Tempting Turkey Assets Push Investors to Assess These Risks

(Bloomberg) -- The case for returning to Turkish assets after this year’s selloff may be growing, but there’s no shortage of risks investors must weigh before taking the plunge in 2018.

The lira hasn’t been this cheap relative to its trade partners in more than a decade, local bonds boast some of the highest nominal yields among major economies and stocks are trading near the widest discount to other emerging markets in more than eight years.

To counter that, inflation is more than double the central bank’s target, relations with western allies are strained and there’s a prospect of early elections, something the ruling AK Party has repeatedly ruled out. Those are among the reasons Turkish assets are among the most vulnerable to shifts in appetite toward emerging markets.

“2018 is going to be another volatile year in Turkish markets,” Per Hammarlund, the chief emerging market strategist at SEB SE in Stockholm, said by email. “Any change in the outlook for global monetary policy will have an outsize impact on Turkish bonds and the lira.”

Here are some events and issues that will be critical for investors looking at Turkey:

Inflation

With price increases running at the fastest pace in 14 years, investors are assessing how serious the central bank is about containing further deterioration.

Authorities expect inflation to slow early in 2018, aided by favorable base effects. Still, the central bank looks past monthly fluctuations, focusing instead on the medium-term outlook, it said on Thursday. With the key rate around 25 basis below headline consumer price growth, investors remain concerned monetary policy is being dictated by political concerns and remains too loose. 

The next big measure of whether the bank is prepared for bold action is its Jan. 18 meeting. JPMorgan Chase Inc. says another 50 basis point increase in likely.

“Foreign investors want to be invested in Turkey, but it is this unfortunate loss of confidence in central bank independence that’s keeping them away,” Simon Quijano-Evans, an emerging-market strategist at Legal & General Investment Management Ltd., said by phone. “Turkish local currency bonds have huge potential for catch up in 2018, but that really needs the central bank to get on top of inflation.”

New York Trial

The high-profile court case of Hakan Atilla, the Turkish banker accused of conspiring to evade U.S. sanctions on Iran, threatens to continue to weigh on Turkish markets as investors fret that revelations in the trial will lead to penalties on the nation’s banks. Turkish officials, including President Recep Tayyip Erdogan, have said the case is an attempt to undermine Turkey’s economy.

“There is the risk that the U.S. imposes fines,” said William Jackson, a senior emerging-market economist at Capital Economics in London. “It is unclear what the likelihood of this is and how big the fines could be. But were they to be imposed, it could hurt the equity market and possibly lead to a pull-back by foreign investors.”

Relations with the West

The trial also threatens to exacerbate tensions between Turkey and its Western allies. Relations deteriorated in 2017 amid criticism over a crackdown on political opponents in the wake of the foiled coup in 2016 and wrangling over policy responses to the Syrian civil war.

While the U.S. eased a visa ban against Turkey imposed after the arrest of some of its consulate staff, its refusal to extradite Fethullah Gulen, a Muslim preacher that Turkey blames for the coup attempt, suggests there may be no quick solution to the standoff between the longtime allies.

For SEB’s Hammarlund, relations with the U.S. and the European Union will continue to be unpredictable. “The Atilla trial may turn out to be less damaging than feared, but the U.S. refusal to extradite Fethullah Gulen, Turkish treatment of U.S. embassy personnel, and the status of Jerusalem could still be sources of friction.”

Local Politics

Early elections could introduce yet another element of uncertainty. While President Erdogan said the government doesn’t have plans to bring forward local and general elections scheduled for 2019, many investors believe that if economic growth remains strong, he will seek to capitalize on that momentum.

“If the economy and his popularity domestically is strong, he may decide some point next year to call an early election and that will introduce political uncertainty and risks for the market,” said Paul Greer, a London-based senior trader of emerging-market debt at Fidelity International.

Growth Pace

The economy is set to slow next year -- and that’s a good thing for Nomura Plc’s London-based economist Inan Demir, who has seen signs of overheating.

A “slowdown can help address the inflation and current-account problems,” he said. “The important point is if the government and policymakers will allow it to slow down or not.”

Turkey’s economy is back on its feet and no longer needs the stimulus program introduced after the coup attempt, a senior adviser to Erdogan said after growth surged to 11.1 percent in the third quarter.

But expectations for new stimulus measures are already growing. QNB Finansbank Chief Executive Officer Temel Guzeloglu has said he expects the limit on the credit guarantee fund, which backstopped a borrowing boom this year, will be increased to 300 billion liras ($78 billion) from over 200 billion liras used so far.

To contact the reporters on this story: Tugce Ozsoy in Istanbul at tozsoy1@bloomberg.net, Constantine Courcoulas in Istanbul at ccourcoulas1@bloomberg.net.

To contact the editors responsible for this story: Celeste Perri at cperri@bloomberg.net, John Viljoen

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