Local political developments can play a tremendous role in the direction of economic and financial market trends in emerging markets. Arguably, Turkey is the best example of how local politics can influence economic prosperity as well as local financial markets.
For years, a lack of central bank independence, economic policy overly focused on GDP growth, and an unorthodox monetary policy framework, all influenced heavily by President Erdogan, led to sustained and substantial lira depreciation and pushed sovereign financing costs sharply higher. The result has been hyperinflation, a collapse in household purchasing power, and underwhelming growth for a highly developed emerging market economy. By no means is Turkey the only economy–emerging or developed–to be bogged down by politics. But, with Turkish presidential and parliamentary elections approaching in the coming months, local politics could evolve in a way where the outlook for Turkey’s economy and financial markets could alter dramatically, and potentially for the better.
General elections are set to take place in Q2-2023, and while the actual date is still to be determined, May 14 appears to be the most likely timeframe. Typically, we would note that the outcome of the presidential election is not as important as parliament/congressional elections; however, with President Erdogan controlling the overarching policy direction for Turkey–especially economic and monetary policy–the presidential election is likely more consequential this time. In our view, President Erdogan’s re-election prospects have declined over the years; however, the recent devastating earthquakes across southern and central Turkey complicate his chances of securing another term even further. While in no way trying to diminish the human impact of the earthquakes, we will focus this report on the dynamics surrounding President Erdogan’s re-election campaign, as well as scenario analyses underpinning our current Turkish lira forecast and how that forecast could evolve should an alternative scenario materialize.
Right now, our base case for the Turkish lira includes President Erdogan retaining office. Despite the challenges associated with Turkey’s economy and the new challenges associated with the earthquakes, we believe Erdogan can gather enough support by deploying fiscal support and other government resources in the coming months. This support can lead to improving economic conditions that generates voter optimism on the longer-term prospects for Turkey’s economy. In addition and taken into account in our base case scenario, is the potential for Erdogan to influence voting intentions or challenge results as a way to win re-election. However, in our view the likelihood of this scenario unfolding is falling, and the probability of regime change is rising. At the heart of the regime change scenario are unsustainable economic conditions, although an underwhelming and inadequate response to the earthquakes is contributing meaningfully to the opposition Nation Alliance gathering momentum. In addition, the Nation Alliance has demonstrated unity in selecting an opposition ticket to challenge Erdogan at the polls, and despite early fragmentation, the alliance seems to now be on solid footing.
Figure 1 outlines these scenarios in more detail, and provides the local financial market implications in both situations. In our view, should President Erdogan retain office, the Turkish lira likely hovers around current levels through the end of the election cycle. Longer-term, as economic trends and monetary policy frameworks go unchanged, large one-off lira depreciations could materialize, but at a minimum we expect lira depreciation through the middle of 2024. In our regime change scenario, the lira could experience one of the most sizable rallies in modern history as an independent central bank gets restored and an orthodox monetary policy framework is implemented.