ISTANBUL BLOG: Parties begin coalition talks to avoid fresh elections

By bne IntelliNews June 26, 2015

Kivanc Dundar in Istanbul -


Horse trading is about to begin in earnest after the first Turkish election in 13 years to produce a hung parliament.

Newly elected Turkish deputies were sworn in on June 23 and President Recep Tayyip Erdogan is expected to ask Ahmet Davutoglu, acting premier and the ruling AKP’s leader, to try to form a government in the week beginning June 26. This will launch a round of negotiating between political parties that have very diverse ideological stances. If no working coalition can be formed, or a minority government fails to win a confidence vote within 45 days, Erdogan can call early parliamentary elections. That election will be held 90 days later.

Failure to form a government will drag the country into snap polls and stoke further uncertainty at a time when the country’s $800bn economy is slowing, inflation is running high at 8%, and its currency is losing value against the dollar. Turkey is considered one of the most vulnerable emerging economies because of its large current account deficit, largely financed by external financing.

Early elections may not break the deadlock 

In the June 7 elections, the AKP won 258 seats in the 550-member parliament with 40.66% of the votes. The centre-left CHP got 25.13% of the votes and 132 seats. The nationalist MHP won 16.43% and the Kurdish HDP received 12.96% of the votes. The MHP and HDP each took 80 seats.

President Erdogan has been urging political leaders to form a government quickly. But some observers think Erdogan is secretly betting that if coalition talks prove futile, the Turkish electorate would soon “regret” their choice at the June 7 election, and the AKP would win enough votes in a snap poll to form a single-party government.

“The best for Erdogan is the formation of a dysfunctional coalition government. He has many weapons to make this happen, all based on the constitution. These weapons include preventing the appointments of the coalition partners and vetoing the laws the coalition would want to put into effect,” wrote the columnist Mehmet Yilmaz on June 22 for the daily Hurriyet.

“He would leave Turkey with a coalition that cannot manage the country and in the end the coalition would dissolve as a matter of course,” said Yilmaz.

However, a recent survey by a polling agency Metropoll suggests a possible snap poll may disappoint Erdogan and early elections would not dramatically change the parliamentary arithmetic in favour of the AKP. Metropoll is one of the few polling agencies that had accurately predicted the outcome of the June elections. Support for the AKP is currently standing at 41.6%, according to Metropoll, which puts support for the CHP at 25.1%. The MHP could get 16.2% of the votes and the HDP would receive 12.9% if snap polls were to be held, said Ozer Sendar, the head of Metropoll.

Sencar also told Hurriyet Daily News that 22.8% of the surveyed support the idea of AKP forming a coalition government with the MHP. Support for a coalition government of the opposition parties CHP-MHP-HDP is 20%, while only 8% favour an AKP-CHP coalition, according to Sencar.

Erdogan remains central figure 

The political parties’ “red lines” make striking a coalition deal very difficult. All the opposition parties demand that the corruption allegations from 2013 against Erdogan’s inner circle must be reinvestigated. They also say Erdogan should stop acting like a politician and remain neutral. The other thorny issue is the peace talks with the outlawed Kurdish group PKK. The MHP says the peace negotiations must end, but the AKP says it is still committed to the peace process.

Davutoglu recently said he would not allow any attempt to undermine Erdogan's authority during the coalition talks. “Erdogan’s shadow nevertheless continues to hang over the political scene, making efforts to form a coalition more difficult than otherwise might have been the case,” said the political commentator Semih Idiz in an article in Al Monitor on June 23.

“The AKP might sacrifice the former ministers accused of corruption, especially since it is clear that they contributed to the party’s electoral losses. But to allow a reopening of the probes against them would mean reopening the case against Erdogan’s son Bilal, which the AKP clearly can’t allow given that Erdogan remains its spiritual leader,” added Idiz.

Bulent Aliriza, director of the Turkey Project at the Center for Strategic and International Studies told the Financial Times on June 22 that “Erdogan is now lying low, waiting to see how things will shape up and then he will make his move. But the idea that he will give up his de-facto control over the AKP, and through it the government, I just don’t see it.”

