Turkey: Analysts Warn of Overheating Risks

Recep Tayyip Erdogan's AKP won a comfortable majority in the Turkish elections, but the Prime Minister's desire to change the constitution could distract the new government from managing an overheating economy, analysts told CNBC.com.

Istanbul's Arasta Bazaar
Maremagnum | Photographer's Choice | Getty Images
Istanbul's Arasta Bazaar

AKP won around 50 percent of the popular vote, but fell short of the 330 seats that it needed to unilaterally rewrite the country's constitution.

Erdogan is believed to want to replace the current constitution, put in place in the early 1980s following a military coup, with one that gives increased power to the presidency. Under the current system, the president is largely a symbolic figure.

With this likely to be his last run for parliament, Erdogan wants to run for the presidency in 2014 under a new constitution, analysts say.

Markets have reacted well to the result, with the Turkish lira strengthening against the dollar. As Wolfgango Piccoli, European director at Eurasia Group, wrote in a note on Monday morning, the strong, but not overwhelming majority "should help to limit the risk of further polarization and allow the next government to focus more on the country's widening macroeconomic imbalances in the short-medium term."

However, Piccoli warned, Erdogan may not give up on his plans for constitutional change, and may look to co-opt independent members of parliament or even opposition party members to support him.

The government has to deal with a significant fiscal imbalance, and some investors and analysts remain concerned that the Turkish economy is overheating, as soaring domestic demand drives import growth.

The Central Bank of Turkey (CBT) continues with a monetary policy that is described as "unorthodox" even by its proponents. The CBT is keeping its benchmark interest rates low while hiking reserve rate requirements, hoping to deter speculative inflows while keeping loan growth under control.

Some analysts, including Reinhard Cluse, an economist at UBS, believe that the government needs to begin a process of macroeconomic tightening, and soon.

"Macro tightening will have to happen very soon because any tightening will need time to have an impact on real economic variables. That's why this has to be frontloaded, and it has to be frontloaded before they go on summer recess," Cluse told CNBC.com.

Parliament is due to go on recess in mid-July, and will return in October. Waiting until then would be too late, Cluse said.

"I'm still very sceptical about whether the tightening measures that have been introduced so far will be good enough, because real economic momentum is very strong," he explained. "Because this widening current account deficit is a reflection of import growth being much faster than export growth, and import growth is being driven by super-strong domestic demand. What I would like to see, as an economist, is spending cuts."

However, with AKP's majority not enough to push through the constitutional changes without courting public opinion in a referendum, the timing of cuts and the ability of the Prime Minsiter to forestall his presidential ambitions will be crucial.

"If AKP has this ambitious constitutional agenda and they want to appease the electorate in the run up to any constitutional referendum, then I know that the chances for any effective tightening are not very good, which makes me all the more concerned as an economist. So the overheating risk is very substantial," Cluse warned.