Turkey: the rigged referendum and implications for economic fragility

Following in the footstep of the rating agencies, investment banks were busy building up a self-fulfilling prophecy before and after the Turkish referendum of 16 April, 2017.

Mehmet Ugur
31 May 2017

Istanbul Stock Exchange. Wikicommons/Thomas Steiner. Some rights reserved.Before the referendum, global and domestic capital betted on the Justice and Development Party (AKP) regime like a horse whose jockey knows how to win by bending the rules. The bet has reflected the business elites’ preference for stability and their lack of interest in democracy.

In what follows, I discuss the rating agency and investment bank bias in favour of right-wing authoritarian regimes, the sources of fragilities in the Turkish economy, and the vengeance with which the institutional cull under the AKP regime may come to haunt both domestic and foreign capital in Turkey.

Rating agency bias in favour of right-wing authoritarian regimes

The role of rating agency bias in the global financial crisis of 2007-2009 has been discussed and documented. There has been a high level of correlation between agency ratings, all characterised by upward bias in the pricing asset-backed securities. Two common explanations for the upward bias are: (i) conflicts of interest and moral hazard problems due to the payment of rating agency fees by security issuers; and (ii) selective disclosures (or ratings shopping) that arise because of the room for issuers to choose the ratings to be published in conjunction with the security they put on offer.

Rating agencies are also known to be biased in favour of authoritarian regimes. According to Archer et al (2007), agency ratings do not differ between authoritarian and democratic regimes as regime type and most other political factors seem to have little or no effect on bond raters. The findings were based on ratings for fifty developing countries from 1987 to 2003. More recent research by Barta and Johnston (2017) reports that the bias is even worse in developed countries: using data for 23 OECD countries from 1995-2014, the authors report that left governments and the electoral victory of non-incumbent left governments are associated with significantly higher probabilities of negative rating changes.

Given this track record, it was not surprising to observe a similar bias in favour of the authoritarian AKP regime in Turkey too. Large-scale corruption scandals that involved the president and minsters in 2013, Turkey’s slide from 53rd to 74th country in the Transparency International ranking for corruption control in 2015, the president’s and government’s interventions into the central bank’s monetary policy decisions from 2014-2016 had only little effect on rating agency ratings for Turkey. Indeed, from 2014-2016, two out of three major rating agencies downgraded Brazil (with an incumbent left-of-centre government) more heavily than Turkey (with a right-wing authoritarian regime). Also, at the end of 2016, Turkey’s credit worthiness (44 points) was higher than that of Brazil at 34 points. And this is despite the fact that Turkey experienced a botched political coup and that the political regime has become ever more dictatorial over the last two years.

Betting on Erdogan’s sultanate after the referendum

Following in the footstep of the rating agencies, investment banks were busy building up a self-fulfilling prophecy before and after the Turkish referendum of 16 April, 2017. The story is quite familiar: drawing on the results of a selected list of opinion polls, Morgan Stanley Research (5 April 2017) declares that a Yes vote is more likely. The prediction is backed by opinions from an unspecified selection of ‘politicians, policy-makers, political analysts, survey companies, local banks and embassies’.

Looking past the referendum, and overlooking the unfair campaign, Morgan Stanley declares that they would ‘hold onto their long bond positions ahead of the referendum’. The reasoning is revealing: the ‘yes’ vote is ahead and the monetary policy is expected to stay ‘tight’. No mention of institutional degradation or doing away with the rule of law under the state of emergency. No word either about the fact that a yes vote would enable the president to control the executive, the legislature and the judiciary – with total judicial and parliamentary immunity.

After the referendum, a long list of investment banks advise in favour of holding long positions with Turkish assets. The payoffs were expected to be high as the markets bounce back due to the future stability (emphasis added) that the continuity of an authoritarian regime would bring. For example, Namoura advised its clients to expect an appreciation of the Turkish currency and increasing bond yields as the AKP regime would remain in power until the elections in 2019. Raiffeisen Centrobank, Radobank, Nordea, and Commerzbank all agree: the narrow (and controversial) victory of the AKP regime would remove political uncertainty and usher in a period of rallying asset prices.

These self-fulfilling prophecies are delivering a short-run rally in favour of Turkish assets. The slide in the Turkish Lira is checked and the Istanbul Stock Market is on an upward trend. The AKP government has played its part by increasing government spending and announcing a set of measures aimed at enabling commercial banks to engage in unlimited securitisation of existing debts. Foreign investors are impressed – despite the fact that debt securitisation was a major cause of the 2008-2009 global financial crisis and that the commercial bank debt to be securitised includes credits extended both to the melting tourism industry and bubbling housing market participants.

The rally can also be observed despite diplomatically worded warnings by the IMF, the February 2017 country report of which projects: a sluggish growth at 2.9% in 2017, with considerable downward risks; domestic consumption to be the main driver of growth; weakened corporate profitability and a sharp fall in tourism revenues; a negative output gap; and a persistent current account deficit of around 6% of GDP.

Self-fulfilling prophecies end in disaster

Self-fulfilling prophecies are driven by expectations which are confirmed by behavioural change and commitment to the chosen line of action. Stated differently, self-fulfilling prophecies generate one-way bets that continue until the pay-offs begin to fall. Any trigger that causes a fall in the pay-offs can instigate a negative self-fulfilling prophecy where flight at the earliest moment is the preferred option. The rigged referendum has increased the probability of a negative self-fulfilling prophecy for several reasons.

