Turkey heads to the polls this Sunday, June 24, for joint parliamentary and presidential elections, with a run-off vote for the presidency pencilled in for July 8, assuming no single candidate secures the required 50%-plus-one-vote victory in the first-round contest. Against this context, I thought it useful to provide a few of my thoughts on these elections—having now had a 20-year long tour of duty covering Turkey.

These elections are hard to call…
As a starting point, it is fair to say that these are the most unpredictable elections perhaps since 2002 and the ruling Justice and Development Party’s (AKP’s) first ascent to office. 

These elections are different for a number of reasons: 

        •       The elections are being held under a new constitution, with joint presidential and parliamentary elections, with more power going to an executive presidency, but with parliament still retaining significant powers (to legislate, block the budget, nominate a majority of supreme court judges and call early elections, amongst others). But to reassume power, President Recep Tayyip Erdogan needs to win 50%-plus-one-vote in the presidential elections – previously, under the parliamentary systém, he often could win with just 40-odd percent of the vote. So the bar for an Erdogan/AKP victory has been raised.
        •       Under changes to electoral rules, parties can now campaign in electoral alliances, which has reduced the importance of the 10% electoral threshold to secure parliamentary representation—hence more parties are likely to enter parliament, which again means that the AKP will likely have to secure a higher share of the vote to secure another majority.
        •       The opposition are more united than ever—they are coordinating their opposition to Erdogan and the AKP. This has seen quite incredible acts of solidarity between the parties, as reflected in the main opposition Republican People’s Party (CHP) giving the fledgling IYI (Good) party 15 of its deputies to enable it to compete in these elections. It has also seen CHP presidential candidate Muharrem Ince visit the pro-Kurdish People’s Democratic Party (HDP) candidate, Selahattin Demirtas, in jail. 
        •       The opposition have a number of far more effective/credible candidates in the presidential election than before in Muharrem Ince from the CHP and Meral Aksener from IYI. The charismatic Kurdish HDP leader, Selahattin Demirtas, is also running his campaign from jail, while many secular Turks seem set to vote tactically in these elections, likely for HDP to ensure it passes the 10% threshold for entering parliament.
        •       Opinion polls are notoriously inaccurate in Turkey—but this time around bias is likely to be extreme, as given the tense and polarised political and security setting, it seems likely that many voters will be reluctant to express their views to pollsters. And indeed, the share of “undecided/undeclared” is unusually high in advance of these elections. 
        •       The AKP will probably also come up against the lethargy over incumbency, after nearly 18 years in office, and a desire for change—perhaps similar forces/factors that recently encouraged change in Armenia, Malaysia, South Africa and even Zimbabwe, where entrenched administrations were pushed from office, sometimes against expectations.

But we also have to accept longstanding and well-known factors working in the AKP’s favour including Erdogan’s strong personal following, and a loyal core base support of perhaps 40% from the majority Sunni Muslim faithful—the CHP still suffers from an Alevi Muslim label. The power of incumbency, control over the levers of power, patronage, fiscal pump priming (1.5 million jobs created over the past year), the fear of something different and uncertain, plus many Turks’ appreciation of a strong leader, a rising nationalist/populist and anti-Western sentiment in Turkey which Erdogan has played to—Erdogan is almost a Turkish/Islamist version of Donald Trump, playing to the populist/nationalist wave. The AKP/Erdogan are also dominating the Turkish media—both state and private sector channels, securing 70% or thereabouts of coverage. I would add here the changing demographic face of Turkey—with a high birth rate in Central/Eastern Turkey, which is the AKP’s core electoral base, and a low birth rate in Western/Med Turkey which is the opposition/secular heartland. Turkey is becoming more socially conservative as a result over time, which has consistently benefitted the AKP in elections since 2002. AKP almost has a tribal loyalty now—more like the support for a football team, and this is a reflection of the increased polarisation of society more generally.

…but expect the unexpected
The consensus view from opinion polls seems to be that the AKP will lose the parliamentary election to an opposition coalition (itself a move away from the AKP’s long-held dominance in parliament), but that Erdogan will win the presidential election in the second round. Hence the view is that Turkey is in for a period of difficult/testing cohabitation. 
I would actually challenge this cozy consensual view, as it perhaps puts too much emphasis on questionable opinion polls, but also ignores the potential importance of the two-stage election this time around. In particular, if Erdogan fails to win a first-round victory in the presidential election, and the AKP loses the parliamentary election, I think momentum will move against him in the second-round poll, especially if he fails to pass the 45% mark in the first-round election. He will be seen as beatable, and I think also the secular media will then move more firmly into the opposition camp, reassured by the fact that the opposition will 
have taken parliament.

Indeed, I think the two surprises, but actually quite likely outcomes, to watch for are either a) a June 24 clean sweep for the AKP and Erdogan in the presidential and parliamentary elections; or b) the opposition win the parliamentary election and the presidency in the July 8 run-off vote. 

Either scenario might provide a fillip to markets. The first as it will provide something of a respite to political uncertainty, and AKP policy makers can then focus on stabilising the stressed macro/market situation. The second, as this would be seen by the market as Turkey’s “Cyril” moment, and the chance for Turkey to return more quickly to its traditional Western allegiances, and perhaps more normalised economic policy.

Should we fear cohabitation?
The consensus seems to be that cohabitation will be bad—that this will see a future President Erdogan in a logjam against an opposition parliamentary majority, and also bring the chance of repeat snap elections. 

