Comment: Is this the beginning of the end for Erdogan's Turkey?

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There is a popular saying in Turkey that one who comes (to power) with an economic crisis goes with an economic crisis. This was true when President Recep Tayyip Erdogan rose to power following Turkey's devastating economic crisis in 2001. But will the current economic conditions lead to change in the country's leadership? To find an answer, Emre Akcakmak recently visited Ankara and Istanbul where we met with several key people including politicians, policymakers and economists.

Even though there are no scheduled elections until 2023, President Erdogan is feeling the heat from the economic slowdown, the opposition's recent election victory in major cities, and possible cracks in his alliance with the nationalist MHP, and even within his own AK Party. In Turkey's new presidential system, where even a couple of percent of swing votes can change the ruling alliance, Erdogan has little room for manoeuvre.

Erdogan is probably the last Turkish politician to take lightly. He has an outstanding electoral track record and his People's Alliance still received more than 50% of the votes at council level despite severe economic challenges. Nevertheless, scenarios for a post-Erdogan era are already on the table.

Our base case for the economy is a ‘muddle-through' scenario in which we expect to see more of the same. That is, in the absence of any major change on the policymaking side, economic growth should be in negative territory in 2019 and remain relatively weak in 2020 with growth at around 2% to 2.5%."

The most popular question in town is what the public support for Turkey's former economy tsar, Ali Babacan, and his new movement will be. Different observers and some recent polls put support at around 10% to 15%, but it is too early to reach firm conclusions.

Given his unparalleled positive reputation among investors, Babacan's popularity, potential electoral alliance and role within that alliance, are already central to political debate in Ankara.

The main opposition CHP's rising star, newly elected Istanbul mayor Ekrem Imamoglu, is also in various equations while the new system and recent election results strengthen the position of his party leader, Kemal Kilicdaroglu, given his ability to form alliances with a broad range of political views.

No easy fix for the economy
Turkey's economic challenges are more complicated than ever. Since the lira melt-down, growth has stalled while inflation, the budget deficit and unemployment have all jumped.

Although the country's $55bn current account deficit has turned to surplus over a 12-month period, the rebalancing was driven primarily by a collapse in domestic demand rather than structural improvements in the economy.

A year later, Erdogan's new economy management team, headed by his son-in-law and Finance Minister Berat Albayrak, still struggles to boost investor confidence, with some market participants even daring to question the reliability of statistical data.

Surprise factors, such as Erdogan's sudden removal of the head of the central bank, further complicate the picture. There are credible long-term structural reform plans, including the one presented by the former Finance Minister Naci Agbal, head of Turkey's Strategy and Budget Directorate.

But implementation remains key, as overcoming economic imbalances will face plenty of hurdles, not least the level of political willingness.

Our base case for the economy is a ‘muddle-through' scenario in which we expect to see more of the same. That is, in the absence of any major change on the policymaking side, economic growth should be in negative territory in 2019 and remain relatively weak in 2020 with growth at around 2% to 2.5%.

We do not expect a sharper rebound - as in previous instances of slow down - because we think Turkey's credit and external-financing-driven rapid economic growth model over the past decade will not be repeatable going forward.

Accordingly, we expect only a modest improvement in the current 14% unemployment rate, which would imply a gradual decline in inflation to around 10% by the end of 2020.

We are particularly worried about the budget deficit, which we think could have been well in excess of 4% of GDP in absence of record high transfers from the Central Bank. Despite a golden opportunity presented by the Fed and global easing cycle, the lira will remain vulnerable, especially if the newly appointed central bank governor impatiently cuts the policy to re-ignite a credit-driven economic growth.

In a negative scenario, where policymaking turns less prudent and fiscal and monetary policies are loosened further, the vulnerable lira might be attacked to an extent that the central bank's net foreign reserves are tested by aggressive speculators.

A weak lira would then re-fuel inflation and put a strain on the country's already highly indebted private sector, resulting in a negative self-fulfilling prophecy with a deep impact on economic development.

In a positive scenario, where we see a change in leadership, policymakers act quickly and decisively by turning their focus primarily to alleviating the pain in the banking system via a recapitalisation programme, possibly in excess of $20bn, and reviving foreign direct investments along with strong incentives such as long tax holidays.

We expect no miracles but are prepared to spend a lot of time on different economic scenarios that greatly depend on political leadership as political leadership depends on the economy itself. Alternative political developments are becoming more likely than ever. Accordingly, we are looking particularly for events that will lead to the return of investor confidence, which might change all equations for the better again.

Emre Akcakmak is a portfolio adviser at East Capital. A version of this article was first published by Investment Week, a sister site to International Investment.