Turkey’s economy is heading in the wrong direction. Several years of questionable policy decisions by President Recep Tayyip Erdogan have financially battered the country, which currently faces mounting debt loads, rising current account deficits, muted international investor interest, a weakening lira, high inflation and sluggish growth.
A devastating earthquake in February that killed nearly 50,000 Turks compounded those woes and increased the pressure on Erdogan as he faced the toughest election since coming to power as prime minister two decades ago.
The opposition alliance, led by the mild-mannered technocrat Kemal Kilicdaroglu, seemed well-positioned to deliver a slim victory going into the May 14 vote. Turkish public polling clearly favored the opposition leader and the mood among many Turkey-facing investors was cautiously optimistic.
An outright victory for Kilicdaroglu was not to be. Erdogan once again displayed his formidable skills as a political operator and his appeal to large swathes of the Turkish public even amid tough economic times, including an average annual inflation rate of 75% in 2022.
After the first round of voting, Erdogan narrowly missed hitting the 50% majority that would have ended the election, garnering 49.5% of the vote. Kilicdaroglu came in at 44.9% of the vote. The vote will move to a run-off between those two main contenders on May 28. Erdogan is widely tipped as the front-runner, flush with momentum from his own votes as well as his party alliance’s strong showing in Parliamentary elections.
Regardless of who wins, Turkey needs to pick up the pieces of its battered economy. Perhaps most importantly, the country needs to find “a new equilibrium,” said Ugras Ulku, head of emerging Europe research at the Washington D.C.-based Institute of International Finance. This would focus on “price stability, orthodox policies, and exchange rate stability.”
Without this “new equilibrium,” foreign investor interest will remain muted. What’s more, Turkey will grow increasingly reliant on its improving ties with several Gulf Arab states, notably Saudi Arabia and the United Arab Emirates as well as its traditional ally, Qatar, and currency swap lines with major players like China and South Korea, Ulku noted.
In March, Saudi Arabia deposited $5 billion in Turkey’s Central Bank, reflecting its “commitment to supporting Turkey’s efforts to strengthen its economy,” the Saudi Fund for Development said in a statement. In 2021, the United Arab Emirates announced a $10 billion strategic fund to support investments by its entities in Turkey.
Traditionally, Qatar has been Turkey’s main Arab world ally and funder. A series of currency swaps between the two countries bolstered Turkey during recent difficult times. The close Ankara-Doha relationship exacerbated strains in Turkey’s relations with Riyadh and Abu Dhabi amid their dispute with Qatar that saw the severing of ties in 2017. Rapprochement among the Gulf Arab states in 2021 paved the way for new support from Saudi Arabia and the UAE for Turkey.
In the face of rising inflation, Erdogan has pushed his Central Bank governors to cut interest rates, rather than pursue a more orthodox policy of raising them to battle rising prices. Soaring inflation has eased slightly this year, dropping to a still formidable 43% in April, according to Central Bank figures.
Turkey will need to tighten its fiscal belt and tame inflation, but Erdogan seems wedded to his unorthodox monetary policy. Ulku notes that Turkey may have no choice but to move toward more orthodox monetary policy — raising rates to tame inflation. “If Turkey fails to attract sufficiently large net foreign funding to pay for imported inputs, which are needed for its manufacturing industry and thus exports, output growth will weaken while the depreciation pressure on the Lira will intensify,” Ulku said.
Erdogan — or whoever emerges from Sunday’s vote — will need growth, Ulku noted, because the election season is not over. Municipal elections in March 2024 will be the latest litmus test for the ruling establishment, and no leader will want to enter those elections with a deteriorating economy.
Is Erdogan capable of a major policy U-turn? Gonul Tol, the Director of the Turkey program at the Middle East Institute, notes that “Erdogan never pays a price for the U-turns he makes.” In her recently published book, Edrogan’s War: A Strongman’s Struggle at Home and in Syria, Tol paints a picture of Erdogan as an evolving figure with little ideological core, moving from a conservative democrat to an Islamist and now a Turkish nationalist.
He is also, Tol notes, “an entrenched autocrat” who controls much of the media and has a playing field heavily tilted in his favor. These factors contributed to his re-election.
Erdogan’s command of the system may also give him some wiggle room if he chooses to make a policy U-turn. But even if Erdogan shifts to more orthodox monetary policy — and that remains a big “if,” — Ulku wonders “how convincing that will be to foreign portfolio investors.” Ulku and other analysts note that the high degree of uncertainty regarding Erdogan’s policies scares off all but the most targeted foreign portfolio investors.
Sergey Dergachev, functional head of emerging markets corporate debt for Union Investment Privatfonds GmbH, who is based in Germany, said he remains “constructive” on Turkish corporate debt, though his firm is “light” on sovereign debt. “We are on the sidelines waiting to see the next round election results,” he said, and noted that any signal that Ankara is rethinking monetary policy would be well-received by the investor community.
Regardless, Dergachev points out that the Turkish corporate landscape has developed robust risk management models and lauded their “resilience to shocks and low degree of leverage,” particularly Turkish exporters seeking out new markets in South, Southeast and Central Asia.
As for Turkey’s impact on the broader emerging markets landscape, Malcolm Dorson, head of emerging markets strategy for Global X ETFs, noted the country remains a small member of the asset class, so he sees little impact. He points to its recent sizzling stock market run as “an inflation hedge,” as Turkish investors poured money into stocks as it lost value amid rising prices.
Dorson fears that Turkey could face an “Argentina situation” on the issue of possible capital controls. They are not there yet, but he notes that “if their synthetic currency controls implemented by the banks turn into real currency controls implemented by the law,” there could be trouble. Continued capital controls in Argentina led the MSCI Index to drop its status as an emerging market. Turkey — along with 23 other countries — is currently a member of the MSCI Emerging Markets Index. Argentina was dropped in 2021.
Dorson suggests investors look more closely at Turkey’s eastern Mediterranean neighbor, Greece. This nation, too, recently held an inconclusive election. But the front-runner, Prime Minister Kyriakos Mitsotakis, won praise from markets for rebuilding Greece’s battered economy. Greek debt is on the verge of an upgrade to investment grade this year, Dorson noted, and a tourism rebound, high-performing banks and EU financing position Greece well for the future.
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