OREANDA-NEWS. August 31, 2015. New elections in Turkey ('BBB-'/Stable) may prolong rather than end the political uncertainty that threatens to exacerbate Turkey's domestic and external policy challenges, Fitch Ratings says.

President Recep Tayyip Erdogan this week asked Prime Minister Ahmet Davutoglu to form an interim government before fresh parliamentary elections, probably on November 1. This follows June's inconclusive elections, when the Justice and Development Party (AKP) lost its majority while remaining the largest party by some margin, and the failure to reach a coalition agreement.

The uncertainty has coincided with the breakdown of the peace process with the Kurdistan Workers' Party (PKK) and the start of military operations in Syria. This could be negative for the sovereign risk profile in the medium term, for example, if there were an escalation of violence within Turkey, or if the country is drawn into a protracted regional conflict.

Political risk in Turkey has long weighed on the country's sovereign rating with concerns about discretionary policy making, government effectiveness and policy predictability. The prolonged electoral process follows a heavy electoral calendar in 2013-2015, and various political shocks, such as the anti-government protests in the summer of 2013 and the fallout from corruption investigations later that year, that have helped undermine economic performance.

Opinion polls predict that new elections will deliver a similar result to June. This suggests that the political outcome may not be conducive to reforms that could gradually revitalise economic growth and promote a durable rebalancing that would reduce the size and improve the quality of the funding of Turkey's current account deficit.

The previous AKP government had formulated a reform programme, but an extended electoral cycle may reduce opportunities for, and political commitment to, its implementation. The recent sell-off in emerging markets currencies, which saw the lira hit an all-time low, highlights Turkey's continuing exposure to shifts in investor sentiment, reflecting the role of portfolio and short-term capital inflows in deficit financing.

Shortcomings in the monetary policy framework are a long-standing sign of Turkey's relatively weak economic policy coherence and credibility. The Central Bank of the Republic of Turkey (CBRT) left interest rates unchanged on 18 August, and published its "roadmap" for the period of global monetary policy normalisation. This includes narrowing the interest rate corridor, which could facilitate monetary tightening, and measures that aim to provide FX liquidity to banks while limiting the impact on reserves. Nevertheless, the roadmap is lacking in detail, and its release offered little support to the lira.

More positively, we do not believe that a political impasse presents an immediate risk to the public finances, which have been kept on a close rein. Pressure for a moderately looser fiscal stance may increase if the economy slows further, but political commitment to fiscal restraint appears broad-based.

Political and policy risks in Turkey will be among the topics discussed at Fitch's upcoming Global Sovereign Conference in Hong Kong on Wednesday. The agenda for this event and our conferences in London and New York on September 8 and September 10 are available at www.fitchratings.com.