Political Turmoil in Turkey: Implications for Sovereign Risk and Asset Volatility

The political and economic landscape in Turkey has grown increasingly precarious in 2025, with institutional erosion and democratic backsliding casting a long shadow over foreign investment flows. The arrest of Istanbul Mayor Ekrem İmamoğlu in March 2025—a move widely perceived as politically motivated—has catalyzed nationwide protests and deepened concerns about the centralization of power under President Recep Tayyip Erdoğan. This episode underscores a broader pattern of institutional fragility, where economic governance is increasingly entangled with political maneuvering, heightening sovereign risk and asset volatility.

Institutional Erosion and Sovereign Risk

The erosion of democratic norms in Turkey has directly impacted investor confidence. According to a report by the SWP Berlin, the judiciary and media remain under significant government influence, while civil liberties face systematic suppression [1]. These developments have strained Turkey’s relationships with European allies and amplified perceptions of sovereign risk. For instance, the Central Bank of the Republic of Turkey (CBRT) raised its key interest rate to 46% in April 2025 to stabilize the lira and curb inflation, a move that, while technically sound, was overshadowed by concerns about political interference in economic policymaking [6].

The CBRT’s emergency interventions, including $40 billion in currency sales following İmamoğlu’s arrest, temporarily stabilized the lira but exposed the fragility of Turkey’s financial architecture. As noted by analysts at the Organization for Security and Co-operation in Europe (OSW), the government’s inability to decouple economic decisions from political agendas has eroded trust in its stabilisation efforts [2]. This dynamic is particularly concerning given Turkey’s reliance on short-term portfolio investments—rather than sustainable foreign direct investment (FDI)—to fund its current account deficit. Portfolio flows, which doubled to $12 billion in 2025, are inherently volatile and prone to sudden reversals during periods of political unrest [4].

Macroeconomic Vulnerabilities and Foreign Investor Behavior

Turkey’s economic vulnerabilities are compounded by structural challenges, including a 38% inflation rate, high external debt, and dependence on foreign currency for trade [5]. The depreciation of the lira to 42 per US dollar in March 2025—a 10% drop—triggered a $7 billion outflow from the Turkish stock market, signaling a loss of confidence in the country’s economic governance [4]. While the government has maintained a 3.1% GDP growth forecast for 2025, this optimism is tempered by the reality of declining foreign reserves, which fell below $20 billion in the wake of the İmamoğlu crisis [1].

The interplay between political instability and macroeconomic policy is further complicated by Erdoğan’s autocratic impulses. Finance Minister Mehmet Şimşek’s credibility has been undermined by the president’s overt interventions, raising questions about the durability of fiscal reforms [3]. This uncertainty has pushed investors toward risk-averse strategies, with bond yields and credit default swaps (CDS) widening to reflect heightened default risks. For example, the cost of insuring Turkish government debt against default rose sharply in Q3 2025, reflecting a deteriorating risk profile [2].

Geopolitical and Structural Challenges

Beyond domestic politics, Turkey’s strategic location and energy dependencies amplify its exposure to external shocks. Analysts at BNP Paribas note that global energy price volatility and geopolitical tensions—particularly with Kurdish groups and regional rivals—have further destabilized the business environment [1]. These factors, combined with the government’s reluctance to address low productivity and labor market rigidities, suggest that Turkey’s long-term growth potential remains constrained [5].

Conclusion: A Delicate Balancing Act

Turkey’s economic trajectory in 2025 hinges on its ability to reconcile political centralization with the demands of market discipline. While the CBRT’s aggressive monetary tightening has provided temporary relief, the lack of institutional safeguards against political interference remains a critical vulnerability. Foreign investors are likely to remain cautious, prioritizing short-term liquidity over long-term commitments until there is a demonstrable shift toward democratic accountability and economic transparency.

For now, Turkey’s strategic assets—its young population, geographic centrality, and industrial base—offer a glimmer of hope. However, without meaningful reforms to restore institutional integrity, the country risks becoming a cautionary tale of how political turmoil can erode sovereign creditworthiness and deter capital flows.

Source:
[1] Turkey on the Path to Autocracy [https://www.swp-berlin.org/publikation/turkey-on-the-path-to-autocracy]
[2] Turbulent stabilisation: Turkey's economy under Şimşek's supervision [https://www.osw.waw.pl/en/publikacje/analyses/2025-07-09/turbulent-stabilisation-turkeys-economy-under-simseks-supervision]
[3] Turkey: When domestic politics intervene [https://www.ekathimerini.com/in-depth/analysis/1276231/turkey-when-domestic-politics-intervene/]
[4] Inflation and political strife test Turkey's stability [https://www.agbi.com/opinion/economy/2025/03/inflation-and-political-strife-test-turkeys-stability/]
[5] Turkey Country Risk Report & Analysis [https://www.allianz-trade.com/en_US/resources/country-reports/turkey.html]