By Nevzat Devranoglu and Ceyda Caglayan
ANKARA/ISTANBUL (Reuters) - Investors could snap up sold-off Turkish assets or dump them with force depending on the outcome of Sunday's re-run election in Istanbul and, days later, a high-stakes meeting between President Tayyip Erdogan and his U.S. counterpart Donald Trump.
The Turkish lira, stocks and bonds have sagged since March amid uncertainty over how the vote might affect Erdogan's economic policies, and strained relations between Ankara and Washington over Turkey's purchase of Russian S-400 defense systems.
The outcomes may set the stage for a rebound or a further slump in the lira by the end of next week, bankers and analysts say. The currency has lost 10% against the dollar so far this year, following a 30% fall in last year's currency crisis.
The stock market, at its lowest levels in dollar terms in about a decade, might revive after the Istanbul election if foreign investors regain trust in Turkey, said Mehmet Gerz, who heads Ata Portfoy fund management firm.
When the initial March vote was scrapped, investors questioned the integrity of Turkey's democratic institutions and wondered whether the months of additional campaigning would distract from needed economic reforms.
A slew of unorthodox government measures to protect the lira raised further questions.
"Turkish stocks are at the cheapest level in a decade," Gerz said, adding "the political framework that will be formed after the election" would set the new direction.
On March 31, the main opposition party pulled off a mayoral victory over Erdogan's ruling AK Party, a stinging defeat for the president seen in part as a rejection of his handling of the economy that tipped into recession last year.
Another AKP loss on Sunday could weaken his iron grip on power, but also restore some faith in democracy. Concerns over the central bank's autonomy, as well as a separate diplomatic row with Washington, set off last year's lira plunge.
In May, when the re-run was announced, foreign investors sold a net $345 million of Turkish stocks.
Compounding the pressure, locals have flocked to foreign currencies since last year's lira crisis, with forex deposits and funds including precious metals held by Turkish local individuals and institutions rising to a record high by June 7.
The trend could change, however, and confidence in Turkish assets increase if reforms are put in place "to get back to rational and rule-based economic management," Gerz said.
SANCTIONS LOOM
Erdogan and Trump are set to meet at a G20 summit in the Japanese city of Osaka on June 29-30, in part to discuss Turkey's S-400s purchase and the threat of U.S. sanctions.
Investors have held out hope the leaders can find a solution despite Ankara's repeated assertions that it will accept delivery of the defense systems and, in the U.S. Congress, a strong resolve to punish Turkey if it does and a U.S. law requiring that sanctions would be implemented.
On Thursday Erdogan told foreign reporters in Istanbul that he would ask Trump whether he thought such sanctions were suitable, adding: "I believe he does not."
U.S. sanctions, which could come as soon as July, could set off another bout of selling in the lira and other Turkish assets. But some investors said much would depend on the details of such a move.
"The current view is that Turkey may not be facing heavy sanctions but (rather) measured economic sanctions over the S-400 purchase. This could create negative flows but I do not expect heavy sales," said Eral Karayazici, a fund manager at Gedik Portfoy.
But Ulrich Leuchtmann, head of forex and emerging markets research at Commerzbank (DE:CBKG), said that Turkey would be "really hurt" if the U.S. enforces its sanctions globally.
"Optimists are saying this is just a lot of noise, it won't be that bad in the end. But I am not so sure about this," he said.
