President Erdogan continues to tighten his grip on power. The lack of any real checks and balances on the presidency does not bode well for the country’s development.
The AKP renamed President Erdogan as head of the party at an extraordinary party conference over the weekend. In the past, the president was considered impartial and was not allowed to be affiliated with any party. However, the recent constitutional reform has reversed that and the center of governmental power now rests at the presidency. A cabinet shuffle is expected any day now, and markets must be cognizant that loyalty may be rewarded over ability.
The next elections aren’t due until 2019. Erdogan can now hold two more terms as president, and not counting the terms already served. The AKP is expected to continue its dominance for the foreseeable future. Indeed, Erdogan could theoretically remain in power until 2029.
The state of emergency in place since last July’s coup attempt remains in place. Recent comments by Erdogan suggest it won’t be lifted anytime soon. Meanwhile, periodic purges of suspected “Gulenists” continue. Turkey scores OK in the World Bank’s Ease of Doing Business rankings (69 out of 190) as well as Transparency International’s Corruption Perceptions Index (75 out of 176).
The recent decision by the US to arm Syrian Kurds was condemned by Turkey. Turkey is concerned that the Syrian Kurds could eventually decide to help the Turkish Kurds in fighting for more autonomy. US-Turkish relations were also strained by violence between Erdogan’s bodyguards and protestors at the Turkish embassy in Washington DC.
The economy is still sluggish. GDP growth is forecast by the IMF to decelerate modestly to 2.5% in 2017 from 2.9% in 2016, before picking up to 3.3% in 2018. GDP rose 3.5% y/y in Q4, recovering from the coup-related slump of -1.3% y/y in Q3. Monthly data so far show in Q1 suggest some very modest acceleration. Still, growth falls far short of the near-double digit growth enjoyed during the early years of Erdogan’s rule.
Price pressures bear watching, with CPI accelerating to 11.9% y/y in April from 11.3% in March. That was the highest rate since October 2008, and inflation is moving further above the 3-7% target range. Low base effects suggest inflation may accelerate further this year.
This supports the case for further policy tightening. The Central Bank of Turkey next meets June 15, and another hike in the Late Liquidity Window rate seems likely. This has become the central bank’s de facto policy rate, and was last hiked 50 bp to 12.25% in April. This rate acts like the upper bound on commercial banks’ average cost of funding, which has been steadily rising.
Fiscal policy is worsening. The budget deficit was around -3% of GDP in 2016. So far in 2017, expenditures have risen sharply even as revenue collection has lagged. The deficit is expected to narrow to around -2.5% of GDP in both 2017 and 2018. In light of recent budgetary trends, we believe that these forecasts are too optimistic.
The external accounts remain in decent shape. Stronger growth in Western Europe has helped exports, while low energy prices and the sluggish economy have helped reduce imports. The current account deficit was about -4% of GDP in both 2015 and 2016, but is expected to widen slightly to -5% in both 2017 and 2018. With FDI near the lows, that means greater dependence on hot money flows to finance the current account gap.
Foreign reserves have continued to fall to new cycle lows. At $85 bln in April, they are the lowest since July 2012. They cover 4 months of import and are only 40% of its stock of short-term external debt. Usable foreign reserves (netting out commercial banks’ FX deposits at the central bank) are even lower, at around $27 bln in April.
The lira continues to underperform. In 2016, TRY fell -17% vs. USD and was behind only the worst performer ARS (-18%). So far in 2017, TRY is -1.1% YTD and is again ahead of only the worst performer ARS (-1.9%). Our EM FX model shows the lira to have VERY WEAK fundamentals, so this year’s underperformance is to be expected.
USD/TRY has traded largely in a narrow 3.50-3.80 range since the end of January. Retracement objectives from the January-April drop come in near 3.67 (38%), 3.7150 (50%), and 3.76 (62%), while the 200-day moving average comes in near 3.4205.
Turkish equities are outperforming after lagging last year. In 2016, MSCI Turkey was up 4% vs. 7% for MSCI EM. So far this year, MSCI Turkey is up 24.4% YTD and compares to 17% YTD for MSCI EM. This outperformance should ebb, as our EM Equity model has Turkey at a NEUTRAL position.
Turkish bonds have outperformed recently. The yield on 10-year local currency government bonds is about -64 bp YTD. This is behind only the best performers Argentina (-149 bp), Indonesia (-92 bp), Russia (-87 bp), Colombia (-77 bp), and Peru (-64 bp). With inflation likely to continue rising and the central bank likely to tighten further, we think Turkish bonds will start underperforming.
Our own sovereign ratings model has Turkey’s implied rating worsening a notch this quarter to BB-/Ba3/BB-. We think Turkey continues to face growing downgrade risks to its BB/Ba1/BB+ ratings.