12 June 2018

Turkish Elections and Why the Opposition Should Hope for an Erdogan Win

It's not for nothing that I am your resident contrarian.

My Turkish friends are furious about this statement. Especially now that some analysts seem to believe that Erdogan might lose these elections.

They keep reminding me that Tayyip Erdogan is a corrupt bully who destroyed the country's institutions to pave the way for an unchallenged one-man rule and ask me why they should hope for him to win again.

There are three very good reasons.

The first one is the fact that Erdogan would never relinquish power and would do anything, including killing scores of people, to remain president. He had done it before, ask the Kurds.

The second reason is the looming economic crash from which there is no escape. Any government will be sitting on a ticking time bomb.

Thirdly, Erdogan destroyed all the major institutions of the country and filled them up with his poorly educated and unqualified supporters. Essentially, Turkey is ungovernable.

This is the end of the Erdogan model and I would rather that he stayed in power to face the consequences of his policies and the major upheaval that will ensue. Besides, this is the only way to avoid a future Erdogan.

Let me explain my thinking.

A Revolutionary Guard Called SADAT

As I said, Erdogan will never relinquish power willingly. If his private polling is in line with the outlier poll I mentioned in my previous post (indicating that Erdogan would lose against Good Party leader Meral Aksener in the second round) he would never allow the elections to take place.

To do so is very easy.
Adnan Tanriverdi

Erdogan has been building up a private militia called SADAT. It was created by Adnan Tanriverdi, a retired brigadier general who was expelled from the army in 1997 for his Islamist views. The organization promotes itself as a defense consultancy but it is much more than that.

SADAT is fashioned after Iran's Islamic Revolutionary Guard Corps (IRGC) i.e. unlike the military which is loyal to the state, SADAT is loyal to the Dear Leader and his regime. For instance, there are eyewitness accounts about SADAT snipers killing people during the botched coup attempt on 15 July 2016.

Tanriverdi is Erdogan's principal military adviser and reportedly he has more influence than the Chief of General Staff. There are credible allegations that SADAT was training ISIS and other terror groups in Syria. They are also quite active in agitating Turks in Europe and they seem to have a hand in recruitment for radical Islamist groups.

If Erdogan's internal polling shows that he might lose, all he needs to do is to direct SADAT goons to start some  street violence in pro-opposition districts in large cities and to have them kill a large number of people.  You may be surprised to learn that extrajudicial killings are no longer a crime  in Turkey.

Next thing you know, he declares that the elections are suspended.

Erdogan is fully cognizant that if his opponents ever get the opportunity, they will uncover all his corrupt dealings and punish him, his family and his entourage very severely. He simply cannot afford to let go of power.

But let's, for the sake of the argument, envisage a scenario where he lost the elections and agreed to step away.

I can categorically tell you that, regardless of its composition, the new government is doomed to fail.

A Crumbling Economy

Turkish economy is about to collapse as it is facing a perfect storm.

The economy is built on borrowed money and a lot of it is short term capital. In a global economy where the Feds increase interest rates (as they are expected to so again later in the year) the dollar is rushing back home, creating a liquidity crisis for the so called emerging markets.

Within that category, Turkey is the worst hit because of its exceptionally weak economic fundamentals.

To begin with, it has a huge corporate debt. As of April 2018, corporate debt was 70 percent of the GDP.

A little over half of that is in foreign currency. Turkish Lira has lost 20 percent of its value since the beginning of the year (40 percent in 2 years and 124 percent in 5 years). As one brokerage put it "each 1 cent depreciation in the currency adds about 5 billion liras to the cost of Turkey’s foreign borrowings."

Very few companies can withstand that kind of profit erosion. As a result, companies that are previously considered too-big-to-fail, began to default or ask banks to restructure their debts. Two recent examples:
On Saturday, Hurriyet newspaper revealed that Dogus Holding, one of Turkey’s largest conglomerates, was in talks with several banks to restructure TL23.5bn ($5.81bn) in debt. Just in September last year, Turkey was still dealing with its largest debt default, Otas, on a $4.75bn loan.
There is also Yildiz Holding, the owner of Godiva chocolates and McVitie's biscuits looking for a $7 billion loan, the largest ever in Turkey.
Turkish food giant Yildiz Holding is to restructure $6.5 billion of its $8.5 billion in debt and the refinancing could be completed by the end of next week, two people familiar with the matter said on Wednesday.
In global markets, Turkish banks are seen as high risk institutions and they are having a hard time raising funds. Fitch has just placed 25 Turkish banks on watch negative citing risks to performance, asset quality and liquidity.

Moreover, the banking sector is holding its breath about the fine to be imposed on Halkbank. If, as predicted, the fine is $30 billion and over, you can forget about Turkish banks being able to raise funds for a good while.

This is happening at a time when there is not much money in Turkey's coffers.

Currently, Turkey's foreign debt is a little over $450 billion and to service it, it needs $188 billion in the next 12 months. Add to that $50 billion to finance a current account deficit of 6.5 percent of GDP (which shot up by 35.6 percent last April to hit almost $7 billion for the month) and you can see the enormity of the problem.

