Tinderbox Turkey: what next?
July’s failed coup triggered a state of emergency in what was already one of the most fragile and risky emerging market economies. We expect the consequences to be severe and long-lasting.
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It is hard to see the failed coup on 15 July as anything other than negative for the Turkish economy. The extent of the pain will depend on the political and policy response.
Should President Recep Erdogan achieve his goal of an executive presidency, erosion of institutional quality will accelerate and investment would likely weaken, reducing both short-term and trend growth.
A pro-growth, inflationary bias is likely to take hold in both monetary and fiscal policy, which could provide a short-term boost at the cost of long-term pain, exacerbated by lira weakness as policy credibility falls and dollarisation (when people use the US dollar in parallel or instead of the domestic currency) rises.
Perhaps the best that can be hoped for is a negative reaction to any attempt to exploit the coup for political gain, manifesting as electoral disappointment for Erdogan’s AKP party (i.e. falling short of the seats needed to amend the constitution), though we think this would still result in a steady tightening of Erdogan’s grip.
From a global perspective, while it is a positive that the coup failed insomuch as a Turkey in the grip of civil war would be a true disaster, managing both the conflict in Syria and the refugee problem for Europe will be much harder with Turkey distracted, if not hostile.
Erdogan’s monetary policy
Monetary policy has been one casualty of Erdogan’s unique school of economic thought, even before April’s appointment of Murat Cetinkaya as head of the central bank.
For some time, Erdogan has railed against what he calls the “interest rate lobby”; essentially any economist who suggests that Turkey should hike rates to fight inflation. In the eyes of Erdogan, these are self-serving comments designed to generate profits for foreign banks. This has piled pressure on the central bank to keep rates low and cut them if possible, despite high inflation.
A more inflationary environment then lies ahead for Turkey, and this is even before we consider the impact of the currency. The Turkish lira weakened markedly on the back of the coup and will deliver a strong inflationary impulse if not brought under control. Unfortunately, with the outlook for monetary policy we described above, this seems an unlikely prospect.
Making matters worse, political shocks in Turkey typically see a wave of dollarisation in the domestic economy. In 2013, for example, following the Gezi Park protests, the second half of the year saw residents’ dollar purchases of $20 billion, after sales of $5 billion in the first half. More recently, prior to the coup attempt, residents had been buying lira on weakness. Time will tell which trend dominates, but this is undoubtedly a risk to lira stability and the inflation profile.
Uncertainty to hamper growth
On growth, as the UK is discovering, political uncertainty generates headwinds. For one, a prolonged period of uncertainty is likely to hit confidence and private spending, particularly investment decisions. Furthermore, the gradual erosion of institutional strength, in the judiciary as well as the central bank, creates a negative environment for business investment, both domestic and foreign.
External liabilities a concern
Another worry for Turkey is the external liabilities position. Turkey has one of the largest external financing requirements as a share of GDP in emerging markets, having actually risen since the 2013 “taper tantrum” (when markets responded negatively to the prospect of a tapered end to quantitative easing) to more than 19% of GDP.
The current account deficit, though reduced, is still high at 4.1% of GDP, with much of the improvement in the trade balance since 2014 driven by lower oil prices rather than fundamental shifts in the Turkish economy.
These imbalances in the external account are likely to receive more attention with the political risk premium rising.