On May 28, Turkey will go to the polls for a second round to choose its next president. A choice that has far-reaching implications for the economy of this country, which has just gone through turbulent years. We remain on the sidelines.
A sui generis monetary policy
For the first time in many years, Turkish President Recep Erdogan is still determining whether he will win a new term in the elections on 28th May. However, the mandate now ending has yet to become obvious for the Turkish economy and its people, who have faced unparalleled inflation. Having exceeded 85% in October, it gradually fell to 43.7% in April.
Under normal conditions, inflation at such levels is perceived as threatening the economy. Accordingly, it prompts the central bank to raise key interest rates to slow demand and support the currency, whose value is quickly eroded.
However, President Erdogan has his economic theories and is convinced that high-interest rates cause inflation. It, therefore, weighs heavily to ensure that the central bank does not tighten its monetary policy or even lower its rates to support it.
Despite inflation approaching on average, over the last six months, the 60% Turkish key interest rates have been lowered several times, from 12% at the end of the summer to 8.5% today. Unsurprisingly, the Turkish currency has lost more than a quarter of its value over the past year… and even close ... The lira lost 27.1% against the euro, and The Istanbul Stock Exchange rose 24.4% (variations for the Turkish currency and the Istanbul dung over one year, in €, as of May 5).
A loss that destroys the purchasing power of households whose wages and other incomes have not kept pace with rising prices. The discontent is growing, especially as corruption remains a scourge in the country, and the authorities’ response to the earthquake that affected the country in February was feeble.
Delicate relationships
Suppose the fall of the Turkish lira is a cause for concern. In that case, the reality is that it should have been even more pronounced under normal conditions since the yields on offer - which are mainly insufficient to offset inflation - do not attract investors… with a few exceptions. And here, everything directly relates to President Erdogan’s relationship with some world leaders.
For example, Qatar, which came several times to the country’s aid, allowing it to refloat its foreign exchange reserves, emptied several times in vain attempts to support the currency. Then there are the Russians who, faced with the ostracism of the West, are taking their capital out of their country through the Turkish route because that country does not impose financial sanctions on them.
To do this, they invest in this country, mostly in real estate. And for a good reason: any purchase of more than 400000 USD (about 364000€) offers the buyer the right to obtain Turkish nationality. A passport provides several advantages for Russian customers. Their purchases of residential real estate in Turkey tripled in 2022.
The Istanbul Stock Exchange is another way these wealthy foreigners preserve their purchasing power. And they are far from being the only ones. Real estate and shares are also highly prized by Turks privileged enough to have access to credit. With interest rates well below inflation, they have every interest in borrowing as much as possible, knowing that repayment will be in a currency worth much less. This keeps investment, consumption and the economy as a whole afloat.
Taken together, these phenomena explain the rise in real estate prices (+141.5% year-on-year in February according to the index of the Turkish Central Bank) but also that of the Turkish Stock Exchange, which has recorded a 36% gain over the past year (price and dividends, in €), a performance of the highest order, but which will only continue if Erdogan manages to perform new tricks in the future.
Difficult election aftermath
The coming months will be difficult for Turkey. A victory by Erdogan perpetuates his control over the country, makes it even more dependent on his moods and personal relationships, and will keep him on an unsustainable path, eventually ending in a significant crisis.
But an opposition victory would not be the panacea. Getting the country out of its very particular reality will not be done without harm. The opposition agrees on a few things except the will to defeat Erdogan and to make Turkey join the ranks, both economically and financially as well as politically, with a rapprochement with Europe, NATO and the United States.
However, normalising financial policy at this stage would inevitably involve a sharp rise in key interest rates, undermining a growth dynamic anchored in cheap credit.
Turbulence would then be inevitable, and the country would need help to stabilise its financial system and currency and be able to do without capital from uncertain sources. Moreover, an eventual departure from Erdogan would lead to a high volatility period. And there is no doubt that if the latter were to leave power, he would remain present in political life, putting pressure on the new decision-makers and ready to go back to the business at the slightest slip of the latter.
Due to its young and increasingly well-educated population, proximity to European markets, and know-how in several areas, Turkey has an enviable potential and could be a privileged partner of Europe. So far, its assets have not contributed to improving people’s standard of living. On the contrary, the fault of a very particular government system favours those close to power, which will continue if these elections are not conducive to change. On the other hand, a possible departure from Erdogan, with a return to the ideals of Atatürk and a more Western approach, could fundamentally change the situation. But we must not delude ourselves: Erdogan’s legacy would be tough to bear, and the country would need much support to succeed in this transition.
In the long term, the European Union would come out ahead of Turkey closer to it. But it is not sure that it has the long-term vision necessary to seize the moment in case of an opposition victory.
It is difficult for the investor to know which way to dance at this stage. But one thing is sure: the challenges will be many in the coming months. So we stay away from the Istanbul stock exchange.
Be the boss of your money
Euroconsumers Invest returns its Money Framework in May to help investors take the best steps for the “next dance”.