Turkey in turmoil – what lies ahead?

investment viewpoints

Turkey in turmoil – what lies ahead?

Dr Salman Ahmed - Chief Investment Strategist

Dr Salman Ahmed

Chief Investment Strategist
Jamie Salt - Analyst

Jamie Salt

Analyst

 

UPDATE: Tough talk and tariffs send Turkish Lira tumbling; we expect further pressure 

 

10 August 2018

President Erdogan has issued a rallying cry to locals to convert their foreign exchange reserves to Lira in a speech today, while the market had hoped for a more settled tone. In our view, the speech lacked any real clarity on strategic direction. The President targeted forces who he claimed are waging an “economic war”, striking a heavily nationalistic tone and building a strong sense of ‘them against us’, as well as reiterating that the nation’s macroeconomic position is still strong.

In what was perhaps the most intriguing part of the speech, the President specifically cited China, Russia, Iran and some European states as “alternatives”, but did not clarify what they would be “alternatives” to. One could see this as a very tempting option for China to gain a significant foothold in the region. 

Immediately following this, Finance Minister Albayrak unveiled the new economic programme. The speech contained reassurances over central bank independence, underlining the need for a sustainable economic approach with a more powerful budget balance. However, after previous empty promises, the reaction will be a case of ‘we’ll believe it when we see it’, plus, Minister Albayrak’s comments lacked detail and did not contain no any of the specific numbers or forecasts that the market was hoping for.

On the back of all of this, President Trump tweeted that the US has authorised the doubling of steel and aluminium tariffs with respect to Turkey. This sent the Lira tumbling even further, and as of writing, the currency is down 20% today. 

Given the collapse of the Lira, we think Turkey will need capital controls and will need to seek external support. An IMF (International Monetary Fund) deal looks problematic, given Turkey’s ongoing spat with the US. That said, the deteriorating situation can bring China and potentially Saudi Arabia to the table in terms of external support for Turkey. In addition, it is important to remember that Turkey is a NATO (North Atlantic Treaty Organisation) member and can also look to use its membership as a massive bargaining chip. The situation in Turkey is likely to remain very volatile going forward and this has potentially strong implications for the global world order as well. 

 

8 August 2018

The introduction of US sanctions has intensified the Turkish macroeconomic crisis, as the country grapples with currency depreciation and inflationary pressures.
 
We have held a negative view on Turkey since the beginning of the year, when the Central Bank’s inaction in the face of a credit-fuelled overheating of the economy was beginning to put downward pressure on the Turkish Lira and associated assets. 
 
At the end of January, the Turkish Lira was at 3.75 versus the USD and inflation was at 10.35% - over double the Central Bank’s long-term target of 5%. A resurgence in oil prices has added to inflationary and current account deficit pressures. CPI inflation now stands at 15% and PPI at 25%, whilst 10-year sovereign yields have touched 20% for the first time.
 
The Lira has now depreciated by roughly 40% against the US Dollar this year to around 5.3 at the time of writing. Current trajectories will, in our view, likely see the Lira become Emerging Market’s worst performing currency, year to date, in the coming weeks and months.
 
This latest bout of negative sentiment is partially a result of the CBRT’s reluctance to commit to continued monetary tightening under Erdogan’s watchful eye. Furthermore, the situation has worsened following the introduction of US sanctions last week against two Turkish ministers.
 
Although recent reports indicate that an agreement is forthcoming, the situation remains volatile. It now looks as though external support may be required. That could come in the form of IMF support, but would require a substantial shift towards more sustainable policies. The prospect of capital controls now begins to seem a real possibility. 
 

Investment implications

  • We expect further policy inaction to continue to put downward pressure on the Turkish Lira and associated assets
  • We believe the idiosyncratic nature of events is causing Turkish assets to underperform, relative to other emerging markets
  • Turkey’s financial sector appears particularly vulnerable, in light of looming refinancing requirements and the sizeable foreign exchange liabilities of Turkish companies 
  • We think Turkey may need to approach the IMF or seek other external support. Otherwise, capital control measures seem to be a distinct possibility.
 
 
Any reference to a specific security or asset class does not constitute a recommendation to buy, sell, hold or directly invest in the company or securities. It should not be assumed that the recommendations made in the future will be profitable or will equal the performance of the securities discussed in this document.

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This document is issued by Lombard Odier Asset Management (Europe) Limited, authorised and regulated by the Financial Conduct Authority (the “FCA”), and entered on the FCA register with registration number 515393.
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