Institutional Investor, IMF edition, Sept/Oct 2015
Turkey finds itself battered by macroeconomic concerns that it can do little to control, but there is cause for optimism that there may be better times ahead. For all that emerging markets have been dragged down en masse by problems from China to Brazil, Turkey is differentiated in a number of positive ways – if it could only convince investors.
“We are going down a hard path, that’s a mild way of saying it,” says Pinar Uguroglu, deputy CIO of BNP Paribas Investment Partners. “It’s not Turkey-specific, it’s a difficult period for all emerging markets.” And the problem is, the world’s investment community doesn’t differentiate. “Every country is put in the same basket, though each has different dynamics,” she says. “There are some global factors supporting us: the decline in the oil price, for a commodity importer like Turkey, we should benefit from. But we are still being hit.”
And it could get worse. “As the US economy recovers, a rate hike from the Fed seems inevitable,” says Hakan Atilla, Deputy General Manager, International Banking at Halkbank. “Therefore we may see a relatively higher cost of borrowing, and a potential outflow from the emerging markets, creating added pressure for markets.”
While there is certainly some truth in the fact that Turkey is being impeded by global events, to foreign equity investors, the headlines don’t look that good either. Ali Kirali, director of economic research and strategic planning at Odea Bank, says: “Increasing political tensions in the run-up to the June election, coupled with increasing geopolitical tensions, has put pressure on both investor and consumer confidence in the first eight months of the year, which in turn suppressed Turkey’s growth.” That election failed to deliver a government, and another will now follow on November 1.
Nevertheless, those on the ground in Istanbul think that a closer look affords a slightly brighter view. Kirali points out that Turkey still managed to grow at one of the highest rates among G20 countries this year, and he’s not alone in seeing a silver lining. “These are challenging days for Turkey, but if you look at the fundamentals, we have a very strong and very young population dynamic,” says Elvan Oztabak, Head of Financial Institutions and Investor Relations at Halkbank. Roughly half of the population is under 30. “The unemployment rate is resistant at around 10%, and there are two very strong pillars of the Turkish economy: the budget discipline is very good, and the banking sector is strong and well regulated.” Atilla adds that public finances are in good shape, with a low public debt to GDP ratio.
Politics are at the heart of everything. “There will be an election in October or November, and then there is another chance for Turkey to perform with a clear slate once a government is in place,” says Selim Yazici, CEO and head of Turkish equities at BNP Paribas Investment Partners. And the economy that government will inherit is not as troubled as some in the emerging world. “Turkey doesn’t have a significant budget deficit, unlike some,” he says. “It has a primary budget surplus.”
That’s true, but the current account deficit is a big issue, and here we come to an apparent contradiction. Late last year, when oil prices started to decline sharply, Turkey was seen as one of the few emerging markets that would benefit from the trend. It was said then that every $10 drop in the oil price would improve Turkey’s current account deficit by $4.5 billion. “According to our calculations, every US$10 fall in per barrel oil prices leads to a 0.5% fall in the current account deficit to GDP ratio, a 0.2% decrease in the inflation rate and 0.3% increase in GDP, all else equal,” says Ali Kirali, director of economic research and strategic planning at Odea Bank. “Of course, in real life there is no such thing as ‘all else equal’.”
Instead, the depreciation of the Turkish lira and an increase in risk premia have countered most of the positive impact of oil prices. “The deficit is shrinking, but not as much as we would have expected,” says Yazici.
Moreover, the currency deterioration has pretty much cancelled out the oil price fall anyway. And it’s not just the dollar to the Turkish lira that matters. Uguroglu adds: “Moves between the euro and the dollar have been against us. Our main export partners are European, so the currency [the falling euro] impacts our export performance.” At Halkbank, Atilla argues that the current account deficit has come down – he says it’s about 5.5% of GDP today from 8% in 2014 – and that it will have an impact on inflation which will be more visible once there is stabilization in the exchange rate.
Another Turkey-specific issue that has arisen more frequently recently is security, a combination of some troubled neighbours (chiefly Syria and Iraq – these days Iran is, relatively speaking, a haven of stability) and the Kurdish issue. While Yazici doesn’t deny this, he says it’s nothing new: “This is something we have been living with for 30 years. I don’t think it will have a big impact on the market, though a successful peace process would be very beneficial for the economy.”
So what should the new government focus on once it gets a mandate? “Focus on the economy,” says Uguroglu. “As politicians prepare for the election cycle, their focus gets shifted. We hope the new government will shift its focus back to the economy. With strong support, the central bank can move to a framework that would tame currency depreciation, and politicians can focus on the structural problems Turkey is facing,” including constant inflation. Growth should be on the agenda, she says. “We will grow 3% if we’re lucky in 2015. Turkey has to do much better, given its population and its condition as a country.”
Kirali agrees. “If the progress in balanced growth efforts can be coupled with long awaited structural reforms once a government is formed after early elections in November, I think Turkey may once again become one of the EMs with brightest prospects,” he says. But that all depends on the election. “If the new government is of a reformist nature and implements much needed structural reforms, I think Turkey will once again become one of the bright spots within the peer EM group. Therefore the election results are very crucial for Turkey and its economy.” Oztabak at Halkbank notes that Turkey has been going through election cycles – regional, presidential and general – for a year now. “Once we have this behind is we will hopefully have several years of an election-free period,” bringing relief in economic data and allowing politicians to focus on reforms to improve individual rights, among other things.
Turkey doesn’t particularly need strident reform, says Yazici, because it’s already done that. “When you compare us with India, for example, Turkey has already done most of the reforms that people call for there. Maybe we need a new pro-growth economic model on the table, and we need a strong justice system so that foreign investors become more comfortable in Turkey. But the fundamental economic reforms are already mostly done.”
The banking system is in good shape. “Turkish banks are still pretty strong,” says Yazici. “There is a good capital adequacy ratio and a low NPL ratio, although it might go up in a high dollar environment. We don’t have any major toxic assets and the lending side is showing 15% growth.”
Indeed, banking is one area investors might look at if they feel the overall markets have bottomed. Uguroglu highlights the banking sector as one of the first sectors to benefit if macroeconomic conditions become supportive, if the currency stabilises and assets move back into Turkish assets. Oztabak agrees, pointing to a capital adequacy ratio of 16% – much higher than most emerging market peers – and an NPL ratio that has fallen from 5.3% in the global financial crisis to 2.9% today. Return on equity has slipped but temporarily stands at 11-12%, and yet many Turkish banks are trading below book value.
Kirali says “Turkish assets are currently undervalued from a macroeconomic fundamental point of view,” and believes once elections are over, “Turkey offers many opportunities thanks to its strong fiscal balance, well-capitalized banking sector and resilience of its exporters in diversifying markets and products.” He expects a recovery in the major exporting sectors as the EU and Russia, Turkey’s main trading partners, begin to recover.
But the question at the moment is whether that stability has yet been reached. “I think we are near the levels of an attractive entry point,” Uguroglu says. “The only hesitation I have is if the currency keeps depreciating. From a value point of view, it’s cheap, it’s just a question of how cheap it can get.” As Yazici puts it: “There’s a big clash between uncertainty and prices. Prices are attractive, uncertainty remains; uncertainty wins, in the short term.”