In an unforeseen outcome of yesterday’s election in Turkey, the Justice and Development party’s (AKP) lost its parliamentary majority for the first time since 2002. The surprise result also stopped leader Recep Tayyip Erdogan’s ambition to change the constitution and make Turkey a presidential regime.
While no change to the constitution seemed to be the preferred scenario for markets, few anticipated such a strong setback for the AKP, and this is causing markets to react nervously.
We only need to look back to Turkey’s pre-2002 environment to understand why. This was a time when Turkey was gripped by constant political instability, with severe consequences for its economy, affecting investment, causing inflation to hit a staggering 85 per cent, and a volatile Turkish lira.
Turkey’s economy was already slowing ahead of Sunday’s election, and the uncertainly about whether AKP can form a government – either as a minority or in coalition – has already caused strong market reaction. The lira has plunged to an all-time low of 2.80 against the US dollar and we believe Turkey’s central bank might need to raise rates to offset any prolonged weakness.
The election result marks an end of predictability in Turkish politics, after years of one-party rule. While the AKP has announced that it will form a government, the uncertainty could last for up to 45 days. And if no government is tenable, the government will be forced to call new elections.
So for now, it’s a waiting game. What’s clear though is that continued uncertainty and ongoing market volatility is likely to force Turkey’s central bank to hike interest rates as steeply as it did in January 2014. Back then, unable to stop market jitters, Erdem Basci, Turkey’s central bank governor, had to more than double interest rates in an emergency meeting, taking them from 4.5 per cent to 10 per cent. Today, such a move could plunge Turkey into recession.