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Markets quick to rethink Turkey’s election

10th November 2015

Turkey has just proved that a week can be a long time in the markets. The rally in local assets that greeted the AKP’s unexpected election victory — and hence the end of months of political uncertainty — on November 1 has dissipated almost completely.

The Turkish lira is back above 2.90 to the US dollar, from below 2.80. Turkish bond yields are higher than they were before the poll and even the stock market has given up half its 5 per cent jump. While investors initially celebrated the electorate’s vote for security and stability, they have begun to realise that neither may be forthcoming.

It is true that after a political deadlock since the previous inconclusive elections in June, Turkey will have a strong government once again. Winning more than 49 per cent of the vote, President Recep Tayyip Erdogan’s Justice and Development Party (AKP) now has a commanding majority of 317 of the 550 seats in parliament.

But this stability comes at a price. Having gambled on a repeat vote and won, the president is now political master of all he surveys and will be even more of a strong man than before. He will meddle more in government policy, despite the fact that he is supposed to be apolitical. And he will pursue his opponents more ruthlessly than ever before — arrests of members of the rival Gulen movement started again last week.

Updating Turkey’s constitution (largely in order to furnish the presidency with real executive power) is undoubtedly back on Mr Erdogan’s agenda. A cross-party effort a few years ago to draft a new constitution ground to a halt but this time around the AKP is in a stronger position.

The Kurdish Peoples’ Democratic Party (HDP), which saw its share of the vote dip from 13.1 per cent to just over the 10 per cent parliamentary threshold, is keen to enshrine greater autonomy and rights for the country’s 15m Kurds and is therefore a natural partner for constitutional change.

Agreeing a deal between the AKP and the HDP will not be swift or easy. It would require an end to the hostilities between government forces and the outlawed Kurdistan Workers’ Party (PKK). Mr Erdogan’s opponents charge him with deliberately breaking the 2013 ceasefire during the election campaign and tarring the HDP — despite its best efforts to publicly renounce violence — with the same brush as the PKK. It worked: between the June and November elections, close on a million voters defected from the HDP, almost all of whom switched to the AKP.

But if — and it is a very large if — the peace process could be resurrected, the HDP may find itself bargaining greater Kurdish autonomy in return for supporting Mr Erdogan’s plans for an executive presidency. The latter is something the party says it will never endorse, but the opportunity for Kurdish self-rule, the culmination of decades of political struggle, may be too great a prize for the HDP to turn down.

Investors need to think about whether the prospect of continued — and even extended — dominance by Mr Erdogan will be good for foreign investment, the country’s credit rating and Turkey’s long-term economic outlook.

Meanwhile, the new government must choose between the pragmatic pursuit of structural reforms (as it did in its early years) and populist growth measures that might provide the sluggish economy with a pop now but do little to raise Turkey’s long-term growth potential.

An early clue will be whether Mehmet Simsek, finance minister, and Ali Babacan, former deputy prime minister — both respected technocrats to whom Mr Erdogan turned during the campaign — will be given senior roles in the new administration or whether he will instead promote less orthodox allies such as Cemil Ertem and Yigit Bulut, who have — like the president — castigated the central bank for not lowering interest rates rapidly enough.

The political pressure on the central bank is likely to increase in any case. Erdem Basci, CBRT governor, will surely be replaced with a more pliable figure when his five-year term ends next April and there is talk of giving the central bank a new mandate focused solely on growth. That would be a signal that Turkey is likely to enjoy less of this elusive commodity in future.

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