On the latter score, I think this is unlikely, as the bar for parliament to call early elections—presidential and parliamentary votes would have to be held at the same time—is high (400/550 MPs have to agree). And to opt for such a scenario, Erdogan would also have to surrender one of this two term limits, and there is a chance he could lose—more likely if this election is also closely fought. Indeed, I think there will be an incentive/pressure for both sides to try to work together. Erdogan likely will try and forge a new AKP/opposition coalition in parliament, with elements of the opposition. And importantly, I think people ignore the fact that the new Executive Presidency does not give “all power” to the new president, as it is more similar to the US or French systems. And one big worry of the EP under Erdogan is that too much power would be concentrated around Erdogan, but in reality, if the opposition do well in the parliamentary elections, parliament will be able to operate important checks on Erdogan in office—e.g. the ability to block the budget, and to appoint a majority of supreme court judges. So, it does not have to be a log-jam and could actually be a best case scenario.

Are there really bad scenarios? 
Perhaps the worst case—aside from a logjam/repeat elections under cohabitation—is a disputed election, after a close win by either side in either/both the elections. This could see street demonstrations by either side, and would then leave the military/security services in a tight spot of deciding which way to move. I think the army would stay on the sidelines and still think this scenario is a relatively low probability. I think Erdogan will accept defeat, if he loses in the presidential poll, a scenario helped by the fact that Ince has promised Erdogan a quiet retirement if he loses.

And what about the market? How is it positioned? 
The big plus is that the market is short Turkey risk—positioning is very light, contrasting it with the heavy market longs in the like of Argentina, South Africa, Egypt, et al. 
Valuations—FX/rates are cheap/attractive, with local rates at/around 20%, and real rates now at 5-7% depending on ex-ante/ex-post inflation projections, and the lira is back to 2002 levels on a real effective exchange rate (REER) perspective. There is, meanwhile, much evidence to suggest that the economy is coming to an abrupt halt from the IR/FX shock—and this should create a favourable deflationary environment in H2 for fixed income—a repeat of H214. Higher frequency indicators are indeed painting a picture of a slowing economy, and we could even see negative sequential GDP prints from the third and fourth quarters.

The Central Bank of the Republic of Turkey’s (CBRT’s) emergency 500bps in rate hikes in the current tightening cycle appears to have stabilised the lira, albeit rates have continued to drift wider as fears over deteriorating fiscal trends, and liquidity problems in the banking sector and wider economy have come to a head. The Treasury heavily drew down its hitherto high cash balance (TRY54bn as of end of May) to just TRY17bn by mid-June, as it pre-paid Eid religious holiday bonuses and pension hikes. This meant that it only just got through June domestic demand redemptions—taking things too close to the line for many. But clearly this was all about fiscal pump priming this side of the elections.

CBRT credibility is in doubt, and part of the problem
Despite the 500bps in rate hikes by the CBRT, the market is nervous, not helped by Erdogan’s disastrous trip to London in May, whereupon he revealed his dislike for high interest rates as a tool to fight inflation, and also indicated his desire to take more control over monetary policy post-election. This is now the key problem for the market, in that it does not favour/believe in Erdogan’s monetary policy views and is nervous that he will further rein in CBRT independence to enforce his own non-market and unorthodox views. This suggests that this is no longer about the level of interest rates, but that there is a fundamental crisis of confidence in the CBRT, and its real independence. Therefore, whoever wins the election will have to go out of its way to shore up and prove the independence of the CBRT. This might require HR changes at the CBRT, post-election—I don’t think in a scenario where the opposition win the elections that the incumbent governor, Murat Cetinkaya, would like to remain in place. But even should Erdogan and the AKP win, high-level HR changes might still be needed, to re-inforce the independence of the MPC. 

Is the IMF coming?
Whoever wins the elections, I don’t think that time is on the new administration’s side—given the global environment and sentiment around emerging markets, with concerns over US rate tightening, the strong dollar and tightening global liquidity, trade wars, perhaps weakening global growth in response, albeit prospects of a soft spot in oil prices could help energy-guzzling Turkey. But with Turkey’s large external financing needs, policy makers will either pro-actively decide to address concerns over overheating/imbalances, will be forced to do so by the market, and/or we might see re-engagement with the IMF. 

An IMF programme would seem an optimal anchor for Turkey at this stage, as provision of an IMF programme could help underpin the country’s key vulnerability in terms of its balance of payments—a wide current account deficit, weight of short-term debt and limited FX reserve cover (low at less than 50%). Erdogan himself has had a strained relationship over the years with the IMF but has been pragmatic in the past (he held assiduously to the IMF programme he inherited back in 2002, and his early years success was significantly due to this)—and needs must, and with local elections looming in March 2019, logic would suggest he moves sooner rather than later to stabilise the economy, which may well need an IMF programme. We might see a repeat of the 2010 scenario where Turkey dances around the possibility of cutting an IMF deal but fails to sign on the dotted line—hoping talks are themselves enough to stabilise the market. I think the situation is much more challenging than 2010, and hence ultimately, unless policy is pro-actively tightened, and quickly, post-election, the market will demand an IMF programme. Admittedly, this will likely be smoother in a scenario of an opposition win, than an AKP/Erdogan win.

One important point though to remember is that Erdogan did in the end, despite his long-held unorthodox view on interest rates, sanction a 500bps hike in policy rates in response to a weakening currency—and importantly in an election campaign. So at the worst time possible, from a political perspective, he did the right thing, and tightened, accepting the price of lower growth. So post-election, logic would suggest he will be even more amenable to address re-balancing concerns. He will then be helped, as noted above, by re-balancing already in full swing as domestic demand is already slowing. Therein, the current account deficit has already likely peaked, helped by improving tourism receipts, lower oil import costs, plus also the weak state now of domestic demand, with a now much weaker and competitive lira.

Timothy Ash is Senior Sovereign Strategist at BlueBay Asset Management.