Turkish economy takes a battering after Imamoglu arrest

The news of the arrest of Ekrem Imamoglu last week triggered heavy losses in Turkey's capital markets, as many investors appear to be losing confidence in the presidency of Recep Tayyip Erdogan.

Turkish stocks experienced their worst week since the global financial crisis of 2008, with the blue-chip ISE 100 stock index losing more than 16% at the peak of the rout.

In response, Turkey's capital markets authority banned short selling and betting on further price declines. At the same time, it eased stock buybacks to support plunging shares. While the index initially rose by about 2%, it soon turned negative again, reaching its lowest level since November.

Observers agree that this development could become a major problem for Erdogan. In recent years, Turkish investors have turned to the stock market to protect their wealth from high inflation, which is hovering around 39% this month.

Officials pledge stability

At the beginning of this week, Turkey's bond and stock markets stabilized somewhat after Finance Minister Mehmet Simsek pledged to do "whatever is necessary" to shore up financial markets.

He stated that Turkey continued to offer good long-term investment opportunities. Together with the governor of the Turkish central bank, Fatih Karahan, he reaffirmed President Erdogan's commitment to maintaining the investor-friendly policies pursued over the past two years to prevent a selloff of the Turkish lira.

The Turkish national currency has depreciated against the dollar, but the fact that it fell by only 3% reassured investors. Timothy Ash, an analyst at RBC Bluebay, told Bloomberg News that "most of the [lira] outflows appear to be coming from foreign investors."

Crisis likely to be short-lived

Erdal Yalcin says Turkey had recently been on a path to stabilization after a "prolonged period of political uncertainty, extremely high inflation, and an ongoing economic crisis." Very high interest rates and currency support by the central bank had managed to "attract international investors back into the country," the economist from the University of Applied Sciences (HTWG) in Konstanz, Germany told DW. That was why both "government bonds and the stock market were clearly on a recovery course" before Imamoglu's arrest.

At the moment, however, the political crisis is affecting the markets, he added, because uncertainty has risen abruptly. "Within hours, international investors withdrew large amounts of capital from Turkey's financial markets. At the same time, the Turkish lira came under severe pressure, forcing the central bank to sell significant reserves to stabilize the currency," Yalcin explained.

No major concern for booming tourism

Tourism is one of Turkey's most important industries, and the renewed political uncertainty could have the most visible impact there, says Dirk Schmücker, research director at the NIT (New Insights for Tourism) Institute in Kiel, Germany.

He believes that the effects may be noticeable on Turkish beaches, but cautioned against overestimating the impact.

"This arrest is not the first time in recent history that the Turkish government has acted differently than what we are accustomed to from most European governments," he told DW.

Marco A. Gardini, a professor at Kempten University of Applied Sciences' Faculty of Tourism Management, is even more reserved in his assessment.

While the measures against the mayor were of "high relevance in international political and diplomatic circles," he told DW, they would have "little impact on the booking decisions of many potential travelers to Turkey."

He believes such events are no longer a "major deterrent" because very few tourists are "avoiding Turkey because of Erdogan's politics."

Gardini believes that the current protests in Turkey will also have little effect on tourism.

Dirk Schmücker also does not see Turkish domestic politics as an impediment to tourism, telling DW that issues of concern would be "a clear threat to personal safety, the aftermath of a natural disaster that makes roads and hotels unusable, or the inability to obtain a visa."

Tourists from Germany and elsewhere, he said, are "quite determined to follow through on their vacation plans," especially if the destination is affordable.

Turkey's financial conditions under scrutiny

Erdal Yalcin thinks that other sectors of the Turkish economy like, for example, banks and the finance sector, are under more significant pressure. Turkish banks could be facing higher refinancing costs, he said, and international investors might cut their funding, increasing the "risk of capital outflows, which could exacerbate liquidity problems and endanger the stability of the entire financial system."

Apart from that, the real estate sector is also vulnerable due to its heavy reliance on foreign investors. "Growing political instability raises the risk of capital withdrawals and financing difficulties, particularly in an environment of rising interest rates and high exchange rate volatility," Yalcin said.

Additionally, export-dependent industries could suffer because they could face tougher conditions as their business partners become "more cautious and potentially demand higher guarantees or risk premiums." Uncertainty in the foreign exchange market also increases hedging costs for export companies, which could hurt their competitiveness, he warned.

The experts believe that the full economic and political impact of Imamoglu's incarceration will only become clear over the course of the year.

Yalcin sees a realistic chance that Erdogan's controversial move will not have long-term consequences, arguing that the Turkish finance minister's announcement of decisive action to protect the economy could be "well received."

Turkey's allies, especially the European Union and the United States, have a vested interest in stable politics, not only as an importantNATO partner but also as a "strategically significant buffer to control migration flows to Europe." This is the reason why critical voices from Europe "have remained cautious so far," he added.

This article was originally written in German.