Turkey's Hot. Nibble at the Edges.
Guessing Erdogan's Next Mood Swing is Tough, But Potentially Rewarding
Turkish assets are not the kind you want to count on for your retirement. The U.S.-traded stock ETF (ticker: TUR) has fallen 7% over the past five years, while global emerging markets nearly doubled. The Turkish lira lost 58% of its value against the dollar. That is, if you put $100 worth of lira in your drawer in February 2016, they would be worth $42 today. It’s hard to make money on a currency like that.
But Turkey’s periodic rallies can be explosive, and we’re in one now. The reasons are not mysterious. President Recep Erdogan, who has run the country since 2003, is a rebel against the “Washington Consensus” of tight money and fiscal discipline that most EMs adopted following their various crises in the 1980s and ‘90s. (Washington itself pays little heed to the Washington Consensus, but that’s another story.)
Erdogan loves to pump credit through his state banks, keep interest rates below the rate of inflation, and generally blow up growth bubbles, especially when elections are pending. These pop periodically as prices spiral out of control and the population moves its savings into dollar/euro accounts, tanking the lira. Then Erdogan sobers up and things get better for a while, at least from investors’ point of view.
Turkey’s latest detox started in early November, when Erdogan fired the lackeys who had been running economic policy, including his own son-in-law as finance minister, and brought in people who actually know what they are doing. TUR has climbed nearly 60% since then and the lira jumped more than 20%. The key has been new central banker Naci Agbal administering gargantuan rate hikes, from a mere 10% to 16.5%. Money folk around the world, fed up with next-to-zero interest at home have figured, well 16.5% is 16.5%. Et voila. “The lira is almost like hard currency now,” raves Tim Ash, who follows Turkey for BlueBay Asset Management in London and is no Erdogan patsy. “Agbal has turned it around single-handedly.”
The problem with 16.5% interest is that it is horribly painful if you happen to own a Turkish business or mortgage, the last thing you need when the country is already walloped by Covid. It can’t “legitimately” be cut until it does its real job of wringing inflation out of the economy. Turkey has had bad luck there. Resurgent prices for oil, the country’s top import, have kept inflation rising even as the monetary noose tightens.
So how long will Erdogan keep delivering the punishment that the market demands? History offers one rough guidepost. After a more acute lira collapse in August 2018, the austerity bout lasted about seven months. The asset rally reversed after five months as investors smelled the president’s resolve weakening.
A few important things are different this time, though. The remedy has not been nearly so extreme; in 2018 Turkish rates went to 24% from less than 10%. Erdogan faced municipal elections in March 2019, an almost irresistible temptation to loosen the financial taps. (He lost the big ones, in Istanbul and Ankara, anyway.) Now the election calendar is mercifully blank until 2023.
There is also a big question over Turkey’s future that has nothing to do with the boss: tourism. Foreign visitors brought a record $35 billion to the beautiful and historic country in 2019, or about 4.5% of gross domestic product. That shrank to near zero last year. If the Covid gods are kind, this summer may see a substantial rebound, which would bolster the all-important lira value. Or not.
There is one key group that doesn’t believe the Turkish turnaround story yet, though: ordinary Turks. They have yet to move their hard currency savings to lira in any significant volume, despite the interest on offer. “Locals are up to their necks in FX,” Ash reports. “It’s going to be slow to reverse.”
So if you have Turkish friends, or a crystal ball on when Europe gets over Covid, you may want to place a strong bet on the Turkish rally. Otherwise, proceed with caution.