Path clear for a referendum on constitutional reform in Turkey

The Turkish lira started 2017 in exceptionally weak form and, with a loss of a good 9% against the euro, revealed the weakest performance of all the world’s major currencies. The lira is currently marking historic lows against both the euro and the US dollar. The prospect of the American Federal Reserve tightening its policy did not exactly help the Turkish currency either. However, the present weakness is currently being driven primarily by domestic factors. Not only is President Erdogan adopting a heavy-handed approach to dealing with his political opponents since last summer’s attempted coup, but governance measures, the uncertainty accompanying these as well as conflicts with radical groups regularly flaring up within Turkey have now left a visible mark. This extends both to the country’s economic performance as well as to its economic prospects. The central bank is also a part of this, having until now only reluctantly adopted measures to counter growing price pressures and to defend the Turkish currency.

President Erdogan recently came a good step closer towards achieving his proclaimed goal of constitutional reform. Having, as expected, taken the necessary hurdle of a three fifths majority, parliament approved the bill to deprive its members of certain of their competences and to concentrate this power with the President. This means that the path is now clear for a referendum on the constitutional reform that could be held as early as the beginning of April. Investors should not pin any hopes on voters rejecting Erdogan’s aspirations. It is also unlikely that the President will on his own initiative make any attempt to appeal to international investors. Yet, given the significant level of (short-term) external debt in the Turkish private sector as well as Turkey’s existing current account deficit, the country is indeed dependent on the favour of investors beyond its borders. Should Turkey fail to regain investors‘ confidence in the foreseeable future and thereby prevent a further flight of capital, the lira can be expected to remain weak. More intense speculation over a balance of payments crisis and capital controls is also not to be excluded.

But this does not mean that the lira should be written off altogether. The Turkish central bank is still likely to be in a position, at least theoretically, to bring about stabilisation. Measures taken up to now to tighten liquidity are a cautious attempt at a more restrictive monetary policy „via the back door“. Here, the central bank is attempting to bolster the currency without openly opposing the President’s demands for lower interest rates. Unfortunately this is unlikely to be enough to win back investor confidence. Rather, a more resolute monetary policy would be necessary in the form of a real increase in key interest rates.

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