The Daily Update - Turkey forced behind the curve

Away from the hard/soft Brexit talks and Trump hiring his son-in-law as a top senior advisor, Turkey appears to have crept back into the headlines as political uncertainty mounts, social and security instability ensue, and the country’s economic outlook looks increasingly bleak.

Politically, the country’s parliament yesterday voted ~⅗ in favour of a constitutional amendment - and can thus hold a referendum in Q2’17 - which could see President Erdogan gain even more presidential power and potentially increase his term to as far out as 2029. A dissolution of parliamentary power in favour of more totalitarian regime could potentially further erode Turkey’s chances of joining the EU, thus weighing even heavier on already fragile investor sentiment.

From a macro perspective, growth has decelerated sharply, and the weakening lira is adding to price pressures; which saw inflation rise to 8.53% in December. Despite the lira plummeting over 6.5% so far this year to new lows against the dollar, in addition to the 17.2% collapse last year, the ‘behind-the-curve’ central bank is yet to intervene on a meaningful scale, most probably out of fear. The CBT today highlighted its concerns over the lira’s slide, and has therefore added ~USD 1.5bn of FX liquidity, and cut reserve requirement ratios across the board by 50bps. The central bank’s willingness to act against the fx mismatch saw the currency briefly fall from record highs, but we are not sure this ‘small token’ will be enough to stem further deprecation. A more substantial policy response is required via a rate hike or through further intervention, although reserves are quickly depleting.

Turkey's long-term rating was downgraded to junk in 2016 by both Moody’s and S&P last year, while Fitch maintained its investment grade BBB- rating, with a negative outlook. Having been classed an EM gem since before the financial crisis, investors appear to be falling out of bed with Turkey; a country which we have never been keen to invest in, mostly due to it’s low 2 star net foreign asset ranking, but also because we had previously seen very little relative value in the country. We would rather invest in similarly rated Russian holdings, where we view the fundamentals as being much stronger. In fact an easy comparison would be to look at the countries’ credit default swaps; Turkey’s 5-year CDS is currently trading over 65% higher than Russia’s.