The results from the Turkish election suggest that the country will return to a coalition government for the first time in more than a decade. This prospect is becoming increasingly popular with the markets, despite the initial negative response which saw the Turkish lira go down sharply against the US dollar in the election aftermath.

“The coalition option was not what the financial markets were expecting, that’s why we saw a first shock in the financial market, but the investors have come to consider that actually a coalition which would represent a wider section of the society may not be a bad idea,” Seltem Iyigun, Coface’s Mena economist, tells GTR.

Founded by current Turkish President Recep Tayyip Erdogan in 2002, the AK Party had, until this election, always managed to secure an overall parliamentary majority. This time it just fell short of the 276 seats required, meaning that a coalition will be necessary to form a government, and the sooner, the better.

“If the leaders come to form a coalition within 45 days, this would largely reduce local political uncertainty” says Iyigun. According to her, the popular sentiment in Turkey would welcome a coalition between the AKP and the social-democratic Republican People’s Party as this would offer a wider societal representation. Other possibilities include a coalition between the AKP and the right-wing Nationalist Movement Party, or a minority government from the AKP. The AKP could also be locked out of power if the other parties, including the pro-Kurdish Peoples’ Democratic Party, agree to form a coalition together, although this is seen as unlikely.

A strong government committed to implementing economic reform would affect positively foreign investors. Seltem Iyigun, Coface

If no coalition agreement is found, new elections will be called, an undesirable option given that the business confidence in the country is just recovering from the election uncertainty. “We could see a risk aversion against Turkey rising again on the financial markets, if a government cannot be formed,” says Iyigun, adding: “We feel that investors are kind of relieved that the election stress is now over. There is no deterioration in international investors’ interest for M&A opportunities in Turkey. However, the formation of the new government will be important. A strong government committed to implementing economic reform would affect positively foreign investors.”

While the Turkish lira has slightly bounced back to around 2.74 against the US dollar from the initial 5% fall following the election result, it stays below its pre-election value – which had already been affected by political instability and the Fed monetary policies. Currency volatility remains a risk depending on the political talks’ progress, putting additional pressure on local businesses indebted in foreign currency. However, according to Iyigun the chances of non-payments due to lira depreciation seem low. “The majority of the [indebted] companies are big companies with the ability to borrow money from international markets, and have FX revenue,” she says. She adds, however, that the non-payment risk related to the lira depreciation may appear due to a narrowing profit margin: “Turkey’s manufacturing sector depends heavily on intermediate goods import so the depreciation of the local currency increases production cost. This may raise the risk of non-payment, otherwise the companies are strong enough to meet their forex liabilities.”

The growth prospect of the country will also influence the economic line the new government will take. Despite a forecast growth of around 3.5%, the country is still not meeting its potential growth rate of 5%. The new government will have to tackle structural economic reform to increase its performance, says Iyigun: “The economy remains overly dependent on domestic consumption which is funded by foreign funds. An overall better regulatory framework and structural changes would be essential to strengthen the production system, competitiveness, labour markets, exports, and help the country to balance the domestic and external demand.”