Edgy Turkish markets may find little respite in ruling AKP

ISTANBUL - Reuters

A poster of Turkish Prime Minister Recep Tayyip Erdogan is seen in an election billboard of his Justice and Development Party with a mosque in the background in Istanbul, Turkey, Thursday, March 27, 2014. AP Phpto

Turkey’s nervous financial markets may find little solace even if local elections on March 30 bolster the ruling party, with any rally likely to prove short-lived as economic headwinds build and political uncertainty persists.

The run-up to the nationwide polls has been marred by a corruption scandal dogging Prime Minister Tayyip Erdoğan’s government as the scandal has raised questions about the political stability in the country, which has been a guarantor of strong growth in the past years.

“The assumption of most analysts is that AKP will still win the elections, albeit not as strongly as in past elections,” Commerzbank strategist Thu Lan Nguyen told Reuters.

“Markets should generally stabilize in this case. But there is a risk that protests will flare up again as people demonstrate their frustration over the results.”

The political turbulence has come at a bad time for Turkey, adding another layer of risk for investors already concerned that its wide current account gap and reliance on capital inflows mean it will be hit hard by cuts in U.S. stimulus.

The economy is slowing and inflation rising, while consumer confidence hit a four-year low in February, just as Turkey tries to dampen credit growth and navigate tighter global conditions.
cy interest rate hike a day later helped it recover, it remains much weaker than the 1.8 level it was trading at before last summer’s protests.

Stocks have fallen some 8.6 percent since Dec. 16, the day before the corruption scandal became public, while Turkey’s 10-year bond yield has risen some 135 basis points over the same period.
Turkey’s five-year credit default swaps were quoted close to seven-week highs at around 260.5 basis points on March 26.

Numbers crunching 
 
Turkey’s growth in the last decade has largely been based on the stability brought by Erdogan, who took office in 2002 after a series of unstable coalition governments in the 1990s ran into
repeated balance of payments problems and economic crises.

Turks’ wealth has tripled in nominal dollar terms over thepast decade, a record which has been one of the pillars, alongside its conservative Islamic ideology, of the AK Party’s growing margin of victory in three successive elections.

But that reputation is under threat.

A central bank March survey of economists and business leaders put year-end growth at 2.6 percent, well below the 4 percent government target. Inflation was seen at 7.98 percent, well above the bank’s 5 percent midterm target.

Finance Minister Mehmet Şimşek said this week the government could lower its growth target if a weak AK Party result, below 40 percent, heightened political uncertainty.

Party officials have set a loose target of equaling the 40 percent share of the vote the AKP won at the last local election five years ago. Such a result could reassure investors.

JPMorgan economist Yakın Cebeci assigned a 55 percent probability to support for the ruling party coming in at 40-45 percent, describing it as a “silver-lining scenario” which could see Erdoğan consolidate power and win the presidency in August.

“This is obviously the most market-friendly outcome,” he said in a note to clients.
But he noted that a much stronger victory for the ruling party could make Erdogan “feel omnipotent” and potentially increase tensions in the country.

On the other hand, a disappointing outcome could tempt the government to pump-prime growth to restore support, stoking inflation, currently the central bank’s biggest headache.

“They might loosen fiscal policy or pump credit into the economy. But doing so would only cause the current account deficit to start widening again, exacerbating Turkey’s existing vulnerabilities,” said William Jackson, an emerging markets economist in Capital Economics.