Investors hope Turkey's election will give economic reformers more clout

By Asli Kandemir ISTANBUL (Reuters) - Turkey's two main parties may be campaigning for parliamentary polls on populist platforms such as higher wages and pensions, but investors hope whoever wins will instead revive the once-admired pace of growth and economic reform. The Nov. 1 election will be Turkey's fourth in just over 18 months, a voting cycle that has fueled investor uncertainty and diverted the minds of economic policy makers away from tackling deep-seated challenges. The return as a ruling AK Party candidate of former deputy prime minister Ali Babacan and the presence of economy professor Selin Sayek Boke in the main opposition CHP reassure some. But President Tayyip Erdogan's pressure on the central bank to cut interest rates has tarnished the credibility of Turkey's economic management team - Babacan included. "Turkey's economic problems are not that deep, and it is not beyond the realms of imagination that a stable, majority, reform-orientated administration ... could make Turkey still a rising economic success story," Nomura strategist Tim Ash wrote in a recent note after a research visit. "But to achieve that, there has to be a spirit of moderation and cooperation on the domestic political front, and a move back from polarization from all sides," he said. Investors have reduced their exposure to Turkey in step with the political turbulence, helping send the lira to a 12-/2 year low in terms of its "real effective rate" - a measure of domestic prices relative to those of trading partners. Foreign investors' equity holdings have fallen by $6.6 billion and their bond holdings by $13.5 billion since the start of the election cycle in March 2014, central bank data shows. "If truth be told, I don't think foreign investors know what to make of Turkish politics. It is a complete mess," Nicholas Spiro, managing director of London-based Spiro Sovereign Strategy, told Reuters. "There has also been a significant loss of confidence in the AK Party in its handling of the economy." HOPE AND FEAR Opinion polls suggest the AK Party will struggle to win back the majority it lost for the first time in more than a decade at the last parliamentary election in June. Should it fail by a narrow margin, it could try to rule alone in a minority government. Otherwise, senior officials in Ankara see a coalition with the CHP as a distinct possibility, an outcome which markets could view positively. Senior members of both the AKP and CHP acknowledge that, despite the populist pledges, what Turkey really needs are measures to tackle high inflation, rising unemployment and slowing growth. A coalition could bolster moderate voices in the government, tempering the influence of some Erdogan aides such as Yigit Bulut, a former TV commentator who once accused Erdogan's opponents of seeking to kill him through telekinesis and who has been among those lobbying hardest for lower rates. "Markets do seem to be pricing in an AKP-CHP coalition government in our view. The market perceives that this scenario will offer the best chance for structural economic reforms being implemented," said UBS emerging markets strategist Manik Narain. But there would be concern over how long such a coalition would survive, given differences including over Erdogan's role. Turkey, long seen by investors as one of the safest bets in the chaotic Middle East, has a young population, diverse export markets and a well-capitalized banking sector. Yet in its latest medium-term economic plan this month, the government cut its growth forecast for this year and next, while the current account deficit hovers around 5 percent of national output. Babacan, a U.S.-educated former management consultant, is said to have wanted to return to the private sector and initially refused nomination for the November election. He has been wheeled out again in an apparent bid to reassure markets. Finance Minister Mehmet Simsek also looks likely to return, officials in Ankara say. Both men have said Turkey needs to boost productivity and value-added exports and reduce its reliance on imported energy, which would help narrow the current account gap. The central bank needs scope to use interest rates freely to fight inflation. In the longer term, economists say Turkey needs to increase its savings rate, improve the quality of its education and reform the judicial system to boost investor confidence and help avoid a "middle-income trap". But the key test for Babacan and Simsek will be defending the independence of the central bank and keeping Erdogan in check. So far they have had limited success. "It is not in the AKP's DNA to share power. Unfortunately I don't think a coalition government would clip the wings of Erdogan," said London-based Spiro. "Babacan and Simsek have lost credibility in the eyes of foreign investors." (Editing by Nick Tattersall/Ruth Pitchford)