With its large, vibrant economy and a considerable push on growth, Turkey is woven into the fabric of the emerging markets story, writes Romil Patel.
To a large extent, the Turkish economy has been funded in dollars, which has helped drive healthy numbers in terms of domestic consumption and overall GDP growth.
But Turkish prices have long been volatile due to the country’s politics. President Recep Tayyip Erdogan is renowned for being outspoken on capital markets, economic policy and central banks, and he is certainly no stranger to causing investor jitters.
Over the years there have been coups, a long-running debate about Erdogan’s position in the state as its absolute leader, question marks around what sort of democracy it is, and so on. As a result of these questions and elevated risks around Turkey, the relatively handsome yields on offer attracted many investors.
But in 2018, a number of catalysts collided to ignite a currency – and therefore confidence – crisis in Turkey that saw the lira lose about 40% of its value against the US dollar. It has experienced a recovery since the worst of the slump, during which time tensions between Ankara and Washington rose over the fate of two men: a detained US pastor and a Turkish cleric. The rhetoric between Erdogan and US president Donald Trump became increasingly hostile as Trump doubled tariffs on imported Turkish steel and aluminium.
Investors had also become increasingly spooked by Erdogan’s influence over monetary policy and as inflation soared, the central bank resisted raising interest rates. Pressure from the president, who called interest rates “the mother and father of all evil”, played a significant role, raising further doubts over the institution’s credibility.
“The central bank had been questioned all year as it had been running loose monetary policy in a rising inflation environment as the economy was overheating,” says Warren Hyland, portfolio manager at Muzinich & Co.
While Turkey refused to take the course of action that investors were craving, Argentina was doing everything prescribed by the International Monetary Fund (IMF) textbook, such as raising interest rates to 60%.
“But while they were doing this, the Argentinian currency went into freefall and the stock market collapsed,” says Akber Khan, senior director of asset management at Al Rayan Investment. “So perhaps some Turkish policymakers were wondering why they should follow this perceived wisdom when another country was doing exactly what the IMF wanted it to and it was not helping at all.”
The net result was a huge sell-off in a number of different assets that led to very significant inflation and a depreciation of the currency to levels not seen for a long time.
Before any central bank activity, Ankara did attempt to take steps to reassure investors. This included reducing the amount that commercial lenders must keep with the regulator and easing the rules that govern how they managed their lira and foreign currency liquidity.
“This was in essence to ensure the markets there was enough liquidity in the system to satisfy any demand for domestic lira, and essentially to avoid any panic in the hope this would reduce pressure on the currency,” says Ehsan Khoman, head of MENA research and strategy at MUFG Bank.
As time went by, downward pressure on the currency mounted and inflation went through the roof, ultimately tipping the Central Bank of Turkey into action. On September 13, 2018, it surprised markets as well as investors by raising its benchmark interest rate by 625 basis points.
Initially stupefied by the central bank’s inaction, observers and investors were subsequently reassured by the aggressive stance it took to stem the flow of inflation and get the economy on to a stronger footing.
A central bank’s ultimate independence and credibility is a cornerstone for price stability across the world, while any intervention by policy-makers in the institution is perceived as a sign of weakness.
“You need convincing measures taken by the central bank, which needs to act independently and continue to do that,” says Wim-Hein Pals, head of emerging market equities at Robeco. “That is pretty tough in Turkey’s current environment, where you have constant pressure from the president.
“It is no different in the States, where Trump is also bashing US Federal Reserve chair Jerome Powell and the Fed, but in Turkey there is even more pressure, given the current state of its economy.”
Robeco has not held any Turkish equities in its global emerging markets portfolio for about 24 months, Pals says. “It was a bit of a painful trade in 2017,” he adds. “That year, Turkey did remarkably well on equities prices and on the currency, which was strong – but we could not understand it, so we did not jump on the bandwagon.”
So, what does Turkey need to do to regain investor confidence and trigger some drive and momentum in the economy?
Not for the squeamish
Investors who want exposure to Turkey and access to the attractive returns need to understand that as with any emerging market, there will be short-term volatility, headline risk and political risk.
“Perhaps Turkey has more than any other, probably quieter, emerging markets, but there is always something happening and now is no exception,” says Khan at Al Rayan Investment.
“You have to be able to ride out some of the volatility if you are going to take advantage of these returns – Turkey is not an asset class for the timid investor.”
In order to boost the currency and ensure continued investment, Turkey introduced new regulations in September this year, making it far easier for foreigners to acquire Turkish citizenship. They can now become citizens if they own real estate in the country worth $250,000 or more for three years – down from $1 million previously.
“Last year’s foreign purchases were $4.6 billion and they want to raise it to $10 billion. That is not inconceivable,” says MUFG Bank’s Khoman. Indeed, residential property sales to foreigners increased 134.4% in October 2018, compared to the same period a year earlier, data from the Turkish Statistical Institute (TurkStat) showed.
For Turkey, relaxing the ownership rules on foreigners is both a smart and fiscal move. Property prices could rebound in 2019 off the back of this, given the regulations are large in terms of scale and scope. Reducing the investment required for Turkish citizenship is a huge step.
“These sorts of measures are reassuring for investors to go into 2019 with cautious optimism,” adds Khoman.
But that alone is not enough. The key question for Turkey is, does it opt for a credible reform programme under the IMF?
A potential IMF reform package and assurances that capital expenditure will be adhered to in 2019 would go a long way towards reassuring investors. Although there appears to be little political appetite for this, a downturn in the first quarter of 2019 could force the government to revisit this option.
What is not entirely clear is how much of a negative feedback loop high interest rates and high inflation are going to have on the domestic economy.
“But fortune does favour the brave,” says Khan, “and the time to buy is when there is blood on the streets.” From a currency perspective, some parts of the region, such as the Gulf, now find Turkish assets much cheaper because the dollar has appreciated significantly. Hence there are opportunities for the dollar-denominated currencies to invest in Turkey.
In May, Dubai’s biggest lender, Emirates NBD, agreed to buy Turkey’s DenizBank from Russia’s state-owned Sberbank for $3.2 billion.
“That is a prime example of a player in the MENA region looking to tap into the structural and secular growth story that Turkey has,” says Khan. “There are a number of banks in the Gulf region that have bought into Turkey and those banks have enjoyed very strong growth in local currency terms.”
In 2019, investors are hoping for less state intervention and will want more guidance about what policy-makers want to do in terms of market-friendly responses to entice investors. This, after all, is a country that boasts a large, well-educated population and straddles the Eastern and Western worlds, both physically and metaphorically.
Summing up the dilemma that investors face, Abhishek Kumar, sector head of emerging markets debt, fixed income beta at State Street Global Advisors, says: “It is difficult to be optimistic on Turkey just yet, but it is also difficult to be underweight in the country because it is too expensive.”
From a wider perspective, unpredictability is an increasingly prevalent theme amongst GCC countries and the broader region. From a foreign policy point of view, the region used to be regarded as predictable – but that is no longer true, given the UAE-Saudi blockade of Qatar, the war in Yemen and the death of Saudi journalist Jamal Khashoggi at the Saudi Arabian consulate in Istanbul.
“No one can say whether the relationship between any two countries will be the same in 12 months as it will in 24 months,” says Khan. “Nobody ever had to worry about the political angle of the Gulf region and how that relates to the broader region.
“They do now.”
©2018 funds global mena