Why Erdogan's Election Victory Cannot Mask Turkey's Economic Woes

Sunday's election victory provided a much-needed boost to Turkey's beleaguered Prime Minister Recap Tayyip Erdogan.

It also gave the country's economy a shot in the arm. The lira soared to its highest rate against the dollar this year on Monday, while the Borsa Istanbul share index surged 0.9%.

Markets love continuity and that's being reflected in these short term gains. However, long-term prosperity in Erdogan's Turkey is far from secured.

Despite his triumphalism on Sunday night, the defiant Prime Minister's vow to pursue "traitors" and make them "pay the price" was telling.

The past four months have been embarrassing for Erdogan and his Justice and Development Party. Graft and corruption scandals have engulfed the leader, who was left exposed in a relentless series of online leaks.

The government crackdown on its opponents has harmed Turkey's already frosty relationship with the European Union and any further purges could provoke a deep freeze. What's more, the scandals have revealed corruption and malpractices at state banks that should leave investors extremely worried. In the long run, Erdogan's Turkey looks more precarious than it has done for years.

Just hours after the ruling AK Party won a resounding victory in local elections, the European Commission offered its interpretation of events, in a brief response.

"Following the overall worrying developments which have taken place over the past three months, Turkey .... Now urgently needs to re-engage fully in reforms in line with European standards," said a Commission spokesperson.

"It also needs to reach out to all citizens, including those which are not part of the majority vote, in order to build the strongest possible engagement on reforms needed to make progress on EU accession."

Following months of revelations exposing high-level corruption, crackdowns that have targeted political opponents and widespread outcry after social media websites were blocked, Brussels may be having serious doubts that Erdogan is a man they can work with.

What's more, the Prime Minister has just secured a stronger mandate from his fellow Turks. The AK Party won 46% of the national vote, a far better result than many had predicted.

For a leader showing an increasingly authoritarian streak, this is just the kind of confidence boost that EU-accession supporters didn't want to see.

"It's a lot of power in the hands of a man who has become increasingly unpredictable and authoritarian," said Amanda Paul, Turkey expert at the European Policy Centre.

"We're going to go through quite a rough period now. It's safe to say that 2014 isn't going to deliver any serious steps forward when it comes to accession."

Yet while the EU can show as much distaste for the authoritarianism of Turkey's leader, there's very little that Brussels can actually do to influence Erdogan. It seems that the EU accession can be kicked down the road until the next leader takes the reins in Ankara.

The most alarming development of Turkey's turbulent winter has been the revelations of graft and mismanagement in the country's financial sector, most worryingly at state-owned banks.

Suleyman Aslan, who was CEO at the country's second largest state-owned bank Halkbank, was found with $4.5m in cash stashed into shoe boxes and a bookshelf.

Subsequent recordings of alleged police wiretaps were then leaked online. They implicated Aslan in a scheme to help a businessman smuggle gold and hundreds of millions of dollars to Iran, which is currently subjected to tough US sanctions. Police say that the money found at Aslan's home was intended as a bribe to ensure the CEO's cooperation.

A separate scandal has engulfed the CEO at Turkey's biggest government bank, Ziraat. Huseyin Aydin was allegedly recorded approving loans to businessmen who said they were under orders from the PM to buy a newspaper and television newspaper.

It's worth noting here that Aydin hasn't been charged with anything but the scandal has damaged his and the bank's image.

Whether or not the any charges are proven in the above cases, the fact that state banks have become embroiled in politics should be enough to unsettle investors.

State-owned banks have been used by politicians in Turkey's recent history to win support. In the 90s, they were used to make unprofitable loans to small businesses and farmers and ran up huge losses in the process.

Moreover, the same state banks' behaviour was behind the 2001 crisis that caused Turkey's economy to contract by 10%. Government-run banks went after loans with such gusto that the country's interbank lending rate soared to an unsustainable peak. As a result, the system crashed.

The state banks have again been accused of serious mismanagement. As the allegations are investigated, and the possibility of further revelations on the horizon, investor anxiety could well fester. While the election victory and some encouraging signs in the economy will boost the Prime Minister for now, Turkey's long term problems are yet to be addressed.