Why Investors Are Calling This the Most Important Turkish Election in Forever

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Election Campaigning Ahead Of Turkish General Election

Local men sit in a teahouse beneath posters for the Justice and Development Party, also known as AKP or AK Party, right, and Recep Tayyip Erdogan, Turkey's president, center, in the Beyoglu district of Istanbul, Turkey, on Tuesday, June 2, 2015.

Kerem Uzel/Bloomberg

Russia's VTB says this is "the most difficult election to read since the ruling AK Party came to power in 2002.'' UBS says elections on June 7 "could transform Turkey's political landscape.'' The president of the country says it's going to be "a turning point in the nation's history.'' Here's why they're getting so worked up.

When Turks go to the polls on Sunday 7 June, they'll be casting a vote, not just for the party they want to represent them, but on their entire political system. That's because President Recep Tayyip Erdogan is campaigning to change Turkey's parliamentary democracy to an executive presidency, and remove the scourge of 'multi-headed decision-making' which he says is holding Turkey back from economic excellence. 

Turkish bond yields have risen 3 times faster than those of any other major emerging market this year, and the lira's been the worst-performing major world currency after Brazil's real, so there's no doubting the stakes are high.

GDP growth's also slipped to around 3 percent, after averaging above 5 in the ruling party's first decade: the question for the electorate now is whether granting President Erdogan greater powers is going to help the economy change gear.

You're saying Turkey already has a president? 

Turkey's always had a president – and that's Mr President to you. The fact Erdogan's had insult/defamation investigations opened against some 200 citizens during his first 6 months on the job is one clue he's not content to use the powers of his office in the usual way. The 61-year old is presently suing journalists for their reportage, a 13 year-old student for his Facebook comments, and a former Miss Turkey for posting a satirical poem on Instagram. In the last year he's built himself a brand new palace 4 times the size of Versailles, pushed through a law that grants him a personal, unaudited budget  and chaired cabinet meetings – something previous presidents usually only did in times of emergency. 

Now he's seeking a new constitution to ratify these, and other, changes, something which will need to be passed by a 2/3 parliamentary majority after the election, or a public referendum.

What will the new system entail?

There's no clear roadmap for what the new presidential system will look like. Although the ruling AK Party's been working on drafting a new constitution since 2011, Osman Can, a lawyer running as a candidate for them told Bloomberg reporters they decided not to publish the latest ahead of the election so it doesn't arouse controversy. But Turks aren't voting blind: they can be pretty certain who'll be in charge. Erdogan's led Turkey for 12 years, and he's said he plans to rule until the 2023 centenary of the Turkish Republic. With the party he established coming top of every election since it was founded in 2001, there's a big chance he will get what he wants.

The firmest clues about the 'New Turkey' (for so the AKP's vision is referred to in election posters and the pro-government press) come from the man himself. "The Turkish presidential system won't be the same as that of the U.S. - nor will it have anything in common with the dictatorships of Africa,'' the president told voters in April. "It'll be unique to Turkey. Think of a bee going from flower to flower and creating a unique blend of Turkish honey.''

I love honey; Erdogan gets my vote!

The thing is that Erdogan's not running. As president, he's constitutionally separate from party politics - which hasn't stopped him chanting AKP slogans, bashing the opposition, and calling on the electorate to re-elect the ruling party with a 400-seat majority at thinly-disguised daily campaign rallies. Erdogan's been indefatigable in attending the openings of universities, airports, roads, and bridges in the run-up to the election, and addressed huge crowds at each event. Opposition parties complain this is unconstitutional. They've had no luck in making the argument through the courts. Selahattin Demirtas, the young co-chair of the pro-Kurdish HD Party, satirized Erdogan's frenetic schedule by holding a press conference for the opening of a can of soda.

This Demirtas guy is funny.

He's also the most important man in this race.

Not more important than Mr Erdogan?

You could say so. Although Demirtas's party has never won a single seat in parliament, they hold all the cards. It's all down to Turkey's strange election system - the d'Hondt method with a barrier. The UK election, in which 1.5 million votes won the Scottish National Party 56 seats compared to one seat for the 3.8 million votes garnered by UKIP looks positively fair by comparison. Unless parties can get more than 10 percent of the national vote, they don't get any representation in parliament at all.

The architects of Turkey's 1982 constitution designed the barrier to keep minority interests out, so they've had to stand as independents. For the first time ever, the HDP, which has its origin in Kurdish politics, is fielding candidates under the party banner. If they get over 10 percent they're likely to deny Erdogan's party the majority it needs to unilaterally change the constitution. If they get even a few votes less, they're out.

Will they make it?

The HDP consistently polls about one percent either side of the ten percent threshold, so it's too close to call. Add to any survey errors the widespread perception there could be voter fraud, and the count is likely to prove controversial. This week the Ankara Bar Association said it's trained "an army'' of lawyers in electoral process and will run a hotline for reporting irregularities, while an organization called 'Vote and Beyond', started by a former McKinsey analyst, is marshalling what is says will be close to 50,000 volunteers to monitor ballot boxes across the country.

If the HDP makes it into parliament, that could automatically deny the AKP the 2/3rds majority it needs to pass the new constitution without external support. If the three main opposition parties do really well on the day, we could witness Turkey's first coalition in over a decade.

What are investors hoping for?

Investors speak of a Goldilocks outcome where the AKP's majority is strong enough to govern alone, but the HDP is still in parliament (disenfranchising so large a segment of the population could bring violence to Turkey's streets). Yet the market's verdict on the AKP's economic governance is not as favourable as it once was. For only the second time since the AKP came to power, the stock market has not enjoyed its traditional pre-election rally versus other EMs.

Inflation accelerated to 8.1 percent in May, its highest level this year, and the lira has bested record lows several times over the same period. A weak lira and concerns over the regulatory environment are weighing on state asset sales, and economists from Goldman Sachs to Bank of America Merrill Lynch say reform is losing steam.

 The guardians of Turkey's economy have undoubtedly taken anti-populist macroeconomic decisions to address the country's current account deficit - like curbs on bank loans that brought the growth of lending down from above 25 percent a year in the AKP's first decade to nearer 15 percent now – and the net energy importer was delivered a boost from the falling price of oil. Yet of the five countries Morgan Stanley identified as `fragile' in its 2013 report, Turkey still has the largest current account deficit as a percentage of its GDP, making it vulnerable to outflows like those anticipated when the Federal Reserve raises its interest rates and prompts a flight away from riskier assets.

Will Turks vote with their wallets? 

Consumer confidence is at its lowest since March 2009, which happens to be the month of local elections in which the AKP won its lowest ever share of the vote. Yet 2014 was marred by a government corruption-scandal, an emergency rate hike, and inflation well above target - still, when Turks voted to directly elect their president for the first time in August, 52 percent of them chose Erdogan.

The population has an average age of 30, so having been mayor of Istanbul in the 90s and prime minister for more than a decade until last year, most Turks can barely remember a time when the former semi-professional soccer player wasn't in power. When they go to the polls on Sunday, it'd be brave to bet against them endorsing his vision once again.

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