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After Turkey’s Election: The Economy Remains President Erdogan's Biggest Challenge

Executive Summary

  • After securing a parliamentary majority on May 14 together with his ultranationalist and Islamist allies, Turkey’s incumbent Recep Tayyip Erdogan has also won a third presidential term in the runoff elections on May 28.

  • Fears of contested election results and a prolonged period of social unrest and political violence dissipated as the opposition conceded quickly and Western leaders congratulated Erdogan without delay.

  • Turkey’s fragile economy, resulting mainly from Erdogan’s unorthodox economic policies and deficit spending, remains the biggest challenge at home and abroad as the president comes under pressure to implement austerity measures.

Implications for International Business

  • Firms can once again consider Turkey for nearshoring opportunities, as the risk of prolonged social and political instability has abated – for now.

  • The country’s depleted net foreign reserves, looming capital controls, and lack of a viable plan to return to sound economic policies, in turn, remain deterring factors.

State of Play Erdogan secures his third presidential term

Despite expectations at home and abroad that Turkey’s dismal economic conditions and cost of living crisis would deny him a third presidential term, Erdogan on May 28 received 52 percent of the votes. The country’s first-ever presidential runoff came two weeks after his coalition of conservative, Islamist, and ultranationalist parties secured a parliamentary majority. Voter turnout of 87 and 84 percent, respectively, in the two rounds as well as his opponent’s immediate concession and quick congratulatory messages from Western leaders dissipated widespread fears of a prolonged period of social unrest and political violence. Nevertheless, the likelihood that the rule of law and democratic standards will erode further spooks markets, as evidenced by the downturn in the Istanbul stock exchange and devaluation of the Turkish lira following Erdogan’s first round victory. Having further consolidated his one-man rule, Erdogan now faces mounting economic challenges. These are mostly his own making, such as by lowering interest rates in the face of rising inflation and compounded by out-of-control deficit spending during the campaign period. Since the president has his eyes on regaining the opposition-held Ankara, Antalya, and Istanbul mayoralties in the March 2024 municipal elections, Erdogan is likely to continue to print liras to boost credits and thereby demand, and with it, hyperinflation. On foreign policy, a politically confident but economically shaken strongman Erdogan will double down on his transactional brinkmanship with Western allies, aiming to extract maximum concessions for example in exchange for unblocking Sweden’s path to NATO, facilitating an extension of the Russian-Ukrainian grain deal, and the EU-Turkey deal on Syrian refugees.

Key Issues Assertive abroad and friendly with autocrats

Under the two-decade rule of Erdogan’s Islamist-rooted Justice and Development Party (AKP), Turkey has drifted away from the transatlantic alliance and its values. First as prime minister and then as president with full executive powers, Erdogan has veered towards a more assertive and transactional foreign and security policy coupled with authoritarianism at home. After dropping the stated goal of EU accession and democratic reforms from the early 2010s onwards, Ankara has forged a multifaceted relationship with various adversaries of the West, including Iran, Russia, and Venezuela. Following Russia’s attack on Ukraine, the country has drawn Euro-American ire for facilitating sanctions evasion. On the heels of his parliamentary and presidential victories, a politically confident Erdogan will gear up his assertive and transactional foreign and security policy, demanding greater concessions from the West in exchange for refraining from playing a spoiler role on key policy issues, such as Sweden’s NATO membership, and offering its good offices in various African conflicts, including in Libya and the Horn of Africa. Coined as the “Turkish Century,” this approach builds on a long-standing desire to transform the country from a middle power to a great power.

Erdogan’s maximalist regional and global policy ambitions, however, run counter to the policies of Turkey’s NATO partners. From its self-perceived position of power, Ankara hopes to continue to reap the benefits of transactionalism by fence-sitting in the Russia-Ukraine war in favour of its position vis-à-vis Moscow in Syria. Erdogan feels that his latest election win will prompt the United States and EU member states to adopt a greater degree of appeasement in relations with Turkey, allowing him to extract concessions in the form of receiving a new batch of F-16 fighter jets and more favorable payments under the migrant deal, among others. Meanwhile, the Turkish government’s growing reliance on various bilateral stopgap measures with non-Western governments to remedy the dramatic nosedive in Turkish net foreign reserves has led to new constraints on Ankara’s policies. These measures include $28 bn worth of currency swaps with China, Qatar, South Korea, and the United Arab Emirates, $5bn Saudi and €1bn Azerbaijani deposits into the Turkish central bank, and a multibillion-dollar deal with Russia to postpone natural gas payments to 2024. Although Europe remains Turkey’s top trading partner with a volume of €198 bn in 2022, the country’s reliance on Russia and China as its top two sources of imports and growing dependence on non-Western capital inflows, could hasten its pivot away from the West.

A domestic economy in dire straits for another year

The opposition bloc’s loss of both parliamentary and presidential elections has ended optimistic expectations about Turkey’s swift return to sensible and predictable policies as well as a rules-based economy. Having lost most competent members of his economic team to the opposition and lacking skilled replacements, Erdogan will continue to muddle through to avoid a hard landing of the Turkish economy. Meanwhile, the country’s cost of living crisis makes it vital for Erdogan to regain Ankara, Antalya, and Istanbul mayoralties that he lost to the opposition in 2019 so that he can divert urban spoils from these metropolises to his disgruntled clients. The prolonged election campaign until the next municipal elections will likely extend the government’s deficit spending – which led to a nearly $20bn budget deficit within the first four months of 2023 – for ten additional months. Given Turkey’s negative net foreign reserves position and the near depletion of the central bank’s capacity to defend the lira, finance experts predict a 25 percent additional devaluation of the Turkish currency by the end of 2023, and 50 percent by the end of 2024. Further erosion of the independence of the central bank and other regulatory agencies will bring about an even more personalized and less predictable monetary policy, exacerbating the environment of financial and regulatory uncertainty.

Against this backdrop, a hard landing is expected before long, with significant risks but also opportunities for global investors. The country’s undercapitalized and overleveraged zombie companies that are solvent only on paper owing to abundant below-market government-backed loans will likely go bankrupt once austerity measures kick in by spring 2024. This will offer value investors the prospect of mergers and acquisitions, while the ongoing Turkish rush for equities, commodities, and other assets seen as a hedge against hyperinflation and devaluation will continue to provide high-risk/high-reward trades for more speculative-minded investors. Turkey’s coming downturn will decrease labor costs in the country, providing a more welcoming labor market for the low-to-mid value-added end of nearshoring investments. Currently, the monthly costs of a minimum wage worker to a Turkey-based employer remains relatively high at $550, making the Balkans and Eastern Europe more competitive locations in the EU’s vicinity. For foreign investors, the increasing likelihood of a sovereign default, a bank run, the freezing of foreign currency accounts, or the introduction of capital controls remain the most salient risks. These might prompt prudent investors to delay their greenfield investments until there is more certainty about the state of Turkey’s public finances, monetary policies, and market dynamics in a year’s time.


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