By Grant Webster, Portfolio Manager, Emerging Markets Blended Debt
Given the importance of the Turkish election, we were on the ground on election night in time to see fireworks lighting up the night sky as jubilant AKP supporters celebrated another presidential victory for Erdogan. The parliamentary result was a bit disappointing for the AKP and they will have to rely on their nationalist allies to have a simple majority. On our trip we met with politicians, central bank, treasury, corporates, pollsters, as well as local economists and corporates to try and make sense of the result and what it means for Turkey’s political future and the near term economic dynamics. With the dust settling after Monday night’s cabinet appointments our latest views are outlined below:
Politics: an uncertain political outcome
- There is a clear sense in the aftermath of the election that the vote itself was largely fair (independent pollsters saw limited instances of voter fraud), but of course the playing field was very heavily skewed towards the AKP.
- The big surprise from the election was how well the nationalist MHP party did – it is only through their seats in parliament that President Erdogan’s AKP have a majority via their coalition formed in February of this year.
- With MHP as the ‘kingmaker’ in parliament, we might see an even more nationalistic tilt from the country. Troublingly the MHP has a long history of precipitating crises when in government. At the very least we should expect an intensification of fighting against the PKK in eastern Turkey and incursions into Iraq. We may also see further tensions with the US, particularly given the number of flash points (Russian missile purchases, etc)
- At the same time, there may be greater tensions within the new government between the coalition partners – the AKP are not used to sharing power.
- Meeting opposition politicians there was a clear mix of emotions, with the CHP disappointed about their showing in the parliamentary election, while the new centrist IYI (i.e. “Good”) party seemed more positive given they only officially formed the party in April. The IYI party will continue to target the centre which should be fertile ground for them ahead of local elections.
- We had hoped to see Erdogan appoint a relatively pragmatic government. However, instead Erdogan has gone in the opposite direction with a highly unorthodox set of appointments including his son-in-law as Finance Minister. On the same day a decree was published that will have far reaching ramifications for the country’s institutions. Most pertinently, Erdogan has increased presidential control over the central bank, and with key details missing, introduced greater uncertainty about the function of the central bank.
- Erdogan should at least follow through with recent claims that the State of Emergency will not be renewed past its next deadline even if little changes given the new constitutional powers obtained by the president and the AKP-MHP parliamentary majority.
Economy: slowing growth should help moderate the current account deficit
- Growth is clearly slowing. Consistent with the macro data and our nowcasts, it was certainly the perspective we got from talking to local corporates on the ground.
- With growth slowing and TRY weakness making imports more expensive, we should see some improvements in the current account deficit. Anecdotally, on the ground we heard from corporates of their import requirements coming in below their expectations. Our current account nowcast points to significant moderation in the C/A deficit in the coming months.
- Our sense from the trip is that the country’s fiscal situation is somewhat worse than we believed. While the headline number will likely deteriorate to around 2.5%1, the actual deficit including off-budget expenditure is likely to be higher. There have been 6 fiscal packages this year – and Erdogan is likely to follow through on election promises. After meeting with the Treasury, it seems clear that there will thus be greater issuance of local debt into the second half of the year. On the other hand, they should be done with the majority of their external issuance.
- The central bank continues to say the right things and our sense is that they think they have done enough (since April they have hiked by a cumulative 500bps) to contain inflation at around the 14-15% level. However, the latest inflation number released this week gives pause for thought. Headline rose from 12.1%1 yoy in May to 15.4%1- significantly above consensus (13.9%1). Core inflation also spiked up to 14.6%1. There are further risks too – if the government is to tighten fiscal policy it will mean removing the cap on fuel prices and introducing other taxes.
Conclusion: vulnerabilities weigh heavily
Turkey has been one of the worst hit markets in the recent sell-off for a reason. Material external vulnerabilities, a lack of central bank credibility and the uncertainty of the June election all weighed heavily on asset returns. Last night’s announcements have done little to assuage investors’ concerns about the country’s trajectory. To place it on a more promising long-term trajectory, what the country desperately needs is a return to genuine orthodox monetary policy (possibly targeting a higher but more realistic inflation target), a tighter fiscal policy, a reduction in corporate FX borrowing and the implementation of its long-awaited structural reforms. However, the new cabinet appointments and decree published yesterday suggests Erdogan will increasingly stamp his authority on the economy – this does not bode well. He will not want to see the economy slow (particularly with local elections likely to be held later in the year) and we see heightened risks that we will see further fiscal slippage and a rolling back of recent interest rate hikes.
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All rights reserved. Issued by Investec Asset Management, issued July 2018.