The Strategist

Erdogan's Party Won. Problems are Just Beginning


11/03/2015 - 14:45



Turkish Justice and Development Party (JDP) of President Recep Tayyip Erdogan unexpectedly won the election on Sunday. This returns the country to one-party system, will stimulate the presidential power, but can also exacerbate deep social divisions.



Yıldız Yazıcıoğlu (VOA)
Yıldız Yazıcıoğlu (VOA)
The Turkish government will remain faithful targets to put in previous years. The Turkish prime minister and JDP’s Head Ahmet Davutoglu, speaking to voters in the party office, announced this on Monday.

Thus, the factor of political uncertainty, hanging over the country for a long time, is finally smearing out. Absence of de facto government in Turkey had been putting pressure on the foreign exchange market, where the lira repeatedly updated lows against the dollar – and the market does not like uncertainty.

Erdogan has said that the political parties will work together on a new constitution that would create a full-fledged presidential republic. The opposition has already called the situation with the election results "a nightmare."

Despite these impressive results, the political situation will remain volatile, as executive powers of the president are clearly insufficient. For this purpose, it is necessary to change the constitution.

Given the absolute majority in parliament, it is quite easy now.

Nevertheless, it is clear that the Republican People's Party and the Peoples Democratic Party will oppose such a decision, since strengthening of presidential power may worsen the prospects for their further political strife under current conditions.

Relationship with Kurds

Apparently, Erdogan was planning to completely eliminate the People's Democratic Party from political life. It was necessary for full and unconditional victory, but PDP’s result have confused all JDP’s cards.

Strengthening the presidency gives more opportunities to achieve this goal, but relationships with Kurds will deteriorate.

If Kurds are excluded from the legal political field, south-east of the country may turn into one of the boiling places in the region. As a large number of Kurds live outside of their native land, clashes with nationalists in major cities and tourist centers, where the Kurdish capital sits, will also be inevitable.

In July, a ceasefire between the army and Kurdish separatists was broken because the terrorist attack, which killed 30 Kurds. Then, two more explosions thundered at a campaign rally, the death toll exceeded 100 people. Islamic state militants are suspected in all the acts of terrorism.

As a result of all these events, PDP had significantly ceased their campaigning, yet it didn’t stopped them from getting 10% of votes.
 
Economic problems

Political instability and inability to quickly bring the political system in order are endangering the country’s economy.

Turkish foreign exchange and debt markets of the country may now face new challenges.

Now the Turkish lira shows heavy fortification since 2008, but increased volatility does not contribute to stability. Besides, break of the lira’s weakening tendency is highly questionable.

Problems in public debt market

Public debt in Turkey was estimated at $ 238 billion (689.8 billion Turkish liras) as of the end of September. Most of this debt ($ 151.2 billion) is posted in the Turkish currency.

The debt continues to grow. Even in August, it stood at $ 233.3 billion (676.2 billion liras).

Short-term external debt reached almost $ 130 billion, and the country will have to pay about $ 180 billion total in 2016.

Restructuration is not going to be easy, as investors withdraw money from the Turkish bonds in the background of instability and falling lira. Apparently, only stabilization of the political situation can change the tendency.

It should be noted that the authorities have been quite effective in reducing the national debt, which in 2014 reached 33% of GDP, that is, the historical minimum. On average, in the 2000-2014 biennium, the national debt stood at 49.5%, and reached an absolute record of 77.9% of GDP in 2001.

Summary

JDP’s result was a surprise not only for observers, but for politicians as well.

Voters are afraid of instability, and these concerns are justified. Domestic economic and foreign policy issues have intensified in recent months, and usually lack a majority in the government only aggravates the situation.

There wasn’t a successful example of a coalition government in Turkey’s history. As a rule, multi-party government eventually led the country to complete destabilization and a military coup.

That is now Erdogan actually got carte blanche to strengthen his authority and enhance the power.

JDP can now form a new government by their own.

- Our people clearly demonstrated in the elections on November 1 that they prefer action and development rather than any disagreements, - said President, stressing that the citizens voted demonstrated commitment to "unity and integrity" of Turkey.

Overall, the result is very good for Erdogan, while the West is now able to increase pressure on Turkey. Despite the likelihood of political stabilization, the situation remains very worrying for investors. Combination of the weak lira, debt problems and stagnation still outweigh the possible benefits.

Analytics

The elections themselves were important for everyone. Now begins a new stage, which will be no better than the campaign.

Erdogan need to achieve his goals and maintain a high level of voter confidence, and here a big problem can appear.

Erdogan has opponents even within JDP itself; hence, it will be not so simple to gain new power. Risk lies in main opposition parties and some members of the ruling party, who can unite against him.

Nevertheless, there’s good chance that Erdogan is able to fit the axe in the helve, even against the backdrop of new political battle.

Formally, JDP can form a cabinet, yet still Erdogan's opponents within the party may complicate the process. A coalition of opposition parties is hardly possible itself.

The situation is complicated by a variety of social and economic problems in the country. Particular difficulties may arise with the refugees.

Germany is committed to send at least the refugees packing. It would have been ideal if they did not penetrate from Turkey.

Europe is suffering from migrants, but Turkey is hosting 4 times more refugees - about 2 million!

