On the night of 15 July 2016, a group of Turkish military officers allegedly connected with the preacher Fethullah Gülen tried to stage a coup to overthrow the Turkish government and President Recep Tayyip Erdogan. However, the coup attempt failed, leaving more than 250 people dead and almost 1,500 wounded. During the last ten years Erdogan was able to reshape the military hierarchy with the help of adherents of the Gülen movement in the justice system, but he could not prevent the coup attempt since he had empowered Gülenist top echelons in the army. Although many of the adherents of the movement in the judiciary, police and media have been almost completely removed since a corruption scandal in late 2013, the military was the last remaining stronghold of Gülen in the country. As it was rumoured that there might be a radical purge of Gülenists at the upcoming meeting of the Supreme Military Council, which convenes every August to consider military appointments and retirements, the coup attempt may have been seen as the only way for the Gülenist plotters to seize the government. There are of course many unanswered questions on the political scene but it appears to be likely that there may be new military coup attempts in the future since most of the generals and army personnel neither participated in the current military coup attempt nor prevented the uprising.
Immediate economic measures
On the economic side, the government took some immediate measures in order to mitigate potential negative effects of the coup attempt. Deputy Prime Minister Mehmet Şimşek stated that Turkey’s macro fundamentals are solid and that the government is taking all necessary precautions. The Central Bank of the Republic of Turkey (CBRT) took a raft of measures to ensure financial stability, including unlimited liquidity to the banking system, zero intraday liquidity facility rates and allowing foreign exchange deposits as collateral without limits.
Economic consequences will be more acute in the medium and long run
Although government institutions have been taking some precautions to ensure economic stability, the consequences of the failed coup attempt in Turkey will affect the country in many ways. We believe that the damage will not be as bad as expected by many in the short run but that the Turkish economy will suffer a great loss in the medium and long run. It has exhibited crucial structural vulnerabilities for more than a decade. Running a current account deficit and having a saving-investment gap are the most important ones. These vulnerabilities are increasing as the political uncertainty rises, affecting capital flows and thus exchange rate volatility. In the first few days following the coup attempt, the exchange rate volatility could be depressed by some measures taken by the Turkish central bank. But it is clear that it is unsustainable unless the political situation is to calm down. As the military coup attempt overthrows the tourism revival (after Turkey tried to mend the earlier damaged Russia and Israel ties), the effect on tourism could potentially last longer. Since the twelve-months rolling growth rate of services exports is already -12.4% as of May 2016, which is the lowest rate in the last ten years, we may assume that it will make an increasingly negative contribution to the current account deficit in the following months.
Current account deficit Achilles’ heel
Turkey’s decade-long chronic current account deficit caused the Turkish economy to become very sensitive to external financing conditions. The share of foreign direct investment (FDI) has become less important as compared to portfolio investment (PI) in the aftermath of the global financial crisis, indicating an economy increasingly dependent on short-term capital flows. Since the outbreak of the global financial crisis, the four-quarter rolling cumulative FDI inflow has had a decreasing trend. The slowdown in the economies of the US and the EU plus increased financial fragility in the Turkish economy are the main economic factors while the conflicts with the neighbouring countries, increased tensions in the south-eastern part of the country, press censorship and the erosion of the legislations are important political factors which are behind the decline in FDI inflows to Turkey. It is clear that the coup attempt will additionally restrict FDI flows into the country because of the possibility of new coup attempts which may prevent foreign investors from investing in Turkey.
Volatile capital flows
Turkey has been able to attract portfolio investments due to relatively higher interest rates so far. However, portfolio investment has become more volatile and has been decreasing since the beginning of 2014 because of both the announcement of tapering the bond-buying programme by the US Fed in December 2014 and the corruption scandal of late 2013. Since the political situation is getting worse, it is likely that the short-term capital flows will become more volatile in the months to come.
The stronger dependence of the Turkish economy on portfolio investment has already made the Turkish lira more vulnerable to global liquidity fluctuations than earlier. The bond-buying programme of the US Fed has slowed down capital flows from the United States to Turkey as well as other emerging markets. The coup attempt, together with the aforementioned political uncertainties, will likely cause the value of the Turkish lira against foreign currencies, especially the US dollar, to steadily decrease towards the end of the year 2016. Although we expect neither a sharp and sudden rise in the exchange rate nor the Turkish central bank to react with increasing policy rates in 2016, we expect domestic demand and especially imports to decrease in the short run. Household final consumption is likely to decline due to deteriorated expectations, while imports may decrease because of both the deterioration in expectations and the likely rise in exchange rates.
GDP growth will be slower than previously forecasted
Negative expectations may damage gross fixed capital formation as well. Therefore, overall, we revise the GDP growth rate forecast for the Turkish economy from 4.1% (as in wiiw Monthly Report No. 7-8) to 2.8% for 2016. In the medium and long run, the attitudes and decisions of Erdogan will be of decisive importance for the Turkish economy. The most important question is whether Recep Tayyip Erdogan will act more autocratic and abandon the rule of law while struggling with the Gülenist plotters. This will have important repercussions on the relations with the United States and especially the EU as well as the domestic opposition. Since it is quite likely that the putschists would have executed president Erdogan if the coup had been successful, Erdogan presumably will insist on revenge. It is clear that he will use the coup attempt to consolidate his position in the country in order to reach his main goal of a presidential system. However, the next challenge of Erdogan will be the economic slowdown.