Euphoria in Turkish markets over the appointment of former Wall Street bankers to run the country’s finances is yet to resonate with international investors, who want to see if hype over a potential policy U-turn is real before they commit money.
(Bloomberg) — Euphoria in Turkish markets over the appointment of former Wall Street bankers to run the country’s finances is yet to resonate with international investors, who want to see if hype over a potential policy U-turn is real before they commit money.
Stocks and dollar bonds rallied following President Recep Tayyip Erdogan’s re-election on May 28, as rumors surfaced he would appoint Mehmet Simsek, an ex-Merrill Lynch strategist, as his finance minister. The gains accelerated this week as Erdogan on Friday named another former Wall Street banker, Hafize Gaye Erkan, to head the central bank.
The appointments have stirred bets Erdogan is finally abandoning the unorthodox economic policies that are blamed for decimating a once-booming emerging economy, causing galloping inflation and an exodus of foreign investors. Yet the market moves so far are driven largely by local investors, with overseas funds actually using the stock surge to sell $52 million of shares in the week to June 2. They added just $15 million to local bonds, according to central bank data.
Investors have been burnt in the past. Many liken Erdogan’s appointment of Simsek and Erkan to previous episodes when he appeared to signal a truce with markets as in 2020. That ceasefire ended four months later with the sacking of central bank governor Naci Agbal, who had sharply tightened monetary policy. After Agbal’s departure, Erdogan doubled down on policies such as cutting interest rates in the face of double-digit inflation.
“We’ve seen this movie before,” said Thys Louw, a portfolio manager at Ninety One. “The proof will be in the pudding, and the question is, how much leeway they will have?”
Erdogan Picks Market Veteran Simsek as Turkish Finance Chief
Louw has a neutral weighting on Turkish debt and plans to keep it that way until there are clear signs of change. Above all, that depends on whether Erdogan — a self-styled enemy of high borrowing costs — permits the central bank to tighten policy. Despite inflation raging at 40% and domestic loans growing at over 50% annually, Turkish interest rates stand at 8.5%, having been cut by more than 10 percentage points from their peak.
Louw sees Erkan’s appointment as reason to be more optimistic, but added “the jury is still out on whether the commitment will be enough to turn the ship, especially when the ship is so close to the rocks.”
Rate-Hike Test
The return of foreign investment is vital for Turkey, which ran a $48 billion balance of payments deficit last year, or 5.4% of gross domestic product. The gap will widen even further this year, Barclays Plc predicts.
Foreign ownership of Turkish assets dwindled to new lows ahead of the election. Direct investment last year, excluding inflows to real estate, stood at less than 40% of its peak in 2007, according to the Economic Policy Research Foundation of Turkey.
The first test will be the central bank’s June 22 meeting, with JPMorgan Chase & Co. and Barclays seeing a hike of 16.5 percentage points on the table. A move of that scale would be among the biggest by the Turkish central bank since at least 2010. Strategists at Bank of America Corp. wrote Thursday they were ready to go long on the lira — on condition that benchmark rates go to 40%.
“Markets are likely to test the water, implying either more front-loaded policy hikes or faster depreciation,” said Erik Meyersson, chief emerging markets strategist at SEB AB.
A U-turn seems evident at least on the currency, with the central bank scaling back the backdoor interventions that were part of Erdogan’s campaign for exchange-rate stability but drained the central bank’s reserve coffers.
That’s sent the lira to record lows, shedding 11% against the dollar this week, though authorities are still intervening to slow its slide.
Politically Unpalatable
Simsek has pledged a “credible program” to rebuild the $900 billion economy, with “transparency, consistency, accountability and predictability” as his guiding principles.
Many argue Erdogan has no choice this time but to cede financial control to Simsek and Erkan, however unpalatable he may find it. His foreign-exchange interventions have left central bank coffers with usable reserves of just $11 billion, according to Bank of America, or $62 billion below what it says would be considered adequate.
Yet individual ministers may rarely be able to make a difference over the longer-term because the scale of adjustment needed to correct economic imbalances is rarely politically tolerable for Erdogan, according to Peter Kinsella, head of currency strategy at asset manager Union Bancaire Privee UBP SA.
And some painful changes would need to come before municipal elections next March. Inflationary pre-election pledges such as salary and pension increases will also take effect over coming months, making Simsek’s job even harder, said Irina Topa-Serry at AXA Investment Managers.
“The consensus thinking is that Erdogan has to embrace an orthodox policy stance because he has run out of options,” said Kinsella. “As soon as things stabilize, the risk is that he will revert to his old behaviour — as has been the case on every occasion for the last two decades.”
–With assistance from Tugce Ozsoy, Ugur Yilmaz, Kerim Karakaya and Julien Ponthus.
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