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Erdogan’s Electoral Setback Sends Turkish Markets Tumbling

Sunday’s Turkish election saw voters put a stop to the president’s bid to amass power, but investors fear a new period of political uncertainty will hurt the economy.

Turkish voters surprised almost everyone on Sunday, delivering the biggest jolt to the country’s political establishment in more than a dozen years. The ruling Justice and Development Party of President Recep Tayyip Erdogan failed to capture a parliamentary majority for the first time since it initially rose to power in 2002, leaving Turkey facing the prospect of a minority or coalition government for the first time since that year. Or yet another election later this year.

Although Sunday’s vote was seen as a win for democracy in the long term and a rebuke to Erdogan and his effort to concentrate even more power in the presidency, the outcome heightened political uncertainty and sent Turkish markets reeling. The Borsa Istanbul 100 index of leading stocks dropped 5 percent on Monday, while the Turkish lira fell 2.5 percent, to 2.75 to the dollar.

Erdogan has grown increasingly autocratic in power, prompting comparisons with President Vladimir Putin of Russia, but the long period of stable rule by the AKP, the party’s Turkish abbreviation, has been a boon for economic development and investment. The election result raises the possibility that the country could be heading back to the days of weak and often short-lived coalition governments that caused the economy to flounder and inflation to run rampant in the 1990s, says Philippe Dauba-Pantanacce, an economist for Standard Chartered Bank in London who covers Turkey and the Middle East. “Foreign investors will most likely sell the story now, until they get a better clarity on the country’s direction,” Dauba-Pantanacce told Institutional Investor Monday.

Erdogan’s AKP won 41 percent of the vote and took 258 seats in parliament. That’s short of a majority in the 550-seat assembly and well short of the two-thirds supermajority that the president had sought to call a referendum on a constitutional change that would transform the presidency from a largely ceremonial position to an executive post with sweeping powers. After 11 years as prime minister, Erdogan last August became the country’s first directly elected president and has largely overshadowed his hand-picked successor, Prime Minister Ahmet Davutoglu. Despite Erdogan not being on the ballot on Sunday, the election was widely seen as a referendum on him and his plan to change the system. Once the results are confirmed, the AKP will have 45 days to form a government, or new elections will be called. After the results came in, Erdogan said no single party could govern alone, but none of the three minority parties have expressed an interest in forming a coalition.

A major catalyst for the AKP’s loss was the Peoples’ Democratic Party (HDP), which is led by Turkey’s Kurdish minority but has won wider popularity for embracing other minorities such as Turkey’s Armenian community and the Alevis, a religious minority that practices a version of Shia Islam tinged with Sufism and Turkish folk practices. The HDP won more than 10 percent of the vote, the threshold for taking seats in parliament. The far-right secularist Nationalist Movement Party and the secularist Republican People’s Party, the party of Turkish Republic founder Mustafa Kemal Atatürk, secured 81 and 132 seats, respectively.

This marks the first time since the republic was founded in 1923 that the Kurds have won a formal voice in the assembly. In the past Kurdish party members have run as independents out of concern that either the party would not hit the 10 percent threshold or that it would be banned from politics, as in the case of the pro-Kurdish Democratic Society Party in 2009. If the election results weren’t such a rebuke of Erdogan, formal Kurdish representation would be the most important takeaway from this vote.

Though Erdogan’s party is still Turkey’s most popular, this ranks as its first major setback at the polls. He founded the AKP in 2001 as a moderate Islamist party and won three majorities as its leader in the general elections of 2002, 2007 and 2011. The period of AKP dominance began with a series of reforms that brought Turkey closer to membership in the European Union as well as a stable macroeconomic policy framework and business-friendly investment rules. Gross domestic product per capita rose from $3,576 in 2002 to $10,3799 in 2008, according to World Bank data, but has stalled since then, failing to break past $11,000. Erdogan meanwhile has become the country’s most dominant leader since Atatürk and increasingly has used his power to go after opponents, ranging from media tycoons to the military to supporters of his erstwhile ally, Fethullah Gülen, a Pennsylvania-based cleric whose Islamic movement wields extensive influence over parts of Turkey’s civil service. Popular opposition to the president’s heavy-handed rule erupted in downtown Istanbul’s Gezi Park in 2013 when thousands of people took to the streets to protest government plans to build a mall there.

Erdogan has also demanded that the Central Bank of the Republic of Turkey lower interest rates, arguing that that would stimulate borrowing, a stance that has threatened the central bank’s independence. It’s unclear whether the central bank governor, Erdem Basçi, will serve out his term, which runs until next spring, according to Wolfango Piccoli, a Turkey specialist and managing director of Teneo Intelligence, a London-based political risk firm. One of the governor’s main supporters, Deputy Prime Minister Ali Babacan, is leaving office, having served a maximum number of terms in parliament. Foreign investment will remain a priority, however, Piccoli says. “AKP is acutely aware of the need to protect existing foreign investments and encourage more, given the country’s high current-account deficit,” he says.

In late 2014 Erdogan unveiled what may be the lasting symbol of his rule: the Ak Saray, a $600 million, 1,150-room palace built in an environmental preserve on the outskirts of Ankara. When Palestinian Authority President Mahmoud Abbas arrived for a visit in January, Erdogan greeted him from a grandiose staircase flanked by 16 men clad in chain mail and helmets, brandishing shields and swords and other gear meant to evoke military costumes worn during the Seljuk and Ottoman empires.

Yet by ending an era of regular military coups, Erdogan has made a profound and lasting contribution to Turkish democracy, even though he himself sought to consolidate power. Under Erdogan the state held trials of generals for plotting coups against him, but after they were convicted and sentenced to jail time came revelations that documents on which the prosecutors relied were faked. The reputation of the judicial system suffered. The end result, however, is a military less likely to interfere with popularly elected politicians. “That was great victory for democracy, despite the AKP’s readiness to bend the rules for political expediency,” says Piccoli.

For now, however, the next government will have to address the economic doldrums. GDP per capita has stalled since 2008, for example, stuck below $11,000. The World Bank defines a high-income country as one with an average income above $12,746 per capita, and Turkey may now be stuck in what’s known as the middle-income trap. A Central Bank of the Republic of Turkey working paper published in September 2014 found that 49 countries that have reached middle-income status since 1960 failed to surpass it, and just eight had succeeded. Another indicator of a middle-income trap is higher wages. After autoworkers went on strike for higher pay in May, Renault-Nissan said it may consider taking auto manufacturing out of Turkey. That would end a 46-year relationship. Portfolio investors have already responded, avoiding Turkish securities and selling off the lira since January, thanks to political uncertainty, according to research from Bank of America Merrill Lynch.

If the AKP forms a minority government, it will have plenty of economic issues to address. The good news is that the AKP under Erdogan has, up to now anyway, listened to advisers at key times. “When the pressure from the market rises, in the past Erdogan has given in to the technocrats,” says Anupam Damani, portfolio manager in charge of global fixed-income strategies for TIAA-CREF in New York. “There are enough technocrats within AKP that the market likes. The key is if they are left to be the stewards of the economy.”

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