But, another well respected local commentator Murat Yetkin argues that the chances are rising for the formation of a grand coalition of AKP-CHP. Yetkin even believes that “if the ongoing backchannel talks succeed, a coalition government between the two parties could be possible by the end of next week”.

Yetkin sees the election of parliament’s new speaker as a litmus test for a possible coalition between the country’s two major parties. “The AKP could let CHP’s candidate win the speaker post as a bargaining chip used to counter CHP leader Kemal Kilicdaroglu’s possible coalition demand to rotate the prime minister,” said Yetkin in his column in Hurriyet Daily News on June 23.

The new speaker of parliament is expected to be elected by July 1 at the latest.

Prolonged risk for the economy

“If no coalition is formed and Turkey heads to the polls again, political uncertainty would remain heightened until the end of the year, which could potentially hamper growth if business investments are postponed,” said Standard & Poor’s, the rating agency, in a note on June 18.

It could consider a Turkish downgrade if developments such as lira volatility, consumer confidence and inflation were to weaken fiscal performance and debt metrics were to deviate from current expectations, warned S&P.

The lira fell to new record lows against the dollar in the wake of the June 7 elections, but the local currency has recovered some of its losses since June 17.

Political risk is not priced in, said Barclays in a report on June 23. “We see increasing headwinds such as a weaker coalition government, a possible US rate hike, weakness in the Turkish lira, weaker EUR/USD, slower growth and increased geopolitical risk on the macro side, which we think are not fully reflected in the valuations and the equity risk premium,” the bank argued.

Barclays believes that even if a coalition government is formed, the longevity of such a government would continue to weigh on market sentiment, affecting stock prices more so than might have been seen previously.

“Turkish companies are now simultaneously exposed to 1) weak TL and 2) weak EUR. Contrary to general expectation that exporters are benefiting from a weaker TL, we think that valuations are yet to reflect the weak EUR and the potential slowdown in the domestic market,” it said in the report, adding that although the country’s medium-term growth prospects are still intact, there is a political risk overshadowing its investment story in the short term.

Danske Bank pointed out in a note on June 18 that Turkey’s economic growth of 2.3% y/y in the first quarter was better than expected, yet, it said, the path is slowing down. Danske expects the economy to grow 2.8% y/y in 2015, just below the 2.9% expansion in 2014.

The valuation of TRY is starting to look attractive, but it remains among the most fragile emerging market currencies and it will continue to underperform in a risk-averse market, said Danske, which expects the local currency to weaken in the next three months against the dollar on expectations of a Fed hike, but to strengthen in the longer run.

As the lira drops further on political uncertainty the central bank’s ability to cut interest vanishes, according to Danske.

Central Bank under spotlight

The question market players are asking is whether the central bank will have more room to act independently under a coalition government.

The central bank, as widely expected, left interest rates unchanged on June 23, a day after the economy minister Nihat Zeybekci renewed his call for lower rates.

The central bank left the one-week repo rate at 7.50% and the overnight borrowing rate at 7.25%, while the overnight lending rate remained at 10.75%.

With its focus remaining firmly on the lira, it does not expect the central bank to change its rate strategy immediately after the elections, said Deustche Bank in a report on June 19. Dynamics of political economy suggest any move before a new government is formed could alter coalition possibilities and the probability of snap elections, argued Deutsche analyst Kubilay Ozturk.

Rate hikes look increasingly likely over the next six to nine months, William Jackson, emerging markets economist at Capital Economics in London told the Wall Street Journal on June 23.

However, analysts disagree on whether the change in the political landscape could help the central bank.

While there is an argument that the weaker standing of the AKP gives the central bank a freer hand to hike rates, it's a very tenuous one to say the least, Nicholas Spiro, managing director at Spiro Sovereign Strategy, told CNBC on June 23 in an interview. "The central bank's inflation-fighting credibility was damaged long before political pressure started to build," he said.

But, Salman Ahmed, global and EM fixed Income strategist at Lombard Odier, disagrees. I think the situation has changed in Turkey after the elections, Ahmed told CNBC. "I would argue, contrary to the consensus, that given the seismic shift in the political situation, the central bank's hand has been strengthened and Governor Erdem Basci) can run a more independent central bank going forward”, he said. 

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