Grant Webster, Portfolio Manager at Investec Asset Management, and Lindsay Williams examine the current crisis in Turkey and what it means for investors.
Lindsay Williams: Let’s talk Turkey now. With me is Grant Webster, Portfolio Manager at Investec Asset Management in London. Grant, before we analyse the current crisis in Turkey, perhaps we could go back a bit, have a look at how Turkey went from the emerging market darling to its current pariah status. What has happened over the last few years? Give us a brief history, if you would.
Grant Webster: Sure. Hi, Lindsay. If you go all the way back, it was in 2000/2001 that Turkey had its previous crisis, also a debt crisis. It led to political change in the country. The AKP came into power, led by Erdogan and a few other people who are, unfortunately, no longer in the government and they followed all the rules so to speak. So the IMF were involved – they brought inflation down, they kept interest rates very high, they reduced growth and, as I say, they followed kind of the rules of the game.
What you saw was very strong growth, they did a fantastic job running the economy and debt levels came down but so they started to build up some imbalances. Dollar-denominated debt has grown in the economy. They also have run a consistently high current account deficit so they are importing far more than they are exporting. Much of those imports is in the form of oil but what it means is that you don’t build up a savings base in the economy and you become increasingly reliant on financial flows and, in Turkey’s case, those kind of form a portfolio of flows which can reverse very quickly, not FDI.
So they have always been fairly vulnerable to changes in the global economy, to changes in what we call financial conditions and they have had a number of occasions over the last years where we have thought they might be in trouble but they have always come back from the brink and they have always done the right thing at the end of the day – hiked rates aggressively, brought inflation slightly under control. Then they have continued on but in the previous episodes I think what has also helped them is the global backdrop has been very supportive. So they have had the help of inflows into emerging markets and vast amounts of liquidity globally from the likes of the Fed and the ECB. Last year, in fact, that certainly helped them.
This time around things are obviously very different. They don’t have that back-stop and so what is called for is higher rates and they have been even more reluctant than in the past to actually tighten policy. They are in a very tricky situation.
Lindsay Williams: So this is nothing new. I distinctly remember an ex-colleague of mine when I worked in London in the 1980’s (it was maybe 10-12 years ago), he phoned me and said why don’t you come to Turkey, which I did. He had built a beautiful house on a hill overlooking the southern coast. He told me he put a chunk of his money into a Turkish bank and was receiving 16%. He said at the time the lira was quite stable but things have, of course, gone awry since then and since then we come to the present day. What has precipitated this current crisis because it seems to be gaining momentum, a little bit of a breather as we speak but it has become really nasty in the last week or so?
Grant Webster: Yes, absolutely. There are a few things. They are all kind of a confluence of things, which have made it worse. Firstly, they held elections recently. Erdogan won the presidential elections and the AKP managed to just win in the parliamentary elections although they had to rely on a coalition with the Nationalist MHP Party.
So that was really the first thing but what that election also brought was it brought into effect some constitutional changes which have delivered far more power to Erdogan, which clearly the market never likes, particularly given his history. Then he selected his cabinet and in his cabinet selection he chose his son-in-law as the Finance Minister. I wouldn’t say he is particularly qualified for the job, unfortunately, and, of course, he tows the same line that Erdogan does.
Lindsay Williams: He was interviewed actually – sorry to interrupt you, Grant – he was interviewed on one of the international television stations and he was sweating bullets. He was dodging questions. He was clearly not qualified for the job and that just doesn’t add to the confidence levels but, anyway, I interrupted – please carry on.
Grant Webster: No, not at all, no, you are quite right. That is exactly the case. In fact, all the really good, orthodox policy-makers and technocrats, unfortunately, have been pushed out. So that is very worrying but then what has further compounded this, of course, is relations with the West and, in particular, the US. Turkey, since the coup, has tried to buy some defence missiles from the Russians, S-400 so-called weapons, which, being a NATO ally, never goes down well, particularly when you are trying to buy them from a country which is sanctioned by the US, so that hasn’t gone down well.
Then also in the thousands of arrests that Erdogan has made since the coup attempt in 2016, he has arrested a pastor, a US pastor, who works and lives in Turkey, Andrew Brunson, and the Americans have demanded his release. It seems like behind the scenes there was a deal done to have the pastor released in exchange for other political detainees in Israel, Turkish detainees. The Turkish prisoners were released but the Turks it seems never followed through on their side of the deal. So that infuriated the Americans, as you can imagine, and it has just really escalated from there.
Lindsay Williams: It really has. You mentioned Russia and then you look at where Turkey is and its burgeoning population and its membership of NATO and its geographically strategic importance and all these things come together and really produce a very nasty and toxic cocktail of potential events that could lead to contagion elsewhere. We are seeing evidence of that already. We have seen the rupee in India coming under pressure. We have seen the South African rand coming under pressure and when Chinese growth figures or economic data doesn’t come in as planned (as it did this morning), then the whole thing can build up into something a little bit more unpleasant than we have even experienced in the last two weeks.
Grant Webster: Yes, absolutely. Investors tend to draw lines between these things and look for the next vulnerable candidate but I would hasten to add that I don’t think it is entirely just Turkey that is causing the contagion effect. For much of the last couple of quarters, we have seen weakness in global markets, weakness in emerging markets on the back of a slight dip in the growth numbers (I mean you still have good growth numbers globally but there has been a slight loss in momentum) plus, with the Fed continuing to hike, it has pushed up financing costs globally.
So there are numerous things taking place here and I think those are also driving markets. When you look at the markets today, as you say, and emerging markets are not performing particularly well at a time where actually the lira is more stable, there are many things going on here.
I think your point on the size of the economy, the size of the population in Turkey and its location is key, I think that is why it is critical at this juncture that the Europeans engage with Erdogan and Turkey and with the US because they really need to ratchet down rather than ratcheting up this rhetoric. It is very good to actually see that I think today Erdogan and Merkel talking and that they have set up a meeting between their Finance Ministers.
Lindsay Williams: Good. Let’s hope that that discourse continues. $64,000 question, Grant – is this a buying opportunity or is this just the start of something that is going to become more meaningful and meaningful in a bad way?
Grant Webster: No, not in Turkey I wouldn’t say. I think you have still got to be very cautious. The measures they are taking at the moment are very, very temporary – behind the scenes hikes; they are trying to squeeze foreigners out of the market. These things only work for a short period of time and they are not by any means solving the main structural problems they have. They are not improving relations with the West. That is what we really need to see and, until you see that, I think you need to be quite cautious in your approach to Turkey, in particular.
Lindsay Williams: Grant, thanks very much for your analysis. That is Grant Webster, Portfolio Manager at Investec Asset Management in London.
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