Turkey in a state of emergency: the political outlook

Widespread arrests and dismissals have by now affected some 60,000 people in the army, police force, media, education sector and the state administration. Although President Erdogan has promised that the state of emergency would be used solely to persecute people associated with the coup attempt, it might also entail a further clampdown on the political opposition and civil liberties. In this charged atmosphere, even Erdogan’s most ardent critics will keep their heads down for now. Further down the line, the expected push towards autocracy will fuel counter-reactions among the 50 percent of the population that have not voted for Erdogan. There will be a lack of political stability also in the medium term.
 
The EU might put its membership talks with Turkey on hold, especially if Ankara reinstates the death penalty. A suspension would not significantly affect Turkish policymaking, as the EU talks have in any case hardly progressed in recent years. For the business environment the Turkish government’s narrow focus on security issues and its weakened implementation capacity will be even more important, as the purges are also affecting state bodies such as the finance ministry. Turkey is highly unlikely to amend its terrorism legislation – a precondition for the visa liberalization promised by the EU for October under the refugee deal. As long as the Balkan route remains closed, a collapse of that deal is however unlikely to result in a new wave of refugees towards western Europe.
 
There is a risk that repeated extradition requests for Fethullah Gülen could aggravate tensions between Turkey and the US. With a weakened army and tensions between Turkey and its NATO allies, Turkey’s already fragile internal security situation could deteriorate further. The fight against ISIS in Syria and Iraq could also be affected. This is not in the interest of the US.
 
Economic impact
 
Although it is too early to quantify the economic implications, it is clear that the failed coup and domestic policy reactions represent a significant confidence shock that further aggravates an already challenging economic situation. This applies in particular to Turkey´s external financing needs. The non-financial corporate sector is heavily reliant on external funding. Close to 60 percent of its debt is denominated in foreign currency. Additionally, Turkey has registered huge current account deficits for many years, which were primarily financed by short-term capital inflows. For this year, we expect a current account deficit of about 4 percent of GDP. All in all, external financing needs in 2016 will equal more than 25 percent of GDP, which is high by emerging market standards.
 
The coup attempt and the political repercussions will weigh on economic sentiment and investment activity. Also, international investors might reassess political risks in Turkey. The rating agency Standard & Poor´s has just recently lowered Turkey´s sovereign rating and assigned the new rating a negative outlook. Economic policy is likely to be more expansionary in an attempt to limit the economic fallout. However, we consider the central bank´s room for lowering key interest rates as limited, since this would weaken the Turkish lira even further and, therefore, increase debt service costs for the corporate sector.
 
Our real GDP growth forecast for 2016, which stood at 3 percent (a fairly low rate for an emerging market with strong population growth) prior to last weekend´s events, will most likely be revised downwards once first reliable economic data becomes available. The main uncertainties going forward stem from the febrile political situation, which requires close monitoring.