Despite Mehmet Simsek retaining his position as Deputy Prime Minister, other recent political developments in Turkey have considerably increased the chances of early elections or a referendum during the remainder of the year, leaving the near-term outlook for the Turkish economy cloudy.
The announcement that Simsek will continue as Deputy Prime Minister in charge of economic management provided some near-term comfort to the market. The lira strengthened by roughly 2% to 2.94 against the U.S. dollar after the May 24 announcement and the 10-year government bond yield declined on the news, from 10.4% to 10% (Chart 1).
In addition, the central bank cut its overnight lending rate by 50 basis points today to 9.5%, the second 50 basis point cut in a row after the new Governor Murat Cetinkaya took office in late April (Chart 2). We expect further rate cuts by the central bank as long as the lira remains relatively stable.
Notwithstanding a short-term rebound in Turkish assets, political developments, security concerns and the global risk sentiment towards emerging market assets will likely weigh on the lira during the rest of the year. With economic activity weakening in early 2016, President Erdogan looks set to intensify political pressure on the central bank to cut short-term interest rates further despite a likely rate hike by the Fed in the remainder of the year. Moreover, the underlying fiscal stance will likely ease further in an attempt to stimulate domestic spending at the expense of much needed progress on the structural reform agenda.
President Erdogan continues to strengthen his ruling AK Party (AKP) and the likelihood of early elections or a referendum to change the constitution towards a presidential system has increased. Prime Minister Davutoglu was replaced with former Transport Minister Binali Yildirim, a close Erdogan ally. And Turkey’s parliament approved stripping its members of immunity from prosecution. This will allow prosecutors to pursue the 138 members of the parliament who are currently facing criminal investigations, including 51 from the main opposition CHP and 50 from the HDP. If the HDP opposition is sidelined by prosecutions and pushed out of parliament, the possibility of early elections increases. It would also likely lead to more violence by the separatist PKK and intensify domestic security concerns. Further security concerns and political uncertainty will likely lead to further delays in new investment decisions and structural reforms, while deterring foreign capital inflows.
