Justin Vela in Istanbul -

It is "only a beginning," Recep Tayyip Erdogan, Turkey's prime minister, said in his victory speech following a September 2010 referendum on constitutional amendments. Erdogan's ruling Justice and Development Party (AKP) is virtually certain to remain in power after parliamentary elections on Sunday, June 12. However, the real test is the margin of the victory, with Erdogan set to call for a new constitution if he wins big. Investors worry that will take his eye off the economy.

AKP currently holds 331 of the 550 seats in Turkey's parliament and Erdogan hopes to push that to 367, which would give him a two-thirds "super-majority" and allow him to write a new constitution without having to go through another referendum. Polls show support for the AKP ranges between 46-52%, well above either of the two main opposition parties. The AKP garnered 46.5% of the vote in 2007.

The current constitution was written following a 1980 military coup and, as September's referendum illustrated, the majority of Turks believe it needs to be amended, although the need for a complete rewrite is questioned by some. Should the AKP gain the outright majority it is seeking, the coming months are likely to be dominated by the constitutional question and Erdogan's apparent wish to turn Turkey towards a presidential system - a goal allegedly aimed at allowing him to retain power for the long-term. However, it's hard to find strong support for such a change.

"Even within the AKP there are quite a few who are opposed to the idea," says Sahin Alpay, a columnist at the pro-government Zaman newspaper. "Then if you ask commentators and intellectuals, an overwhelming majority are against the idea. I have seen some surveys that show maybe there is some 50% support among the public - there's a lot of support for whatever Erdogan thinks. Myself and many others would raise hell over it."

Meanwhile, whilst the markets are generally happy to see the AKP - which is credited with ushering in a period of political stability and economic growth - remain in power, there is also concern. Turkey's story has changed in this year. Until 2010 the country celebrated growth of around 9% of GDP per year under the AKP - second only to China among the G20; today observers are hoping - possibly against the inevitable - that the country can avoid a messy post-election period and that the government will instead focus on dealing with an economy showing alarming signs of overheating.

"The current consensus is that an AK Party two-thirds majority would be a market negative, as it would risk concentrating too much power in their hands ... it could well un-nerve markets," says Tim Ash, Head of Emerging Markets Research at the Royal Bank of Scotland.

Economic challenge

In the face of poorly performing assets this year, the markets are keen to see the next government focus on the economy, and in particular fiscal and monetary policy in order to reign in signs of overheating in the form of rising inflation and a current account deficit which analysts at Danske Bank worry could hit double figures this year.

In May, headline inflation rose the most since January 2002, coming in at 7.17% year-on-year, up from 4.26% in April, according to TurkStat, but the Central Bank of the Republic of Turkey's is still forecasting full year inflation will come in at 5.5%. The current account deficit, which is forecast by the government to widen this year to $39.3bn, or 5.4% of gross domestic product due to a domestic demand for energy and imported consumer goods is pointed to by rating agencies such as Moody's as a factor keeping the country below investment grade status.

For months investors have wanted the central bank to change its policy of keeping interest rates low while hiking bank reserve requirements, which is largely seen as ineffective. Critics say the policy does not take into account the expected year-end rise in inflation, nor sufficiently curb lending for credit happy Turks. Danske Bank suggests loan growth is still running at a stunning annual pace of around 35%. Once the election dust has settled then, attention will move to the central bank's June 23 meeting to see if the policy is adjusted. In a recent release, Citigroup analyst Ilker Domac suggests it's likely "to take certain measures to alleviate these concerns," which presumably means policy rate hikes in the second half of the year.

With Turkey's growth model overly reliant on the central bank's stockpile of foreign reserves, Domac says, any new policy should focus on permanently raising the savings rate to help finance growth. Structural reforms are also necessary to increase the country's productivity and competitiveness. "However, we believe that the jury is still out on the political will of such a government to press ahead with a comprehensive reform package aimed at bolstering macroeconomic stability and changing Turkey's growth strategy," he adds.