TURKEY: When it rains, it pours – EAST CAPITAL COMMENT

By Emre Akcakmak, Portfolio Manager, East Capital.*

It was not so long ago that Turkey was the darling of international investors. Political stability, a young population, a fast-growing economy, declining inflation and a series of rating upgrades encouraged investors to buy Turkish equities and pushed Borsa Istanbul to all-time highs by May 2013 – with an impressive 84% gain in EUR since the beginning of 2012. However, investors’ sentiment towards Turkish equities has taken a dramatic turn since then.

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FED tapering
The release of the minutes of the US Federal Reserve’s meeting in May 2013 was the start of the reversal in the Turkish market’s upward trend. According to the minutes, a number of FED officials showed willingness to slow down the pace of asset purchases – what’s come to be known as “tapering” – indicating that the period of abundant global liquidity was coming to an end. As one of the main beneficiaries of that liquidity due to high external financing needs, Turkey immediately came under pressure and the stock market gradually lost 8%, the Lira weakened and the Lira denominated benchmark 2-year bond yields started inching higher.

Gezi Protests
However, the real shock to the market came during the first weekend of June when environmental protests in the heart of Istanbul, at Taksim Square and Gezi Park, turned into nationwide anti-government protests in a matter of a few days, taking both the government and investors by surprise. There was a considerable increase in volatility as the Lira started losing value and bond yields increased sharply. Along with fears of tapering and a broad based EM sell-off, political instability led to outflows from both bond and equity markets. By mid-June, the Turkish market had lost all its year-to-date gains and market outlook had turned sour.

Syrian tensions
The summer months passed with a lot of volatility and in search of new market equilibrium. Following range-bound trading until mid-August, the Turkish market had another leg down as debate about the FED’s tapering picked up and speculation about a possible US-led military intervention in Syria intensified. Along with its emerging peers with large current account deficits, such as India and Indonesia, Turkey was among the weakest markets, as it lost another 10% and the Lira continued to depreciate.

Signs of life
Following four consecutive months of declines up until August, the Turkish market rebounded strongly as tensions over Syria eased and the FED made the surprise decision of not starting tapering in September. The FED’s announcement in particular led to a short-lived market rally as turnover printed its all-time-high, with USD 3.5bn versus a daily average of USD 1.5bn. As another indication of the positive mood, by mid-October bond yields declined to a two-month low.

Corruption and bribery investigation
The last quarter of the year went by with a more positive mood and a relatively constructive outlook as political stability was restored to a large extent, significant steps were taken with regards to Kurdish peace talks and talks on various energy deals with the Kurdish Regional Government (KRG) gave investors hopes of a lower current account deficit in the coming years. At the same time, the market was focused on the FED’s tapering decision as investors preferred to bide their time and monitor the news coming out of the US.

However, a perfect storm for Turkish equities came towards the end of the year when the FED’s tapering decision coincided with an unexpected corruption and bribery investigation, which included several high profile people close to the ruling AKP. Market volatility increased as bond yields rose and currency depreciated again. Stocks of certain state-owned companies and others with government connections took a big hit as uncertainties following the corruption investigation led to panic selling.

EM currency sell-off
Following the announcement of the FED’s tapering decision, emerging markets started seeing another wave of large outflows due to renewed worries about global liquidity conditions. Emerging market currencies started weakening against the Dollar and central banks rushed to hike the rates in a bid to prevent local currency depreciation. As pressure increased, the Central Bank of Turkey decided to hold an extraordinary meeting during which it decided to hike the policy rate decisively by 550 bps to 10% in order to prevent further Lira depreciation.

Where to from here?
After almost nine months of turbulence, which has caused a sharp currency and equity correction, it is relevant to ask what comes next for the Turkish financial market. Although we believe the worst is behind us, there are still several external and internal issues that may cause volatility in the coming months. Externally, tapering may continue to cause uncertainty for economies with large financing needs like Turkey and the situation in neighbouring Syria remains very difficult. Internally, there may be more to come from the corruption and bribery investigations, as well as local elections in March and presidential elections in August.

At the same time, the equity market has corrected substantially, which has opened up possibilities to build up positions at attractive levels. Moreover, the policy response to the currency weakness, while arguably late was quite decisive, suggesting that the Central Bank has now set a floor to the currency, limiting the downside risks.

In conclusion, the time for a renewed interest in Turkey is approaching, but we may not be there just yet.

*East Capital Group is a Stockholm-based  emerging and frontier market asset manager specialising in Eastern Europe and emerging Asia. The group, an independent partnership set up in 1997, manages about 3.5bn euros in public and private equity funds as well as  separate accounts.

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