Turkey's local election surprise: What will it mean for the economy?

The thumping victory of Turkey's opposition party over President Recep Tayyip Erdogan's AK Party (AKP) in Sunday’s local polls could be indicative of voters' objection to the economic problems in the country, but it is unlikely to lead to any immediate major shift in policy, analysts say.

The Republican People’s Party (CHP), which gained control of Istanbul and Ankara, blamed the nearly 70 per cent inflation rate, sluggish development, and the vigorous monetary tightening policy that has increased borrowing rates as factors that damaged the AKP's performance.

Despite Mr Erdogan and his party facing their worst defeat in more than two decades in power, the leader said they will stick with the current economic turnaround programme.

In a speech at 12.30am, Mr Erdogan said the government would pay greater attention to pressing issues including the recovery of the areas hit by last year's earthquakes and economic challenges.

Following his remarks, Turkey’s lira, which hit a record low against the US dollar, reversed its losses and was trading at 32.11 to a dollar as of 7.56pm UAE time.

Turkey main stock market, the Borsa İstanbul's BIST 100 share index, closed up by 0.17 per cent on Monday.

On Monday, Turkish Finance Minister Mehmet Simsek also said his country will continue to implement its medium-term economic programme, which was announced in September with the goal of reducing inflation.

The government “will prioritise savings by controlling public spending”, in addition to implementing a tight monetary policy and selective credit and income policy, to permanently reduce inflation to single digits, he said in a post on X.

"If the economic distress of high inflation is largely to blame for this defeat and the only way to address this is to stay the course on orthodox policy, then President Erdogan is likely to continue backing his technocratic economic policy team,” Hasnain Malik, head of emerging markets strategy at Tellimer, an investment research firm based in Dubai, told The National.

“Short-term, that is reassuring for all Turkish asset prices. But this defeat will make [Mr] Erdogan's finger on the populist policy trigger more itchy once inflation recedes. Medium-term, that increases risk."

Will it impact monetary policy?

After winning re-election in May last year, Mr Erdogan constituted a new, more orthodox economic team, headed by central bank governor Hafize Gaye Erkan and Finance Minister Mehmet Simsek.

Following her appointment, Ms Erkan pursued a more conventional monetary policy to contain inflation, by gradually raising benchmark interest rates.

In February, after her resignation, Turkey named the central bank’s deputy governor Fatih Karahan as its head, signalling a continuation of the transition to more investor-friendly, orthodox economic policies that she had put in place.

In March, Turkey’s central bank increased its benchmark rate to 50 per cent, from 45 per cent, as part of efforts to curb soaring inflation.

Mr Karahan has vowed to increase rates further if inflation continues to rise.

“Even though the [local election] news hints at a potential change – for better – in the future, we won’t see a meaningful change in the immediate aftermath of the municipal elections," said Ipek Ozkardeskaya, a senior analyst at Swissquote Bank.

“The monetary policy will remain unchanged and the USDTRY – which is trading higher in the wake of the latest elections – should continue trending higher at a potentially higher speed as the central bank may put in less effort to counter the lira’s depreciation now that the elections are behind,” she said in a note on Monday.

In October, the International Monetary Fund commended Turkish authorities for raising the policy rate from 8.5 to 30 per cent in September, which “has in turn boosted confidence, reduced pressures on the lira, and begun to cool domestic demand and ease distortions created by negative real interest rates”.

As monetary policy tightens and the overall policy stance becomes less accommodative, inflation is forecast to fall to 46 per cent at end-2024 from 69 per cent at end-2023 as exchange rate pressures ease, the IMF said.

However, it said further policy rate increases are needed to reduce inflation, accompanied by lower reliance on quantitative measures.

“After the surprise election results, the constructive reaction of Turkey’s president could reassure investors as the government could continue to deploy efforts to strengthen the economy,” Daniel Takieddine, chief executive, Mena, at broking firm BDSwiss, told The National.

“The stock market could see some volatility as investors digest the news and the impact of the elections becomes clearer. The real estate sector and others could face some challenges, but long-term growth prospects remain positive.”

Istanbul's influence

Istanbul continues to be the economic powerhouse of Turkey, with the city accounting for approximately 31 per cent of the country's gross domestic product, or around $276 billion, Mr Takieddine said.

Turkey’s largest city and most expensive housing market, it is home to about 20 per cent of the country's industrial labour force.

Istanbul also generates roughly 43 per cent of the country's total exports and attracts a substantial portion of foreign direct investment, he said.

“Istanbul's diverse economy spans sectors such as finance, tourism, services, and manufacturing. With its strategic location and economic vitality, Istanbul remains a crucial driver of Turkey's economic growth and development,” Mr Takieddine said.

With the CHP now at the helm in Istanbul, controlling Turkey's largest city is likely to give it a bigger boost on the national level.