Market Extra: What you need to know about Turkey’s election this Sunday

Turkey will head to the polls on Sunday to vote for a new president, but the snap election called by incumbent President Recep Tayyip Erdogan comes as the emerging economy is beset by a flagging currency and economy, setting the stage for a downbeat stretch for the country.

The election called in April was seen as intended to solidify Erdogan’s political grip by forgoing a scheduled 2019 vote.

Last year, a constitutional referendum expanded the scope of the president’s power, and the Turkish leader recently sought to exert influence over the central bank.

ABN Amro economist Nora Neuteboom’s base case is that Erdogan will win but his Justice and Development Party (AKP) will fail to secure a majority in parliament, leading to a coalition government that could prove an unfavorable outcome for markets. It would keep pressure on Turkey’s lira, which has weakened on the back of the political turmoil and as the U.S. dollar has become resurgent against many emerging-market and developed-world currencies, buffeting the economies of country’s with dollar-denominated debts.

“The elections come at a tough moment as the economy is at a turning point and during the economic slowdown, there is very little room for policy mistakes,” she continued.

The lira is particularly vulnerable to the U.S. dollar’s DXY, -0.38%  rally that began in April, due to its reliance on foreign, and especially dollar-denominated, funding. On top of that, the Federal Reserve is committed to raising rates, underlining a U.S. central bank that in the midst of a tightening cycle that could further strengthen the buck and exacerbate Turkey’s economic and fiscal weakness by further weakening the lira.

The Turkish lira USDTRY, -0.0380% hit a fresh historic low against the U.S. dollar on Tuesday, according to FactSet. In the year to date it has almost dropped 25%. One dollar last bought 4.7369, up 0.1% on Thursday.

Market participants previously said a win by an opposition candidate could lead the lira on a rally, akin to the move the South African rand USDZAR, -0.5888%  enjoyed as longstanding leader Jacob Zuma stepped down.

Erdogan’s main opposition is the Republic People’s party (CHP) with candidate Muharrem Ince, who is a former teacher, and falls center-left of the opposition party spectrum.

Erodgan’s opposition candidates

Erdogan is seen as a candidate least-favored by markets because of his criticism of the Central Bank of the Republic of Turkey, which already has had to intervene three times this quarter to support the ailing lira. The president has said he wants to take more responsibility for monetary policy going forward. This led market participants to fret over the CBRT’s independence and to lose confidence in Turkish assets.

“The view of Erdogan is that low interest rates will encourage investment into Turkey because investors will become encouraged to take advantage of lower borrowing costs,” said Jameel Ahmad, global head of currency strategy and market research at FXTM. “This view is not economically incorrect, but it also does not fully take into account the dangerous effect the lira depression is having on the Turkish economy.”

The central bank is in the tough spot to navigate Turkey’s ailing economy and currency, a government critical of interest rate cuts and double-digit, consumer-price inflation. The last CPI print stood at 12.1% for the 12 months leading up to May. The central bank’s annual inflation target is 5% but that level hasn’t been achieved in past years.

See: Here’s why South Africa could become the next emerging-market carnage

Read: As emerging markets wrestle with trade-related woes and the dollar, is the pain over?

Although Turkey is far from the only emerging market facing an economic bind, analysts think it’s worst of out of the bunch. “Turkey’s annual external financing requirement—reflecting the current-account deficit and maturing debt—sits at $200 billion,” Neutboom wrote. “FX reserves are around $80 billion; liquid reserves are estimates to amount to only around 50% of the total reserves.”

Turkey is the odd one out among EMs

If Erdogan remains in power and investors’ bearish attitudes don’t change, portfolio flows, which so far have covered Turkey’s external financing requirement, could dry up, she said.

On top of the currency and rates impact, the new U.S. protectionist approach to trade espoused by President Donald Trump, could add to the embattled nation. White House tariffs pertaining to the imports of steel and aluminum also hit Turkey, which will begin implementing retaliatory tariffs on $266.5 million worst of U.S. goods from June 21, according to Turkish news outlet Hurriyet Daily News. The U.S. and European Union are Turkey’s largest trade partners.

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