(News Bulletin 247) – The presidential and legislative elections taking place this Sunday see two candidates with diametrically opposed visions of monetary policy compete, while the country’s currency has collapsed with rates too low in the face of inflation .

Recep Tayyip Erdogan, who has been in power in Turkey for 20 years now, awaits an all-risk election. Both the legislative elections and the presidential election are taking place in the country this Sunday, May 14. For the first time since his accession to the head of Turkey, the Head of State faces a rival who seriously threatens him, namely Kemal Kiliçdaroglu, candidate of the Republican People’s Party (CHP) and head of a alliance bringing together six opposition parties.

“Recent polls indicate a tight race between incumbent President Erdogan and CHP leader Kilicdaroglu, the opposition candidate, but give Kiliçdaroglu the winner in the first or second round,” notes Charles-Henry Monchau, chief investment officer of the bank. Syz.

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On the economic level, these are two very different lines which clash with the hollow future of a national currency, the Turkish lira, rolled by years of too low rates. Recep Tayyip Erdogan has, in fact, pursued a counter-intuitive policy in the face of galloping inflation.

“The country’s currency has never been so weak against the dollar, particularly in a context of excessively flexible monetary policy, current account imbalances and concerns about the presidential election”, underlines John Plassard de Mirabaud.

Although falling, inflation reached over 44% year on year in April, after hitting a record high of over 85% in October. “It is possible that Turkish inflation is much higher than the official figures say. The independence of Turkstat, the statistics body, is very questionable. And if we look at inflation in Istanbul, which is published by the local chamber of commerce, it is 20 to 30 percentage points higher than the official national data,” notes Guillaume Tresca, senior emerging markets strategist at Generali Insurance Asset Management.

A Turkish lira actually overvalued

In the face of soaring inflation, Erdogan has stubbornly opposed any rate hikes by Turkey’s central bank, convinced that such hikes fuel inflation. The Turkish central bank has thus led a series of cuts in its main key rate, going from 19% in 2021 to 8.5% since the end of February. The central bank then reduced its rate by 50 basis points (0.5%) following a terrible earthquake which had caused more than 45,000 deaths.

“In recent years, the strategy of the Turkish central bank has been difficult to read for the market, with strong interference from politicians who wanted to move towards growth at all costs. We can say that it is not independent” , summarizes Guillaume Tresca.

This results in a plunge in the Turkish Lira. Against the dollar, the national currency is still suffering this year, the greenback having appreciated by 4.4% since the beginning of 2023 against the Turkish lira, an increase which reached 28% over one year. A dollar today is worth almost 20 Turkish liras against 7.6 at the end of 2020.

And yet these recent declines mask a more complex reality. “The depreciation of the Turkish lira in recent months has actually remained contained in view of the pressures that are supposed to be exerted on the currency. To give an idea, in the summer of 2018 or the end of 2021, the currency had experienced episodes of a 10-15% drop in a single day”, develops Guillaume Tresca.

“Several measures have been taken to prevent a plunge in the currency. The central bank of Turkey, although it does not say so officially, has intervened regularly in the foreign exchange markets to support the currency, which has resulted in the massive melting of its foreign exchange reserves. At the same time, restrictions on the use of foreign currencies have been put in place for companies and individuals, which can amount to a light form of capital control, “he adds. -he.

“In the end, the Turkish lira is very likely overvalued. It is difficult to determine the “right” rate of the currency but we can think of a rate of 1 dollar for 23-24 pounds”, assesses the strategist. “And for foreign investors it is very difficult to position themselves on the Turkish lira,” he warns.

Towards a new fall after the election?

Faced with the very unconventional policy of Recep Tayyip Erodgan, Kemal Kiliçdaroglu poses as a defender of a more liberal policy, advocating a return to economic orthodoxy and promising to restore the credibility and independence of the country’s central bank. . Which, on paper, is likely to stem the fall of the Turkish lira, at least in the medium term.

“A more credible and tougher monetary policy would be put in place, and would bring inflation down. In addition, the central bank with regained independence would attract capital flows, which would strengthen the Turkish lira”, estimated at the end of March. Swiss Life Asset Managers.

But in fact, it is to be feared that the Turkish currency will suffer another bamboo blow after the results of the elections, whatever their outcome.

“It is very complicated to anticipate the results of Sunday’s elections and to draw up hypotheses. Nevertheless, it appears that the Turkish lira should fall in the two “central” scenarios that we can try to outline”, judge Guillaume Tresca.

“In the first scenario, if Erdogan remains in power, we can think that the political leader will move towards an economic policy that is a little less heterodox than before the elections. He would relax a little the measures that prevent the Turkish lira from depreciate sharply, because it has less interest in supporting the currency than before this political deadline. And the situation on the foreign exchange reserves of the Turkish central bank is, moreover, difficult to sustain. The currency would therefore fall. But we would remain in a very heterodox policy”, develops the strategist.

“Now this assumption amounts to assuming rational decisions in Erdogan, which has never really worked in the past,” he said.

In the second scenario, Kemal Kiliçdaroglu and the opposition would come to power. “In this case, the candidate has promised to return to a very orthodox economic policy. Which should result in a sharp rise in key rates, to 40% or even 50%,” said Guillaume Tresca. “In this case, the Turkish lira would also fall, simply because again the relaxation of the support measures for the currency – in particular the constraint on the exchange rates – would lead to a correction. In addition, a weaker currency is necessary to stabilize macroeconomic imbalances in the country,” he said.

“To mitigate this potential decline, in addition to key rate hikes, the opposition will have to quickly manage to restore the credibility of the central bank by appointing very competent leaders,” adds Guillaume Tresca.

Charles-Henri Monchau expects, for his part, that whatever the outcome of the elections, orthodox monetary policies will be put in place, deeming them “inevitable”. He estimates that the Turkish central bank could raise its rates between 20% and 30%.

“In a scenario of imbalances adjustment and rising interest rates, the pound could strengthen and risky assets (equities) could see their volatility increase. Even though the Turkish equity market is very cheap [avec un ratio P/E de cinq soit des actions qui s’échangent à peine cinq fois les bénéfices, NDLR]a correction phase is to be feared”, he warns.

“The presidential elections in Turkey could be a ‘game changer’ for the country and international relations if the government were to change. However, we can expect very high volatility regardless of who wins the elections. “, concludes John Plassard.