The new constitution enables the president to monopolise all powers. Control of the legislature is ensured in article 116, under which the president can dissolve the parliament. Control of the Constitutional court is ensured in Article 146, under which 12 out of 15 members of the Constitutional Court will be appointed by the president. Under Article 104, the president monopolises the executive power, including the power to appoint and dismiss the senior state executives. Under article 119, the president also has full power to declare state of emergency and martial law. Against this full control, the president is immune to  criminal liability and/or parliamentary scrutiny.

As a result, elections are now a less likely means of changing governments in Turkey: whilst the party in power would mobilise all state resources to maintain its rule, the opposition would be forced to rely on the streets for regime change. Local and foreign business interests are likely to be targeted. The probability of such targeting will be an increasing function of people’s perceptions of the business elite as complicit in propping up the AKP regime.

The power of the street in non-Kurdish regions of Turkey will cause serious fissures in the nationalist coalition against the Kurds that cuts across all mainstream parties. As a result, nationalist support for ratcheting state terror against the Kurds is likely to weaken. Any such weakening is likely to open new channels for the Kurdish political movement to strengthen its demands for democratic autonomy. What is more important is that the armed sections of the Kurdish political movement would seek democratic autonomy by defeating the AKP regime rather than negotiating with it.

The change in emphasis is evident in a piece published on the ANF NEWS website on 25 May 2017. Mustafa Karasu, a high-level Kurdistan Workers’ Party (PKK) representative who is known to have participated in the Oslo negotiations with the AKP government until 2014, states the following: “Of course, many problems in the word have been resolved through negotiations with governments. However, the Kurdish question cannot be compared with other issues in the world. This is because we are faced with a mentality that seeks genocide rather than resolution of the Kurdish issue. … Therefore, Turkey is in need of a democratic revolution. The Kurdish issue can be resolved only through a democratic revolution.”

Beyond these political fragilities that the authoritarian AKP regime brings with it, the institutional cull in Turkey is feeding economic fragilities too. The risks associated with the drive for securitisation mentioned above should be considered in conjunction with the risk of a bursting housing-market bubble in Turkey. An FT piece on 19 May 2017 bears the following title: ‘Istanbul’s prime market hit as investors rethink Turkish property’. Turkey’s exponentially increasing residential property market has been a major boon for the AKP regime. In 2016, the property price index increased by 13% on average and by 12% in Istanbul. The prime home index, however, has fallen by 8.4% over the same year. This is a bad sign for a regime whose fortunes are tied with the property market, particularly the high-end of the market.

Taking into account the fact that the demand for property is a significant part of the domestic demand that is driving GDP growth, the increasing risk of a housing-market crisis constitutes a major source fragility in the Turkish economy. This risk is increasing not only because of the fall in the prime-market prices but also because of the increasing demand for property in foreign countries such as Portugal, where a golden visa programme for anyone spending more than €500,000 on property is considered by well-to-do Turks as an ‘insurance policy’.

Another source of fragility in the Turkish economy is the persistent current account deficit, currently at around 6% of the GDP – the highest among the emerging markets. Given the risk premia that Turkey is paying to finance this deficit, the servicing of the external debt is increasing. In addition, Turkey needs to grow at least 3.5% per year to avoid further increases in the unemployment rate, which is currently at 13%. A broader definition puts the figure at about 20%, with the official rate for young people aged 15-24 years standing at 24.5%. However, any increase in the growth rate, which can be obtained mainly through fiscal expansion, would exacerbate both the current account deficit and the budget deficit.

Finally, there are structural sources of fragility too. According to OECD figures, the poverty rate in Turkey is currently at 17.2%  – worse than 28 out of 31 OECD countries. According to official figures reported in the opposition paper Cumhuriyet, the number of people on at least one type of social support program in 2014 was 30 million, up from 23.7 million in 2012. This is equivalent to about 40% of the population. The explosion in the number of people receiving state benefits may well be designed to secure voter support. However, it comes with a fiscal cost and with a dependency-culture cost that hits labour-market participation and skills at the same time.

Wrapping up


Erdogan at the G-20 summit on Financial Markets and the World Economy in Washington, D.C., November 2008. Wikicommons/Presidencia de la Nación Argentina.Some rights reserved.The business elites’ bias in favour of stability and right-wing authoritarian regimes has generated a self-fulfilling prophecy that has paid off since the vulnerabilities of the Turkish economy were exposed during the 2008-2009 crisis. This prophecy, however, is not sustainable and has made the Turkish and global business elites complicit in the dictatorial drift in Turkey. This choice has low cost for foot-loose finance capital as the latter can pull out of the country quickly when the chickens come home to roost. However, it may well cause regret among foreign direct investors and domestic industries that cannot divest so quickly. Perhaps that is part of the reason why the two leading conglomerates in Turkey (Koc and Sabanci Holdings) have started to sell shares massively  (with a total value of $600 million) – leading to falls of 6% in Koc share prices and 2.25% in Sabanci share prices in one day after the sale.

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