Political uncertainty weighs on Turkey’s economy and equities market

Erdinç Benli, co-head of GAM’s global emerging market equities team, comments on the economic and stock market impact of Turkey’s impending election.

Turkey’s voters will head for the polls for a second time on November 1 after the AKP party failed to form a coalition government in June.

The upcoming elections will be closely watched around the world, with Turkey in the midst of a political crisis amid growing domestic spates of violent attacks, as well as increasing conflict at its borders.

The AKP party believes that it can perform better in the upcoming round of elections, owing to changes in the electorate’s sentiment, particularly due to the deepening ISIS conflict. This plays into the hands of AKP because attacking PKK separatists and ISIS shows willingness to bring back peace to the country. AKP can expect to win some votes from the nationalistic wing and centre.

The tragic bombing in Ankara is heating up the atmosphere in Turkey ahead of the election.

All parties are blaming each other for the bombing. Erdogan accuses the terrorists (ISIS, PKK), and HDP is blaming the government not having put in place enough security during the demonstration or even for complicity for the attack.

This event increases the political and the risk of a permanent domestic conflict. Surprisingly, the reaction of the equity market so far is very benign and the currency lost only little against the US dollar. This shows how much bad news is priced in already and that investors are positioned defensively.

Election outlook

Political campaigns of the likes of the AKP, pro-Kurdish party HDP and pro-nationalist party MHP have increased the polarisation of the Turkish people. Most parties apart from AKP oppose a presidential governance system.

In this round of elections, the public pressure for political parties to form a coalition government and reach a consensus will be much higher. Forming a coalition government is a chance for Turkey to metamorphose and work in different political views. But it will be a bumpy road.

Chances are high that the new coalition government won’t hold for long due to the polarising political views. There is a possibility of the coalition breaking-up and a renewed election in 12-18 months’ time.

Economic impact

A relief rally is likely should AKP get enough votes to form a single party government. However, risks include Mr. Erdogan continuing to intervene in political decision-making. This would be negative for investor sentiment in the long-term.

The most pro-economic outcome is AKP keeping its votes from the June election (41%) and forming a coalition government. However, the stability of this coalition will be questionable over the longer-term.

Political differences will lead to setbacks from time to time; AKP is not sufficiently amenable to other parties’ views. An important question remains over whether government figures will be sitting on key decision-making chairs regarding the economy and central bank.

Further economic weakness is highly likely if no sustainable government can be formed as the risk of downgrades by rating agencies is heightened.

Stock market impact

The Turkish Lira has plummeted more than 20% since the start of the year. Interest rates have soared, while consumer confidence has plunged to multi-year lows.

Turkey’s political uncertainty continues to rouse investor concerns, with foreign investors selling Turkish equities. All the while, Turkey’s central bank continues to walk a tight rope; faced with the dilemma of raising interest rates given a slowing economy weighed up against a weakening domestic currency and high inflation levels.

Turkish equities are currently trading at multi-year lows in US dollar terms, making them one of the largest loss-making markets this year, underperforming the overall emerging markets (EM) complex by some 15%.

Investors have reduced their exposure to Turkey, yet market setbacks caused by political uncertainty can open up good buying opportunities.

Turkey’s real effective exchange rate recently fell to its lowest levels in 10 years, which should help export-oriented companies as well as tourism – an important source of foreign currency.

But, increased terrorist attacks on or near Turkish soil could seriously affect the country’s tourism sector – a major income generator.

Low energy prices also help Turkey since a very large portion of the current account deficit comes from the energy bill. With +3.8% GDP growth in the second quarter 2015 versus last year, the economy is doing better-than-expected. Corporate earnings have also come in better than expected for the first half of 2015.

Based on the recent opinion polls, the most likely election outcome is a coalition government between AKP and CHP, which is the most ‘market friendly’.

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