new Erdogan administration?

So at this point in time, I think Kilicdaroglu will win, but it’s not a high conviction view, and it could easily change over the next few weeks.

Bottom line is the election is very difficult to call. I would equally not be surprised at this stage by a narrow Erdogan win or a landslide for the opposition, and if either happens I think I will be “duh, that was obvious, why did I not see that?”

All the above is not very good for readers - having covered Turkey now for 23 years, I am saying basically I just don’t know. And if anything, I am flip flopping.

Q? How is the market positioning for elections?

Answer: Well convictions are low. Foreign investors mostly left local Turkish markets years ago, despising Erdogan’s crazy unorthodox monetary policy views - indeed, local equity/bond exposure has reduced from over $140bn a decade ago to a fraction (closer to $20bn) of that at present. Credit exposure has been underweight for a few years now, and as some optimism of an opposition win builds these underweight positions are being reduced producing credit outperformance over the past month or so, but I doubt few people are betting the bank on Turkey longs on an opposition win in the elections.

The problem is that while an opposition win will likely see a speedy return to orthodoxy, likely making one of the better EM stories for the second half of 2023, the view is that another Erdogan term will be pretty terminal for the Turkish economy. It’s a very binary call at this stage, with big up and downside potential.

On the latter, Turkish has well known vulnerabilities, including a wide current account deficit (>$50bn), a weight of short term debt falling due (>$180bn), limited FX reserve cover (gross FX reserves of just over $120bn, but as most of these are borrowed, net reserves are negative to something close to $60bn). Erdogan’s unorthodox monetary policy views have kept real interest rates heavily negative, hence subduing capital inflows, actually fuelling portfolio outflows, and the BOP has only been balanced by a combination of FX devaluations and calling a friend - borrowing money from friends such as Qatar, Saudi Arabia, the UAE and Russia. The price has been high inflation - falling from a high base at present, but still over 50%.  Muddle thru has been the policy script for the past year, trying to borrow money from autocratic regimes overseas to try and anchor the lira to cap inflation, but this has left the lira again looking overvalued. If Erdogan wins, the question is how he will “balance” the balance of payments for his next term? The general assumption is he will not raise interest rates to defend the lira, so I guess the lira will have to adjust weaker again, perhaps much weaker. The latter will again create concerns around macro financial stability - will the deposit base stay invested, will Erdogan eventually, kicking and screaming be forced to normalise policy? The first move just feels like it would be weaker on an Erdogan win, and then we will have to see just how bad it gets before Erdogan does something to try and stabilise the situation.

Q? What happens if the opposition win the election?

Answer: Well the names being touted to lead the opposition’s economy team are all credible, orthodox and well known to the market - Bilge Yilmaz from the IYI party, Babacan/Canakci from the Deva party, and potential replacement central bank governors (Hakan Kara, Illker Domac). Assuming an opposition win, I think this team will move to quickly normalise monetary policy - hiking policy rates to 25-30%, at least. They will benefit from a credibility reserve, the markets will trust them. The lira will be more market determined. Capital inflows will return, but likely the desire to rebuild central bank reserves and close the negative NIR position will weigh on the lira over the longer term. Companies are already complaining about an over-valued exchange rate, and unlikely the new team will want capital inflows to drive yet more over-appreciation.

Question markets I guess will revolve around broader coalition unity. Can a six party coalition really work and, to subdue inflation, tighter policy will be required which means lower growth, and higher unemployment. Perhaps the latter can be alleviated somewhat by an expected surge in inflows of foreign direct investment from Europe and the West more generally, as the business environment is expected to improve.

I personally don’t think the post Erdogan economic adjustment will be that difficult with a return to orthodoxy and with a credible team in place. Question marks will lie around potential skeletons in the cupboard - rate hikes will hurt banks on their securities portfolios, and questions will abound about the quality of the state owned banks asset quality. Some bank recapitalisation will be required but with a starting point of public debt only around the 30% of GDP level, there is plenty of slack to absorb potential losses and state bailouts going forward.

Q? What about the relationship with the West?

Answer: Well Erdogan has obviously been trying to play Russia, the West and the Gulf states off against each other to secure financing to get him thru this election cycle. Tensions abound on a range of issues with the US, particularly over Finland and Sweden’s NATO membership, alignment with sanctions on Russia, Syria, et al. The West has struggled to figure out how to play Erdogan in the run up to elections, despite obvious concerns over human rights, rule of law, relations with Russia, et al. In the end the West has opted for a non confrontational approach, not risking playing into Erdogan’s hands by gifting him an election win on the lines that the West is trying to influence the election and ensure his defeat. Clearly the West would love an administration in Ankara more aligned with Western interests, but it is going out of its way not to be seen to do anything which might be construed as support for the opposition. Perhaps the West also knows  that this election is knife-edge, and they might still have to deal with an Erdogan administration after these elections. So the West is just playing for time, hoping that the elections might spring a positive outcome, where a new administration in Ankara would be more closely aligned with Western interests. This may not be the case even with an opposition win, given the IYI party is strongly nationalistic in orientation and would favour a more independent foreign policy line, closer to that currently pursued by Erdogan.

Encouragingly, the Turkish Parliament finally ratified Finland’s NATO membership. And the hope is that after the election, it will also sign off on Swedish NATO membership. The latter will be critically important for the US and indeed other European powers, and post election I think huge pressure will be then placed on Ankara (whoever wins) to sign off on Sweden’s NATO bid but also to push Turkey to signal more clearly whether it still wants to be in the Western club, or wants to continue to pursue a much more independent line, with its own stronger relations with Russia and the Gulf. But whereas I think the West has held back from pressurising the Erdogan administration on this before the election, for fear of creating a voter backlash in favour of Erdogan, I think post election the West will have less to lose, and will push Turkey to decide whether it wants to be in the Western alliance/orbit or not. Sanctions on Turkey, post elections are possible, to push Ankara to make the right decision. And I think Turkey chooses the West primarily as the war in Ukraine has brutally exposed the West’s technological advantage in defence. Before the war in Ukraine, Russia had appeared as an alternative supplier of high end military technology to Turkey - for example S400s - but I think this conflict has brutally exposed the limits of Russian military technology and kit. If Turkey wants to maintain its military capability, with high end military kit, it’s only really the West that can provide this, unless Ankara wants to look much further afield to China. Even then, the performance of even second generation Western military technology in Ukraine against what was claimed to be fourth or even fifth generation Russian kit has been so superior, that the Turkish military surely will pressurise the next administration in Ankara to smooth relations out with its erstwhile Western allies, to access this technology - e.g. F16 upgrades.

Net net, whoever wins this election is likely to have to make a choice as to in which strategic orbit Turkey falls, and I think Ankara will have little option but to look back West. That’s a plus from a longer term investment perspective.