Turkey: off the investor's menu?, August 2018

Turkey is rarely the subject of conversation outside the month of December but, with an escalating economic and currency crisis, the country – not the bird - has been dominating the financial news feeds in recent weeks.

The country's economic challenges are numerous: its economy has been overheating (house prices have more than doubled over the past five years, for example); its companies have borrowed a substantial amount of foreign money; inflation is at 15% and the sizeable current-account deficit is widening as US interest rates rise, to name but a few of the issues.

As a national that straddles eastern Europe and western Asia, how concerned should investors be about the risk of market contagion from Turkey's slump? We asked some experts:

On Turkey:

Paul Greer, portfolio manager, Fidelity International

“While Turkey’s fundamental challenges are numerous, there are plenty of straightforward textbook solutions which, if implemented, could halt the downward spiral of investor confidence and asset prices. An aggressive interest rate rise from the Central Bank would be a good start, and structural reforms would also help a great deal including measures to encourage manufacturing and export sector expansion, diversifying the country’s growth model away from consumption and construction.

“Other useful measures would include tax reform to broaden the revenue base, boosting the country’s savings ratio, a commitment to the genuine independence of the Central Bank and more flexibility in the labour markets. Turkey’s awkward diplomatic relations with The West, and the US in particular, also need to be addressed and remain a deep concern for foreign investors.

“Turkey has many redeeming qualities including a vibrant business-focused economy, strong demographics, a well-educated population and a well-capitalised banking system to name but a few. The solutions to its latest crisis are obvious to many market participants, the key however is whether there is the domestic political willingness from the government to adopt them.”

RWC’s Emerging Markets team

Overall, the current macroeconomic environment does not look encouraging and the country will likely go through a significant period of re-adjustment. At the same time an agreement with the International Monetary Fund will have to result in President Erdogan making a U-turn in international policy in order to improve relations with the United States and Europe.

Our fund, which is on the Chelsea Core Selection, has maintained a limited allocation to Turkey throughout 2018. The average fund weight has been 1.2% since the start of the year and has been specifically focused on companies that we believe possess strong pricing power, that are able to pass on inflationary pressures to their customers and therefore grow their earnings in real terms.

“Turkcell, the leading telecom operator in Turkey, is a good example of this. The company has a superior network position and a clear strategy of developing and monetising innovative digital services which allows it to profitably capitalise on the trend of increasing mobile data usage. On its existing subscriber base of 37.6m, the company is adding 500,000 new customers each quarter and, thanks to its high quality network and digital portfolio, it is seeing strong growth in average-revenue-per-user. The company is highly cash generative and trades at a substantial valuation discount to global telecom operators, despite exhibiting a faster growth profile.

On possible contagion in Europe:

Julian Chillingworth, chief investment officer, Rathbones

“We don't think the troubles in Turkey will snowball into a wider emerging markets crisis, such as the one that hit Asia in the 1990s. Most other developing nations have much healthier fundamentals. However, the European Central Bank says it has been monitoring Continental banks’ exposure to the country: Spanish banks in particular appear to be holding a lot of Turkish debt – roughly a quarter of bank capital and reserves. French and Dutch banks also hold a solid amount. If they take heavy losses on these loans it may lead to another European banking crisis through the backdoor. For now, investors will be scrambling to determine whether these loans were made to well-capitalised Turkish banks and blue chips or to entities of a much lower calibre.

Christopher Smart, head of Barings' macroeconomic and political research team

“Our analysis suggests that the Turkish government has enough money to pay any of its own debts coming due over the next few years and most large banks and firms should be able to meet their debt obligations under current conditions. The currency depreciation will inflict balance sheet losses and likely tilt the economy into recession at some point.

“However, Europe's overall exposure appears relatively small. Eurozone exports to Turkey amount to about 1.5% of total exports, which limits the likely damage to European growth. In terms of European bank exposure, Spain's BBVA has the largest vulnerability while Unicredit, ING, BNP and HSBC also face losses. But most estimates of Europe's aggregate lending exposure to Turkey are less than 1% of European GDP.”

On possible contagion in Asia:

Sriyan Pietersz, investment strategist at Matthews Asia (Matthews Asia Pacific Tiger is on the Chelsea Core Selection)

“Turkey's problems appear idiosyncratic and while its woes have sparked short-term volatility in emerging markets, the probability of a long-term impact is low. There are three potential channels of contagion: trade, banking sector exposure and capital flows. Emerging ASEAN and India's exposure to Turkey is small via the first two channels of trade.

“Indonesia, India, and the Philippines, are perceived as being more exposed to a slowdown in capital flows and, in response, central banks have raised interest rates. Higher interest rates may involve forfeiting some growth for the sake of stability, but it is worth noting that India, the Philippines and Indonesia are among the fastest-growing countries in Asia with GDP growth rates in the range of 5.3% to 7.7%.

“Asia could benefit from reallocation flows within emerging markets as investors move away from more vulnerable economies such as Turkey, South Africa and Argentina. We believe Asian market volatility offers investors the opportunity to build positions in ASEAN and India, in economies where fundamentals have improved over the past five years and a new domestic-driven growth cycle is commencing.”

Past performance is not a reliable guide to future returns. You may not get back the amount originally invested, and tax rules can change over time. The views of the people quoted are their own and do not constitute financial advice.

Published on 28/08/2018