European Council on Foreign Relations

Turbulence in Turkey

Ever since Fed Chairman Ben Bernanke hinted that the purchase of US government bonds is to be phased out (the famed “tapering”), emerging markets have been feeling the chill. Now that the u-turn is becoming a reality under Bernanke’s successor Janet Yellen, the turbulence is spreading from Brazil to Indonesia. Tightening monetary policy drives yields up in the US and is an incentive for investors to shift away from assets in the emerging world. The move has put a great deal of pressure on their currencies, stoked inflation and threatens to sap growth projections.

Turkey is a prominent casualty. It is highly dependent on financial flows from outside, not least because it’s running a high current account deficit – 7 percent of GDP in 2013. The Turkish lira has lost one third of its value against the dollar over a period of 12 months and 16 percent since mid-December as a corruption scandal broke out. Inflation has gathered momentum. The Turkish Central Bank’s efforts to reverse the fall through sales of foreign currency came to nothing and last week, in a dramatic move following an emergency meeting, the bank increased interest rates (the overnight lending rate went from 7.75 percent to 12 percent, the one-week repo rate to 10 percent from 4.5 percent, and its overnight borrowing rate to 8 percent from 3.5 percent).

The timing could not be worse as Turkey enters electoral cycle (local elections take place on 30 March and presidential elections in August and potentially a constitutional referendum and early general elections by the end of the current year). It is easy to see why Erdoğan had resisted tightening of monetary policy: apart from the credit squeeze for businesses, it also depresses emergent middle classes’ consumption, which has been buoyed by the supply of cheap money. As Hurriyet’s economic commentator Emre Deliveli notes, though households debt levels remain relatively low, they have risen exponentially in the past decade: from 4.7 percent of disposable income in 2002 to 55.2 percent in 2013. Low growth means sluggish expansion of incomes with all attendant difficulties in servicing outstanding debts. Consumption habits are sure to be affected with negative consequences for support levels for the ruling AKP. To put things in context, the party has lost votes, in absolute terms, only once in the past – at the last municipal elections in 2009 when Turkey suffered a brief recession triggered by the global financial crisis.

Coupled with the bitter punch-up with Fethullah Gülen and his supporters, Erdoğan has a problem on his hands. We will know the score at the end of March. Istanbul is the main battlefield – incumbent mayor Kadir Topbaş (AKP) and Mustafa Sarıgül, the contender from the opposition Republican People’s Party (CHP) are running neck-to-neck. Each polls roughly at 42 percent. Though the AKP has an edge of at least ten percentage points nationwide, the looming contest for Istanbul promises fair amount of suspense. In a country where so much power has been concentrated in the hands of a single ambition-driven individual, a proper electoral challenge cannot be a bad thing. 

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