The outcome of Turkey's recent election has left the markets feeling uneasy. Incumbent president Recep Erdogan, known for his expansive policies which have resulted in an alarming 45% annual inflation rate and halved the value of the lira over the past two years, secured over 49% of the first-round vote. This virtually ensures his victory over reform-minded challenger Kemal Kilicdaroglu in the upcoming runoff election in two weeks.
The iShares MSCI Turkey exchange-traded fund (ticker: TUR) experienced a significant decline of more than 7% on Monday, reflecting the market's dissatisfaction with the election results. Additionally, the lira depreciated by half a percentage point against the dollar.
These reactions are not unwarranted. At 69 years old and after two decades in power, Erdogan shows no signs of abandoning his unorthodox belief that high interest rates are the cause of inflation, rather than a means to combat it. Furthermore, his erosion of civil liberties and disregard for Russian sanctions have turned European investors away, thereby depleting their ability to offset Turkey's chronic current account deficits.
Blaise Antin, head of sovereign research at TCW, points out that Turkey's central bank currently holds a record low of -$68 billion in net foreign reserves. Antin explains that Erdogan must either raise interest rates or allow the currency to depreciate further. However, it is unlikely that he will choose to raise rates.
Nonetheless, investors who are willing to take on some risk may find opportunities in the Turkish market. One potentially profitable avenue is through the country's hard-currency bonds, which offer annual yields ranging from 9% to 10%. Antin asserts that the chances of default are low, even with another five years of Erdogan in power. He highlights Turkey's strong repayment history, favorable public debt ratios, and diversified economy as factors that set it apart from other single-B sovereigns offering higher yields.
Another avenue for potential profit is the Turkish lira itself. Over the past six months, the lira has steadily declined, but this decline has been offset by high local interest rates. Senior currency portfolio manager at State Street Global Advisors, Aaron Hurd, reveals that his firm has earned an annualized return of 10% on lira investments this year - a 15% interest carry minus a 5% currency loss. Forward contracts currently project a 30% devaluation of the lira over the next year. Despite this, Hurd remains optimistic, stating that even if the lira were to depreciate by 29%, he would still make a profit. This provides him with some reassurance.
In conclusion, Turkey's election results have left the markets with a sense of concern due to Erdogan's policies and his disregard for economic orthodoxies. However, there are opportunities for investors who are willing to take on some risk, particularly through investing in Turkish hard-currency bonds or leveraging the potential profit of the declining lira.
Turkey's Election Results and the Impact on the Lira
The outcome of the recent Turkish election is expected to have a significant impact on the country's currency, the lira. While a victory for President Erdogan would strengthen the lira in the short term, experts believe that this effect may not last beyond this year.
Under a market-oriented administration led by Kilicdaroglu, it was anticipated that the props used by Erdogan to support the currency, such as forced purchases by state-owned banks, would be removed. As a result, many market analysts had predicted a 15% depreciation of the lira over the summer. However, Erdogan prefers to maintain an image of stability, which has led to a less volatile lira.
Although this temporary stability may provide some relief, there are concerns that it may be short-lived. Experts warn that the lira could once again experience a decline in value in the near future.
Interestingly, while a sinking currency and high inflation are typically unfavorable for stocks, Turkey's intermittent equity rallies have been explosive. In fact, the local stock market doubled in value during the second half of last year as investors saw it as their best option for safeguarding their savings.
Despite the challenges posed by the lira's depreciation, Turkey's export sector has actually benefited from this situation. The decline in the currency's value has made Turkish goods more competitive on the international market, boosting the performance of some exporters. For example, shares in companies like Koc Holding and Ford Otomotiv Sanayi have seen significant gains.
While some investors may be wary of fully investing in Turkey, experts suggest that completely disregarding it may not be wise. According to Steven Schoenfeld, CEO of Market/Vector Indexes, "You might want to underweight Turkey, but not zero it out."
However, it is essential to recognize that the current political landscape in Turkey is far from ideal. A financially stable country that is aligned with the West would be more beneficial for both Turks and the global community.
Nevertheless, for bold investors, there may be silver linings amidst the uncertainty, as long as Erdogan manages to avert a major economic crisis. As James Jeffrey, former U.S. ambassador to Ankara, humorously exclaims, "Turkey is the country of the future economic collapse, and always will be."
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