(Bloomberg) -- Turkey will hold a runoff election, with President Recep Tayyip Erdogan just failing to secure enough votes for a first-round victory.

The 69-year-old, looking to extend his two decades in power, will face Kemal Kilicdaroglu, 74, in another vote on May 28 after doing better than polls predicted.

Turkish stocks and bonds dropped, while the cost of insuring the government’s debt against a default spiked, as the results wrong-footed investors betting on a quick end to Erodogan’s unconventional economic policies, which include keeping interest rates well below the level of inflation.

“This is a major disappointment to investors hoping for a win for opposition candidate Kilicdaroglu and the reversion to orthodox economic policy he promised,” said Hasnain Malik, a strategist at Tellimer in Dubai.

Erdogan won 49.5% of the votes, while Kilicdaroglu secured just under 45%, with nearly all the ballots counted, Turkey’s High Election Board said on Monday. Another contender, Sinan Ogan, received 5.2% and was eliminated from the race.

A runoff would be the first under the current electoral system and suggests a more divided electorate than in 2018, when Erdogan won in the first round. That was the first vote under the new executive presidency Erdogan set up that extended the role’s powers and which critics say eroded Turkish democracy.

“Our nation has made its decision,” Erdogan said in a speech from the balcony of his party headquarters in Ankara before the outcome became official. His alliance retained a majority in Turkey’s parliament, which Erdogan said will help him get reelected in the second round of voting.

His main rival portrayed the election results as a sign of weakness for the incumbent. “If our nation says second round, we respect that,” Kilicdaroglu said. “Erdogan could not get the results he desired.”

Uncertainty for Markets

The polarizing campaign has whipsawed markets. Turkish stocks slumped as much as 6.7% Monday before triggering a halt in trading. The lira fell 0.4% to 19.66 per dollar at 4:03 p.m. in Istanbul and Turkish state lenders sold foreign-exchange to support the currency on Sunday evening ahead of official results.

Turkey’s Markets Drop as Bets for Erdogan Exit Unravel

“Two weeks of uncertainty is a scenario that markets dislike the most,” said Cagri Kutman, Turkish markets specialist at KNG Securities.

In the end, Erdogan powered through and did better than many polls predicted ahead of the toughest election battle of his political life.

“Sunday’s result marks a huge win for Erdogan,” Emre Peker, Europe director for Eurasia Group, said. “The president is likely to ride his strong approval rating, surprise win in parliament, and incumbency advantages to secure reelection in the run-off.”

A surprise showing by Ogan, the third candidate in Sunday’s race who ran on anti-immigrant platform, was a key factor in keeping the front-runners from securing a majority. 

How Ogan’s voters might behave in the second round could swing the vote in either direction. In remarks late Sunday, Ogan criticized Erdogan’s unconventional economic views and refrained from endorsing either of the top two contenders. 

Kilicdaroglu, however, was endorsed by Turkey’s pro-Kurdish party, making it difficult for Ogan to throw his support behind Erdogan’s rival. 

“In comparison to his opponent, Erdogan is better positioned to win the votes that went to ultra-nationalist candidate Ogan in the first round,” said Wolfango Piccoli, co-president of Teneo Intelligence in London.

Erdogan, the country’s longest-serving leader, has molded the NATO member into a regional power that plays a growing role from Ukraine to Syria. 

He even maintained strong support in much of the area hit by the devastating February earthquakes that left more than 50,000 people dead. Survivors and opposition parties have accused the government of not responding to the disaster adequately.

But increasingly erratic economic policies left him vulnerable after an inflation crisis last year gutted household budgets.

“It would be good if there was a change,” said 55-year-old gas station worker Cengiz Caliskan, who had voted for Erdogan in the past but backed Kilicdaroglu this time. “I didn’t think Kilicdaroglu would do a better job than Erdogan but the same people were getting rich by staying in power too long.”

Kilicdaroglu was running on a promise to restore the rule of law, mend strained ties with the West and return to economic orthodoxy. 

Another term for Erdogan would likely mean a continuation of “unorthodox and unsustainable policies” and macroprudential measures, Moody’s Investors Service wrote in a note. This would have a heightened risk of very high inflation and severe currency pressures, it added. 

If Kilicdaroglu were to win a second round and implement more mainstream economic policies, that would be positive for Turkey’s credit rating, Moody’s said, adding the path to this would be challenging.  

All Eyes on Economy

It’s Erdogan’s approach to the economy that will likely dominate the final stretch of campaigning.

The lira has been under pressure since Erdogan ramped up a slew of unorthodox policies starting in 2018, including state interventions in FX markets and interest-rate cuts even as inflation surged. Turkey will be under pressure to double down to hold the lira stable in the coming weeks.

Turkey’s Stealth Interventions Hit $177 Billion Before Vote

The central bank will hold its next rate-setting meeting on May 25, three days before the runoff vote. 

“I would expect Erdogan and his government to maintain market stability at all costs going into the second round,” said Nick Stadtmiller, head of product at Medley Global Advisors in New York. Any dip in Turkish markets “would suggest a chink in the armor of Erdogan’s policies.”

--With assistance from Taylan Bilgic, Inci Ozbek, Tugce Ozsoy, Baris Balci, Kerim Karakaya and Demetrios Pogkas.

(Adds official confirmation of second round of voting)

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