Ostensibly Turkey's Central Bank has roughly $100 billion in its foreign currency reserves. But that might be a major overestimate. Some of that money is in gold and a good chunk of it is commercial bank reserves deposited there. Analysts from UBS and other banks estimated (in 2017) that the real figure is closer to $35 billion and I know some analysts who put it even lower.

There is one more threat to the Turkish banking sector and that is the real estate bubble. Turkey's economic growth was largely fuelled by construction. With increased demands, construction companies rushed to build residential and non-residential buildings and banks happily provided financing. As long as prices went up and interest rates stayed flat, the formula worked.

One of the ways banks kept interest rates flat was to raise their funds abroad. With both the Dollar and Euro having a low interest rate, they could charge a higher domestic rates and make a healthy margin. In fact, they were so confident that things would stay the same, they sold long term (10-15 years) fixed rate interest mortgages. That encouraged further demand and led to even more construction.

When foreign currency interest rates started to creep up (and domestic rates shot up) those long term loans became a major liability. The banks saw their margins disappear and started losing money.

But now the construction sector is in deep trouble. One analyst is expecting serial bankruptcies. This is partly because construction companies are unable to fund their projects and have a hard time collecting the money they are owed. Currently, they survive with a barter system -a percentage of the building in exchange for materials to build it- but it is not tenable and industry insiders warn against a serious implosion in the second half of the year.

When construction sector loans start defaulting Turkish banks will be in serious jeopardy.

And that is not all.

Inflation hovers around 12 percent (and this is despite changing the measuring basket in an effort to get a lower figure) and it is rising.
[A]n inflation report showed consumer prices rose 12.15 percent in May from a year earlier, with the worst core reading on record and producer prices advancing more than 20 percent.
Normally, faced with similar situations, Central Banks hike up interest rates. That cools off the economy, reduces demand and gets inflation under control. And it also supports the currency.

However the Turkish Central Bank has been unable to do that because Erdogan is opposed to raising interest rates. He summoned the Chair of the supposedly independent Central Bank to his party headquarters to dress him down about "interest rates [being] the mother and father of all evil"

He is convinced that the best way to fight inflation is to lower interest rates. When he recently shared this rather unconventional axiom to money managers in London they laughed him off.

Still, when the Lira hit 4.92 against the Dollar in May the Bank had to move in to prevent the psychologically traumatic 5 Lira barrier and raised interest rates by 300 points. Which meant  a hike from 13.5 percent to 16.5 percent. It wasn't enough: four days ago, the Bank raised it again by 125 basis points to reach 17.75 percent.

But it was too late. Despite a initial rally, the Lira did not recover and the Dollar is still hovering around 4.52 and Moody's just threatened to lower Turkey's credit rating again (last downgrade was in March to Ba2, which is "junk" category).

That would force Turkey to pay a significant risk premium for any money coming into its banks.

In fact, the situation is so bad that more than one analyst warned that Turkey will be the ground zero for the next global debt crisis. Famed economic historian Russell Napier made the same prediction recently. And famous Harvard economist Kenneth Rogoff admitted the plausibility of that scenario. The fear is not that about the $330 billion foreign bank exposure in Turkey. They worry that a Turkish default could trigger a chain reaction involving Argentina, Brazil and even Italy.

In any event, whoever wins the elections, they will have two options. They will either hike up interests rates dramatically or let inflation soar.

If they choose the first solution, that would destroy the construction sector which is sitting on a glut of unsold buildings and they will bring down the banks that financed them. Moreover, higher rates would make credit very expensive, severely slowing down economic activity. That in turn will raise the already double digit unemployment to new heights.

If they choose the second solution, that is keep rates low and let inflation go crazy, this will lead to rapidly increasing prices and will decimate people's purchasing power. Turkey already went through 100 percent inflation rates in the 1980s  and people will not take this lying down. High inflation will also push foreign currency up making imports prohibitively expensive.

If the opposition wins and they choose one or the other option they will be blamed for people's economic woes. I can easily foresee major street protests (helped by SADAT) to clamor for new elections. Erdogan will return triumphant and that will be that.

An Ungovernable Country

Turkey's economic problems are well known. What is not generally discussed is the dismal shape of its institution.

Erdogan's early success was largely credited to the technocrats belonging to Fethullah Gulen's Hizmet movement. They ran the economy and staffed the senior positions in state enterprises.  For instance, the incredible success of Turkish Airlines owed a lot to their managerial know how. The carrier maintained an annual 10 percent growth for a decade and remained profitable. It was elected Europe's best airline for many years and had the lowest cost profile among large carriers.

Since 2013, Erdogan has been removing these technocrats and replacing them with his own pitifully underqualified supporters. Just to use the same example, 8,000 people were fired or pushed to early retirement at Turkish Airlines. The new managers reversed the trend the airline went "from big profit to big loss."

The same thing happened with the army, judiciary, general state bureaucracy, schools and universities and any institution you can name as Erdogan got rid of anyone who could represent a challenge to his rule.

A new government will have to run the country without the participation of these institutions. And that is not a tenable position.

Replacing Erdogan's cronies would take a long time and in many cases, the previous staffers either left the country or are too broken up about their treatment to be able to make a reasonable come back.

So, while seeing Erdogan defeated would put a smile on my face, I would much rather have him dealing with the inevitable chaos after the elections.

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