Turkey is anything but a darling of the financial markets. Since President Recip Tayyip Erdogan began tackling rising inflation in 2018 with measures that are the exact opposite of any finance textbook, foreign investors have pulled out massively. A few days before Turkey’s presidential and parliamentary elections, they hold less than 30 percent of Turkish company shares and less than 1 percent of government bonds issued in lira. The risk of losing the money completely is too high.
Because Erdogan’s opinion, according to which lower interest rates would also lower inflation, has led to a decline in the economy and currency. Fueled by the energy crisis, which is also omnipresent on the Bosporus, inflation rose to 86 percent last year. It is now only 44 percent, but this is also the highest value of all industrialized and emerging countries in the world after Argentina. At the same time, the lira falls in value. Most recently, it was at its lowest level against the euro since 2005. One euro is now worth 21.4 lira. A low has also been reached against the US dollar at 19.6 lira per dollar.
What happens if Kılıçdaroğlu wins
This will not change much from Monday. Although international investors are hoping for a victory for opposition leader Kemal Kılıçdaroğlu and a return to normal monetary policy, no rapid improvements in the situation can be expected from this. Because unraveling the chaos that Erdogan has created will take time. Kılıçdaroğlu would have to appoint a new central bank governor who does not follow Erdogan and his ideas. This in turn would have to raise interest rates, which are currently at 8.5 percent. However, as with the ECB and the Fed, this cannot be done in one big step, but would have to be done in many small steps and could take months, if not years. There is another month-long lag before this shows improvements in business or inflation.
Bank analysts expect that the lira will continue to fall even in the event of a major victory for the opposition. The consensus is 25 lira per dollar in the short term, with the currency expected to settle at 23 lira per dollar in the medium term. That would be a minus of around 15 percent compared to the current rate. “Making all the changes overnight would be catastrophic,” explains Cristian Maggio, portfolio manager at Toronto Dominion Bank in London, “there will probably be a series of interest rate hikes first and then, with a delay, easing in trading.” The latter means regulations, for example , according to which companies whose turnover is generated by more than 10 percent in currencies other than the lira are not allowed to get loans in the Turkish currency.
What happens if Erdogan wins
The presidential race in Turkey is close, so another victory for Erdogan is quite possible. That would mean an extension of unorthodox monetary policy and the central bank dependent on the president. In that case, international investors are likely to stay away from Turkey and the lira will continue to depreciate. Inflation would then also not be fought effectively as long as Erdogan does not change his interest rate dogma. However, the negative prospects for Turkey are manageable in this case, because foreign investors have already withdrawn so far from the market that there can no longer be any major outflow of capital – but also no improvement in the situation.
The worst outcome would be a split vote, with one party gaining a majority in parliament but the other winning the presidential election. In this scenario, the President would have far more power than Parliament, but it would still be more difficult to enforce laws. For investors, this would mean the highest level of uncertainty about Turkey’s future course, and uncertainty is something investors usually run away from. Accordingly, the analysts at Morgan Stanley expect “a disorderly and significant adjustment in both the lira exchange rate and the development of interest rates for Turkish bonds” in this case – without putting both into concrete numbers.
