Investors, markets to keep close eye on Turkish economy after PM steps down

Before elaborating why, let’s just very briefly recap what has happened over the past week in the country. 
Late on May 1, a new political blog suddenly appeared and became a hit. Dubbed the “Pelican Brief,” the blog included a single entry eccentrically and boldly explaining how President Recep Tayyip Erdoğan and Davutoğlu had been embroiled in a “rift.” Although this text was not taken seriously by many people, events just after it appeared were quite interesting.

Davutoğlu, the prime minister and leader of the Justice and Development Party (AKP), said in a press meeting on May 5 - after a meeting of his party’s Central Executive Board (MYK) - that he had decided to step aside. His decision came after the party’s consulting bodies and Erdoğan, pointing to a recent move by the 50-member Central Decision and Executive Board (MKYK), removed Davutoğlu’s right to appoint local AKP leaders.

Turkish stocks and the Turkish Lira tumbled on concerns of mounting political turbulence, although they started to recover slightly after Davutoğlu’s press meeting. 

The key point for investors and markets will be what happens next in terms of Turkey’s economic reform agenda and institutional framework. These have been problematic for a while in the face of an obviously slowing economy and generally rising unpredictability. 

It is no secret that Turkey’s economic bureaucracy has been reshuffled in a dramatic fashion over the last couple of years as contradicting views have appeared and grown. This has created a kind of “dual-administration” in Ankara. 

For instance, management of the country’s main stock exchange, Borsa Istanbul, recently changed in an unexpected way. At the Borsa Istanbul general board meeting at the beginning of April neither its chairman nor its CEO were reelected, even though they came to those positions just one year ago. 

Although the appointment of a new Central Bank head was more or less unproblematic, it remains a big question whether – and how - appointments will be made to other key economic institutions. For example, the Treasury has not had a president since 2014, when its then undersecretary İbrahim Çanakçı was appointed as an executive director of the International Monetary Fund (IMF). Çanakçı had been known as an ally of the reformist group within the AKP.

Although economic growth in Turkey rose to 4 percent in 2015, reflecting stronger private and public consumption, the World Bank predicts that it will slow down to 3.5 percent in 2016 because of a more negative contribution from net exports compared to 2015.

One of the main topics on the economic agenda of the prospective new prime minister will be how to stimulate growth. It is well-known that Erdoğan and his economy aides favor cuts in interest rates to accelerate investments in a bid to revive growth. Investors - who will be key to any shift of Turkey toward a healthier growth path based on investments and production rather than consumption - will be closely following whether the new administration will fulfil reforms while ensuring the independence of economic institutions. This is particularly true at a time when bad debts and bankruptcies are rising and exposing the country’s fragile real economy.

The latest developments in Turkish politics have had a huge effect on the country’s predictability. We may even be entering yet another election cycle if the expected constitutional change debates become even more heated in the coming period. 

Under the increasing stress of security concerns, geopolitical problems and the refugee crisis, Turkey must maintain a degree of stability and predictability in order to maintain its economic viability.