Political Risks Remain Elevated Despite Erdogan Victory

BMI View: Turkish Prime Minister Recep Tayyip Erdogan will remain the de-facto leader of the ruling Justice and Development Party (AKP) and the driving force of its policy agenda after assuming the presidency on August 28. This implies a continued drive to consolidate influence over the central bank, judiciary and media that will keep social and political tensions elevated and pose key risks to financial stability.

Turkish Prime Minister Recep Tayyip Erdogan secured victory in the first round of Turkey's first ever direct presidential elections on August 10, in line with our expectations. Erdogan won 52% of the vote according to preliminary projections, which despite being lower than most polling data suggested, is nonetheless sufficient to reaffirm his mandate. Erdogan will have to step down as head of his Islamist-leaning AKP by August 28, when he officially takes on his new role for a five-year term.

Change Of Office, Little Change In Role

Erdogan Still Dominating Ballot Box
Turkey - AKP Vote Shares With Erdogan As Party Leader, %

BMI View: Turkish Prime Minister Recep Tayyip Erdogan will remain the de-facto leader of the ruling Justice and Development Party (AKP) and the driving force of its policy agenda after assuming the presidency on August 28. This implies a continued drive to consolidate influence over the central bank, judiciary and media that will keep social and political tensions elevated and pose key risks to financial stability.

Turkish Prime Minister Recep Tayyip Erdogan secured victory in the first round of Turkey's first ever direct presidential elections on August 10, in line with our expectations. Erdogan won 52% of the vote according to preliminary projections, which despite being lower than most polling data suggested, is nonetheless sufficient to reaffirm his mandate. Erdogan will have to step down as head of his Islamist-leaning AKP by August 28, when he officially takes on his new role for a five-year term.

Change Of Office, Little Change In Role

Despite the largely ceremonial role traditionally assigned to the president of Turkey, we believe Erdogan - who is approaching the end of his third and final term as prime minister - will remain the unofficial leader of the AKP and the driving force of its policy agenda. At first this will occur simply through the implicit support of the party and the appointment of a loyalist interim prime minister, but Erdogan's ambition is ultimately for Turkey to adopt a presidential system via constitutional changes.

Erdogan Still Dominating Ballot Box
Turkey - AKP Vote Shares With Erdogan As Party Leader, %

General elections in June 2015 will be a key facet of this strategy, when the AKP hopes to win a two-thirds parliamentary majority in order to be able to unilaterally amend the constitution. Erdogan and the AKP's margin of victory in recent elections, as well as the inability of opposition parties to capitalise on rising anti-government sentiment or put forth any credible challenge to the AKP, suggest that this is possible. Proposed constitutional changes can also be put to referendum, which would be a viable alternative in the absence of a two-thirds parliamentary majority following 2015 elections.

Erdogan struck a conciliatory and inclusive tone during his victory speech, which stands in sharp contrast to his divisive and polarising campaign rhetoric. However, we do not see this as signalling a fundamental shift in Erdogan's autocratic tendencies once president. Instead, we believe that Erdogan's ambition to maintain his grip on power and extend further political influence over the central bank, media and judiciary - as well as the AKP's mounting incursions into Turkey's secular social traditions - will continue to act as a source of social and political tension in the country.

Cabinet Shake-Up Could Upend Market Sentiment

The key questions now are who will be the prime minister, and how the cabinet will look, between now and 2015 elections. As we have previously surmised, there appears to be no place for AKP co-founder and current president Abdullah Gul, whose more moderate approach would stand the best chance of healing social rifts. There is speculation that Foreign Minister Ahmet Davutoglu is the leading candidate to assume the premiership, but whichever candidate is chosen will be a close loyalist of Erdogan who is unlikely to challenge his authority.

No Post-Election Bounce This Time
Turkey - TRY/USD Exchange Rate (RHS, inverted) And Borsa Istanbul Equity Index

More importantly, in our view, is the potential for Deputy Prime Minister in charge of the economy Ali Babacan and/or Finance Minister Mehmet Simsek to lose their positions within the cabinet. We believe this could lead to a rapid and destabilising loss of investor confidence that could prompt sharp losses in Turkish financial markets. The probability that their tenure is nearing an end following presidential elections has increased significantly, paving the way for more unconventional voices within Erdogan's administration to emerge as key decision makers and an erosion of central bank independence ( see 'Erdogan Victory Assured, But Key Questions Remain' August 7).

The AKP's narrowest margin of election victory was in 2009 and coincided with a sharp downturn in economic growth, and we see downside risks to economic growth as the biggest threat to the AKP's dominant political position in the years ahead. We forecast real GDP growth to accelerate towards a long-run average of 4.0% by 2017, but medium term economic potential could be much lower if a loss of investor confidence cuts Turkey off from favourable external financing conditions.

Foreign Policy Risks PKK Peace Process

In his victory speech Erdogan, re-affirmed the government's commitment to pursing peace and reconciliation with the militant Kurdistan Workers Party (PKK), pledging to continue working towards extending greater rights and freedoms to Turkey's Kurdish population. The Kurdish vote has become key for the AKP, and we believe that keeping the peace process on track will remain high on the agenda. However, sectarian conflict in Iraq and Syria poses major risks to this goal.

The PKK has often claimed that the Turkish government's support for rebels fighting Syrian President Assad has fuelled extremist Islamist elements. Indeed, the rapid advance of the radical Sunni militant group the Islamic State (IS) in Iraq and Syria has brought it into direct conflict with Kurdish strongholds, with the PKK now being drawn into the conflict. IS still holds 49 hostages from the Turkish consulate in Mosul, and thus has key leverage over the Turkish government, which thus far has unsurprisingly not taken a hawkish stance against the group. We see this as a key source of conflict between the PKK and Turkish government that could derail the peace process in the coming months.

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Sector: Country Risk
Geography: Turkey
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