Foreign exchange merchants are making ready for Erdogan’s election chaos

Turkish flag over a DenizBank building. Turkey is expected to go to the polls on Sunday.

Ismail Ferdous | Bloomberg | Getty Images

The Turkish lire is already facing some of the most volatile conditions in global currency markets ahead of the country’s landmark elections this weekend. Traders predict a likely collapse if incumbent Recep Tayyip Erdogan retains his presidency.

The lira is currently trading at a record low of 19.56 U.S. dollar – and market watchers are predicting there is more downside to come.

Both the presidential and parliamentary elections will take place in Turkey on Sunday. In the event of Erdogan’s victory, it is “highly likely that the Turkish lira will collapse within a few months,” Mike Harris, founder of consulting firm Cribstone Strategic Macro, told CNBC.

“Ultimately, the lack of confidence in investments will mean that the Turkish lira is likely to be one of the worst-performing currencies in the world for some time,” he said.

This is mainly due to the unorthodox economic policies of the current President.

“For several years, led by Erdogan’s crazy currency ideas, the Turkish lira has been extremely volatile and in crisis,” he said Steve H. Hanke, Professor of Applied Economics at Johns Hopkins University.

The Central Bank of the Republic of Turkey did not immediately respond to a CNBC request for comment.

Turkey’s monetary policy emphasizes the pursuit of growth and export competition rather than containing inflation. Erdogan supports the unconventional view that raising interest rates increases rather than curbs inflation.

The president’s refusal to raise interest rates played a crucial role in the lira’s historic plunge, which saw it fall from less than 4 against the dollar in 2018 to 18 against the dollar in 2021.

“Concerns about actual election uncertainty and then uncertainty about a possible change of government and how they might handle FX are behind the sharp rise in FX volatility to this 42.7% level,” said Paresh Upadhyaya, director of fixed income and securities currency strategy at Amundi US, who added that the lira’s volatility rate was around 10-12% in December.

“If Erdogan wins, which is our baseline view, USD/TRY could rally to 23.00,” wrote Brendan McKenna, emerging markets economist and FX strategist at Wells Fargo, in an email.

“The lira is grossly overvalued due to intervention efforts, and depending on how the election plays out, the currency could move sharply in one direction or the other,” McKenna said.

A ‘very sharp rally’ if opposition wins?

Erdogan’s biggest contender is joint opposition candidate Kemal Kilicdaroglu, who vowed to reintroduce orthodox economic policies and curb Turkey’s skyrocketing inflation rate.

And if the opposition emerges victorious, the lira will see some strengthening, at least initially, Upadhyaya said.

“It means that the Central Bank of Turkey will regain its independence and be given full mandate to pursue traditional economic policies,” he said.

Higher interest rates would help lower the country’s inflation rate, lead to a “rather severe recession” and help bolster foreign exchange reserves that have been depleted trying to defend the lira, he continued.

In a regime change scenario, the lira could still see downward movement in the short term if FX intervention efforts are halted, but a very strong recovery could occur in the longer term.

Brendan McKenna

Wells Fargo’s Emerging Markets Economist

However, according to a May 9 Commerzbank report, the positive reaction will be short-lived.

“The coalition is made up of smaller parties that came together only to overthrow Erdogan,” wrote Tatha Ghose, the bank’s senior economist for emerging markets.

“Market enthusiasm could wane if the coalition ran into problems working together or implementing policies, which would remind markets that Erdogan can return to power,” the report said.

Still, Wells Fargo’s McKenna anticipates a more optimistic long-term outlook for the currency.

“In a regime change scenario, the lira could still see a downtrend in the short-term as FX intervention efforts wind down, but in the longer-term, there could be a very strong recovery.”

Decoupled Market

Turkey is currently struggling with an inflation rate close to 50% after breaking a 24-year high of 85.51% last October.

Regardless of whether the lira free-falls or regains some ground, the domestic impact is still likely to be limited.

“Turkey is now a largely decoupled market with much lower flows and no real international involvement,” Ghose told CNBC in an email. Likewise, Upadhyaya sees no spillover impact.

“I don’t expect any contagion effects to other emerging market currencies or even G-10 currencies,” he said.

One analyst says Erdogan has lost control of the narrative

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