Experts have repeatedly talked about "exporting instability" in Turkey from Syria. Besides, and in general, Ankara is playing a significant role in the Syrian tale.

As a result, the country has been exposed to several terrorist attacks. In recent years, the authorities themselves have aggravated the situation by their actions, even though the steps are justified by need to respond to the attacks.

In October, for example, the Turkish air force bombed The Kurdistan Workers' Party positions in northern Iraq. In late July, the Turkish authorities started large-scale military operation against PKK members in the south-east of the country. In August, the Army crossed the border into Iraq to carry out a ground operation.

Turkey’s fears are well founded and understandable. Ethnic Kurds in Turkey live on the border with Syria, Iraq and Iran. The authorities cannot allow creation of a full autonomy even in Syria, as it will be the first step to combine the Kurds, who see themselves as a divided people, and intend to establish a separate state. This means beginning of a full-fledged war between the Kurds and Turkey, which is unlikely to voluntarily give a large enough piece of its territory.

If the situation will develop in this way, the flow of refugees will only increase. It is clear that events in the Middle East do not contribute to social stability in Europe and tensions could be reduced with help from the Turkish side.

Perhaps it would be easier if Turkey were the European Union’s member, what actually Ankara is seeking. Moreover, German Chancellor Angela Merkel has promised to restore the draft of Turkey's accession to the EU, and to start issuing Schengen visas to Turkish citizens under a simplified procedure next year.

It is unclear if Turkey believed these promises of integration, as apparently Europe intends to simply allocate 3-5 billion euros for refugee camps organization. There is a strong likelihood that once the problem of refugees in Europe ceases to be so severe, the project of joining will be dead once again.

Nevertheless, Erdogan still has a leverage. Turkey is an important market for Europe; the authorities understand and actively use it, even though the lira depreciated in 2014 and imports from Europe declined.

Last year, the index fell by 3.8% in value terms, amounting to 74.6 billion euros. At the same time, the main drop was recorded in the most important sectors of Europe and Germany, that is, machines, equipment and industrial goods. These products account for more than 56% of EU exports to Turkey.

Loss of such a market would be a major blow. Turkey's share in supply of machinery and equipment from the EU was 4.4% in 2014, industrial goods - 5,6%. Considering the past year, Turkey has an opportunity to further develop the domestic market, reducing imports from the EU.

In general, Erdogan appeared today in a difficult situation from the geopolitical point of view. As a NATO member, Turkey should respond to Russia's actions in Syria, as everything is in close proximity to the border and sometimes Russian aircrafts can overfly the Turkish territory. It is obvious that the authorities are not keen to do it, although they actually have no choice.

As for relations with Russia, it is also not going smoothly, as Turkey is experiencing a very serious pressure. Experts do not exclude the possibility that the Turkish side may withdraw from the "Turkish Stream" project for political reasons.

Russia has already offered a good discount on the gas, but the strong external and internal contradictions do not allow making a decision. Yet, the dream of being a major gas hub has not disappeared in Turkey. Erdogan is likely to still try to defend their right to implement the project, even being threatened to refuse the dream of joining the EU.

Along with all the political, social, internal and external challenges, it is necessary to stabilize the economic situation. It would be extremely difficult. The recent lira’s strengthening of was made possible only because of the elections’ unexpected results and the dollar weakening due to US Federal Reserve’s recent actions. Still, the outflow of capital may be resumed any day now, which is not very promising from investors’ point of view.

Investors do not believe in the country’s economy. They have been running from Turkey for the second year, resulting in a virtually endless depreciation of the Turkish lira. Turkey has to cover varioust holes in balance sheets, and as a result, we see a sharp fall in foreign exchange reserves.

For the first time since 2012, Turkey's foreign exchange reserves fell below $ 100 billion.

Since mid-2014, the lira has been experiencing an epic fall, and it runs the risk of loss of control over inflation and its sharp rise.

The central bank, meanwhile, takes no special actions. Either the controller does not understand the complexity of the situation, waits for elections results and clarification of the political situation, or feels the political pressure. Note, that in fact, Erdogan pointed out the need for the Central Bank to reduce interest rates last year.

All the problems also exert strong pressure on the debt market. Yield on 10-year government bonds was higher than 10% in September and early October, although it is now down to almost 9%.

Cost of credit default swaps, i.e. insurance against default to bondholders, has also declined. Now it has fallen to 235 points compared to 300 points for more than a few months ago. For emerging economies in difficult circumstances, this is a very good indicator, especially as long as Ankara does not allow anyone to doubt its ability to pay.

Public debt in Turkey was estimated at $ 238 billion (689.8 billion Turkish liras) as of the end of September. Most of this debt ($ 151.2 billion) was posted in the Turkish currency.

This debt is rising: in August, it stood at $ 233.3 billion (676.2 billion lire).

Short-term external debt reached almost $ 130 billion, and the country will have to pay about $ 180 billion total in 2016.

It can be very difficult to repay the $ 130 billion amid increasing capital outflows from emerging markets and reduced investor appetite for risky assets. Full-fledged default is out of the question, but some payments can be skipped or postponed, even though the market does not believe in such a scenario.

based on Financial Times, World Bulletin, Reuters, Wall Street Journal's publications




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