A fresh bout of turbulence hit the ailing Turkish economy May 6, when the Higher Election Board quashed the opposition victory in the March 31 mayoral race in Istanbul, fueling fears that Turkey’s rulers are no longer committed to ceding power through elections. The turbulence is likely to continue until, and perhaps beyond, the election rerun, scheduled for June 23.
A series of elections in recent years have increased the fragility of Turkey’s faltering economy, which badly needs structural reform. The presidential and parliamentary balloting in June 2018 and the local elections on March 31, however, have led Ankara to pursue populist measures instead of focusing on reform.
Many had hoped that the aftermath of the local elections would bring a transition to an overhaul program, including a tightening of monetary and fiscal policies. Instead, the ruling Justice and Development Party (AKP) and its Nationalist Movement Party allies objected to the Istanbul victory of Ekrem Imamoglu of the main opposition Republican People’s Party (CHP), leading to 35 days of wait-and-see for the economy. Eventually, under pressure from President Recep Tayyip Erdogan, the election board made the unprecedented decision of voiding the result — a move that many consider a “massacre of law” — and scheduled another vote for June 23, setting the stage for full-fledged turbulence.
The Turkish lira nosedived as soon as the decision was announced. It has continued to lose value ever since, despite interventions to curb its fall. The lira, which traded for less than 6 per dollar ahead of the decision, hit 6.24 against the greenback at noon on May 9, its weakest level in eight months.
Market actors believe that Ankara pushed public banks to sell foreign currency to save the lira from an even more dramatic slump. According to traders speaking to Bloomberg, state-run lenders sold more than $400 million of foreign currency after the lira breached the 6-per-dollar mark on May 6. The sum was later said to have reached $1 billion.
Yet, this effort to control exchange rates via public banks is hardly sustainable, especially at a time when the decline in central bank reserves is making headlines in the international media. To control exchange rates, the central bank has to hike interest rates on the lira, or the rates will spiral out of control and go through the ceiling. The bank, however, remains under harsh pressure against hiking rates, as Erdogan and the domestic market-reliant business groups behind him strongly oppose such moves.
The lira's slump, however, is not solely fueled by domestic political jitters and electoral uncertainty. There are also headwinds from the global political climate.
Tensions between Ankara and Washington are running high over the looming delivery of Russian S-400 air defense systems to Turkey amid increased contacts to avert a crisis. As a reminder, it was political spats with Washington, resulting in US sanctions on Ankara last summer, that fueled the currency crisis in Turkey. The economic contraction triggered by the currency shock is still ongoing.
There is also the additional factor of Washington fanning global jitters. On May 5, President Donald Trump threatened to raise tariffs on Chinese goods, reigniting global concerns over the trade war between the world’s two biggest economies. According to some estimates, a new escalation in the war would hit both sides, with China losing $1.2 trillion, or 1 percentage point of its gross domestic product (GDP), and the United States losing $870 billion, or 0.45 percentage points of its own GDP.
The impact of such global woes is usually bigger on emerging economies such as Turkey because when the global economy contracts, it also shrinks the room for emerging economies to export their goods, secure external borrowing and roll over their debts.
US sanctions designed to curb Iran’s oil sales are also negatively affecting Turkey, Iran’s western neighbor. Turkey is now supposed to go looking for alternative oil suppliers with higher prices. This, in turn, threatens to widen Turkey’s current account deficit and raise the cost and prices of energy at home.
In sum, the AKP government faces an adverse global climate as it struggles to manage politics and the economy at home. The Turkish economy, which contracted 3% in the last quarter of 2018, shrank another 4% in the first quarter of this year, according to an estimate by a research center at Istanbul’s Bahcesehir University. The official figure is scheduled to be released in late May.
Year-on year consumer inflation hit 19.5% in April, with no sign of slowing. Food inflation is even higher, reaching 32% and standing out as a crucial factor swaying voter behavior.
The unemployment rate is even more alarming. The new official rate, scheduled for release May 15, is expected to be a record one, exceeding 15%. The rate currently stands at 14.5%. In terms of numbers, more than 5 million are looking for jobs. A broader definition of unemployment that includes people who have given up on chasing jobs puts the number at 8 million.
The gloomy economic indicators, coupled with uncertainty over the mayoral election in Istanbul, have also stoked Turkey’s risk premium, which is reflected in credit default swaps (CDS) and constitutes the most important indicator for international investors. Since the cancellation of the opposition’s Istanbul victory, the country’s CDSs have surged to more than 480 basis points, severely decoupling from those of its emerging economy peers. This means that external borrowing is becoming all the more difficult for Turkey, with the money paid on interest rates reaching exorbitant levels.
In sum, the cancellation of the mayoral election in Istanbul has plunged Turkey into another highly fragile period. The economic turbulence is expected to exacerbate the daily financial woes of Istanbulites and lead them to respond accordingly when they vote in the June 23 rerun election.