Complex Made Simple

The game changer Istanbul election and the fate of the Turkish Lira

Does the Municipal election defeat of President Erdogan change anything for the outlook of the Turkish Lira and economy?

Turkey faces 20% inflation, a collapse of the Lira, $178 billion in external debt due in 2 years, a surge in borrowing costs, and more Erdogan will be tempted to increase public spending to squeeze Istanbul’s new mayor, meaning a higher budget deficit The Turkish lira has rallied to 5.77 against the dollar, and the Borsa Istanbul also soared 2.5% to trade above 96,000 points

By Matein Khalid: Chief Investment Officer and Partner at Asas Capital  

There is no doubt that the victory of Istanbul’s opposition mayor Ekrem Imamoglu is a game changer event in Turkish politics, on par with the 2016 abortive military coup d’état, the breakdown of Ankara’s ceasefire with the secessionist PKK in eastern Anatolia or the Constitutional amendment that enabled President Erdogan to become the most powerful autocrat-politician in the Turkish Republic since the death of Mustafa Kamal Ataturk in 1938. As Ekram Pasha said in his victory speech, “we want to start a new chapter, a new era in Turkish politics.” For the first time in two decades, President Erdogan faces a credible political opponent. 

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This was no mere municipal election but a devastating public rejection of President Erdogan’s recent authoritarian, even autocratic policies and attitudes. Turkey faces an economic abyss – 20% inflation, a collapse of the Lira, $178 billion in external debt due for repayment in the next two years, a surge in borrowing costs, panic buying of the US dollar and gold, an embryonic banking crisis, failed diplomacy in Washington, Berlin, Brussels, Cairo, Riyadh and the Gulf capitals (ex Qatar), new conflicts in Syria, northern Iraq and Cyprus.

It is ironic that President Erdogan and the AKP’s political ascent began after he was elected Mayor of Istanbul, when Turkey was still a secular Kemalist parliamentary democracy still emerging from the shadow of General Kenan Evrens’ military dictatorship. The public in Turkey’s most educated, most sophisticated cities – Istanbul, Izmir, Ankara – has now totally rejected Erdogan’s brand of authoritarian rule and Islamist populism. Erdogan had annulled Ekram Imamoglu’s victory in the original March municipal election in Istanbul but the rerun only increased the Republican (Jamhuriyet) Peoples Party candidate a much higher margin of victory, with 54% of the vote. Amazingly, for the first time, the Republican Party, once a bastion of secular Kemalist values and aggressive Turkish nationalism, won votes even in the impoverished, pious districts of Istanbul like Laleli and won the votes of ethnic Kurds (known as “mountain Turks” in the nationalist lexicon). 

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The opposition win in Istanbul, the former capital of the Ottoman sultans and the Byzantine emperors, the fabled Constantinople of history and myth, means the fault line in Turkish politics between the AKP and the Jamhuriyet Party (CHP) now runs through the Bosphorus. Ekrem Imamoglu, who thrashed Erdogan protégé ex-Prime Minister Binali Yilderim, in his home city – is now a credible future post-AKP Turkish President.

In retrospect, Erdogan made a strategic mistake when he bullied the courts to order a rerun of the March election.  As Erdogan himself has said “if we stumble in Istanbul, we lose our footing in Turkey” – and a 9 point loss (45 – 54) in Istanbul last week was the biggest stumble of his political career.

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There will be profound economic consequences from Mr Imamoglu’s decisive win. One, the AKP has lost control of Istanbul’s $4 billion municipal budget and vast patronage networks. Two, Erdogan will be tempted to increase public spending to woo voters even as he uses the court, media and banking system to squeeze Istanbul’s new mayor. Three, this means a higher budget deficit and governance gridlock between Istanbul and the Ankara-based AKP high command.

The Turkish lira has rallied to 5.77 against the US dollar after Ekram Imamoglu’s decision win in Istanbul. The Borsa Istanbul also soared 2.5% to trade above 96,000 points as Istanbul erupted in celebrations, a vote of confidence in the new opposition Mayor. Since the US Dollar Index has fallen to 96.50 after the Powell Fed’s dovish message at the June FOMC and the plunge in US Treasury bills, notes and bond yields, emerging market currencies naturally got a bid on Planet Forex. However, Imamoglu’s win does not change the ugly financial realities of the Turkish economy in June 2016 – a dangerous dependence on offshore hot money, a politically impotent central bank, a credit-fueled construction boom gone badly wrong, a high risk of hyperinflation, a draconian external debt, a sovereign credit vulnerable to multiple downgrades, a new Kurdish revolt in Anatolia and 3 million Syrian refugees who cannot return to Syria even as the siege of Idlib triggers a brutal death toll. 

The Turkish lira will continue to tank against the US dollar as long as relative inflation rates diverge on such a colossal scale. However, as long as the US dollar remains weak, I prefer to buy the Brazilian Real against the Turkish lira on prospects for pension reforms in Sao Paulo. In foreign exchange, it is mission-critical to pair the strong with the weak in both G-10 and emerging market currencies. That much, at least, is certain.