Thursday, September 2, 2010

Market Impact of the Referendum

A loyal reader asked me a couple of days ago whether tattoos and central banks really mix in a financial blog... Given my latest Hurriyet column, they obviously do:), but her real question was whether a NO vote in the Referendum would adversely affect the markets here?

It all depends on what is being priced in, and it is impossible to be 100% certain on that. We can only make some assumptions and guesstimates.

Let's start with the obvious. A "no" is definitely not priced in. Almost all the surveys are pointing to a "yes", although some are very close. Moreover, June BOP data or more recent flow data from EPFR hint that bond and equity flows to Turkey are going strong, meaning that foreigners have just shrugged off political risk. Moreover, almost all the analyst reports I have received lately see a "yes" victory as in the bag. All this means that the short-term adverse impact of a "no" on markets would be quiet bad, especially because it would question not only the legitimacy of the market-friendly AKP government, but also the sustainability of the single-party government.

A similar argument can be made for a narrow "yes" victory, especially if voter turnout is low, giving the opposition the chance to question the legitimacy of the AKP.  By the same token, a very strong "yes", in excess of 60%, would effect markets positively in the short-term. I would define the market-neutral, i.e. priced-in, territory in the 54%-58% range- don't ask me why, I have no econometrics to support that, I am just using my spider senses, as I am your friendly neighborhood economist.

But more interesting would be the long-term consequences of the referendum, as markets will revert to business as usual after a couple of days. And that depends on the reaction function of the AKP. In layman's terms, in case of a narrow "yes" or "no" victory, will the AKP throw off fiscal prudence (whatever is left of it) totally aside and open the coffers for all-out pork-and-barrel spending? The longer-term consequences of such a pre-election spending binge policy would be disastrous, not only for the country's fiscal stance but also inflation and monetary policy, as I have been continously warning in my Hurriyet columns.

My guess: Let me first give the important disclaimer that I am not solely depending on my work with KONDA, but all the surveys floating out there: "Yes" wins 55-45, not much market impact, business as usual... But the AKP opens up the coffers nevertheless...

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