Turkey: Why coalition talks could hit its economy

With coalition talks set to get underway in Turkey – amid the real risk of early elections if they fail — economists are worried about the potential for more economic turmoil.

In Sunday’s elections, after 13 years in power, the ruling Justice and Development Party (AKP) failed to win the majority needed for it to govern alone, meaning that it now has to find a coalition partner.

The vote was a blow for Turkish President Tayyip Erdogan, who had hoped to change the constitution and consolidate his hold on power following an election win.

The AKP is now expected to try to form a coalition with the Nationalist Movement Party (MHP), the Kurdish People’s Democratic Party (HDP) or Republican People’s Party (CHP) – or it could try to oversee a minority government.

If a government is not formed within 45 days, snap elections could be called, meaning that political uncertainty could “drag on,” Fitch ratings agency warned late Monday, and “aggravate tensions regarding economic policy.”

“The election heightens uncertainty about economic policy and personnel that had emerged before Sunday’s vote. Slowing GDP (gross domestic product) growth had increased tensions regarding efforts to rebalance the economy, cut reliance on net capital inflows, and lower inflation,” Fitch said in a note.

It added that although a coalition, “might bring moderating influences into play…this is far from certain.”

William Jackson, senior emerging markets economist at Capital Economics, warned that a coalition was unlikely to be formed quickly, and that, in the meantime, Turkey’s economy could suffer.

The country was once considered the rising star of emerging market economies, with a booming economy that expanded by 8.5 percent in 2011. But it has been hit hard over the last few years, and grew by less than 3 percent in 2014, missing official targets.

“Even if a coalition were to be put together, this might raise concerns that the AK Party would have to cede to opposition parties’ more populist pledges, such as large rises in the minimum wage,” Jackson said in a note Monday.

“While such measures might help to boost growth in the near-term, they would merely exacerbate the economy’s deep-seated existing vulnerabilities.”

One of the main issues worrying market watchers is the perceived loss of independence at the country’s central bank, which has come under pressure from President Erdogan of late to cut interest rates in an effort to boost growth — despite high inflation and a weaker Turkish lira.

The lira took a further dive on Monday following the election result, weakening around 5 percent against the dollar, and the Turkish central bank attempted to prop up the currency by cutting interest rates on foreign exchange deposits.

But Egemen Candir, forex manager at Bosphorus Gaz Corporation, told CNBC he was confident that – whatever the outcome of coalition negotiations – Turkey’s central bank would regain its independence.

“I think that the biggest change (we’ll see) further on – even if there is a new AK party in government in September – there will be a freer and more independent central bank that can actually control the economy more properly than it has done in the past six months,” he said.