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The collapse in the price of oil should have set the scene for a year of outperformance for the lira and the Turkish economy generally, given its status as an oil-importing emerging market. It has certainly provided some respite.
October figures put its current-account deficit at $163 million, the lowest since 2009, while Fitch states it will narrow to 4.6% of GDP from 5.8% in 2014. GDP growth has been better than expected too, with a 3.8% rise in Q2 2015 relative to the same period in 2014, while corporate earnings have also beaten expectations.
Yet despite this, the lira has suffered alongside commodity-exporting currencies such as the Brazilian real and the Russian rouble. The single biggest reason for this is the political risk investors see in Turkey – with two elections in the space of six months – which has deterred foreign investors, given a lack of clarity over the country’s economic and political model.
Actual and expected inflation (%) |
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Other problems have also contributed. Inflation has been creeping up: the central bank’s (CBRT) latest forecast in October put it at 7.9% for the end of this year, and 6.5% for the end of 2016. Lira-denominated loan growth – often indicative of the mood in the Turkish economy, given how responsive this indicator is to changes in its relatively pro-cyclical monetary conditions – has been slowing, suggesting a cooling economy.
After a strong second half of 2014, extending into the early part of 2015, Turkey has found itself caught in a vicious cycle: low confidence has pushed down the lira, which pushes up inflation and then rates, further undermining confidence.
In the run-up to the election, this cycle was broken, with lira gaining ground before and after AKP’s victory. The question is whether this is a temporary blip or whether a more positive feedback loop can be maintained.
HSBC attributes the lira’s initial rally in large part to the lack of foreign positioning in the local market, and the fact Turkey’s current-account deficit has been gradually narrowing. However, the bank is cautious on its prospects in the medium term.
Société Générale is equally cautious in its assessment. Kit Juckes, macro strategist at the French bank, believes the euphoria surrounding the lira will prove “highly unsustainable as long as the CBRT does not follow through with its inflation-targeting mandate and AKP does not prioritize long-overdue structural domestic reform”.
Much therefore depends on which AKP, and which president Recep Tayyip Erdogan, is seen ruling Turkey in the coming years: the reformists of their early years, or the autocratic and divisive figures seen of late.
Erdogan will need to demonstrate skilful statesmanship to steer the country in the opposite direction, say analysts.
Stocks are cheap, yields are high, the lira is weak. Emre Akcakmak, East Capital |
Even if the country makes great strides reducing the current-account deficit and inflation, foreign direct investment will quickly dry up if investors fear the prospect of a continued civil strife – given a deeply divided election – or a spike in terrorism.
Market players are, in general, bearish and reckon the lira is set to further depreciate in the medium term. Capital Economics forecasts the lira will weaken to around 3.50/$ by the end of 2017 – bang in line with projections in the forward market – from 2.81/$ earlier this week.
However, Erdinç Benli, co-head of global emerging market equities at GAM, is optimistic that, at heart, Erdogan remains the pro-market force that so impressed investors in the early days of AKP rule.
“Erdogan is still market-orientated since his power also depends on the wealth of Turkish people,” he says. “The evidence for this is in the last 18 months, when the economy slowed, inflation increased, the lira fell and he lost votes in June.
“The economy is very important to him and his focus will be on delivering growth. When the economy is good, it gives you room to pursue your political goals.”
Emre Akcakmak, portfolio manager at East Capital, says the perception of Erdogan, and AKP, has probably changed more than the underlying reality.
“The perception of AKP depends also on expectations,” he says. “When it was first elected, it had no track record and investors had low expectations of it. In the early days, its strong performance on reform and its commitment to the EU accession process surprised on the upside.”
Now expectations are higher, says Akcakmak, while outcomes have gone the other way.
“This has eroded investor sentiment,” he adds. “This is why there is a certain degree of scepticism. However, AKP is still perceived as a pro-market party by the majority of the investor community.”
Both fund managers agree the market will be waiting to see the composition of the new AKP government.
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Investors have ignored fundamentals for the last 12 months Erdinç Benli, |
Akcakmak says: “The market will pay particular attention to who prime minister Ahmet Davutoglu appoints to his economic team, in particular what post well-regarded policymakers, such as Ali Babacan, gets.”
Mehmet Simsek, the finance minister, is another name investors will want to see in an important post. If names of that calibre get the top jobs, investor confidence will rise, though Simsek’s relative silence during government attacks on the independence of the CBRT disappointed some investors.
The CBRT has been very much at the centre of the political uncertainty in Turkey, with divisions opening up between it and Erdogan in the aftermath of the election in June. This has fed speculation that Erdogan might use his new mandate to subjugate the central bank.
“While attention often focuses on macro reforms that could deliver stronger economic performance over the medium term, we would put more weight on any moves aimed at reinforcing the independence of the CBRT,” says David Rees, senior markets economist at Capital Economics.
However, HSBC suggests there is now less chance the CBRT will react to a stronger TRY, which had triggered much of the tension.
“In June, the CBRT was more optimistic on inflation and assumed that CPI would end 2015 at 6.8% and 2016 at 5.5%,” says the bank. Now, with a more pessimistic view on inflation, the CBRT might welcome lira appreciation that will ease inflationary pressures, it adds.
From AKP’s side, the hope is that, with its majority restored and Erdogan’s position consolidated, the temptation to make populist attacks on CBRT independence will ease. With the lira having gained some ground, and more to come, perhaps, once a strong economic team is named, the central bank will be under less pressure.
Lower rates
If positive lira momentum can be maintained, the CBRT might even be in a position to lower rates next year, following the appointment of a new governor.
This is not, however, a consensus view, as the bearish forward market indicates. Capital Economics’ Rees predicts a fragile lira will eventually force interest rates higher.
“Assuming that inflation abroad remains lower than in Turkey, the lira will need to depreciate in nominal terms just to maintain the competitiveness of local firms at current levels,” he says.
Besides inflation, the big concern in Turkey is the current-account deficit – a big, structural problem, rooted in the fact that Turkey is a major importer of oil.
East Capital’s Akcakmak says: “[The current-account deficit] cannot be solved overnight. But it should be tackled in the longer term – whether that is accelerating alternative-energy investments, improving efficiency to reduce imports or something else.”
Akcakmak believes that, with Turkish assets currently attractive in pricing terms, there is plenty of upside potential.
“Stocks are cheap, yields are high, the lira is weak,” he says. “So there is scope for this base to build some momentum. But that can only go so far. To keep it going, AKP needs to act constructively and restore investor confidence. Every election is a chance for a new beginning.”
GAM’s Benli agrees, adding: “The political-risk premium should decline from here provided that a market-friendly economy team is nominated and structural reforms are tackled.
“Then the focus will be on external factors and fundamentals. Investors have ignored fundamentals for the last 12 months.”