Turkey is becoming investible again

Turkey is a top 20 global economy with annual GDP in excess of $1 trillion. (Source: Getty Images Europe/Bloomberg)

Whisper it quietly, but Turkey is on the verge of becoming investible again for foreign investors. After years of political interference in its monetary policy, a collapse in the Turkish lira's value over the past five years and a soaring inflation rate, there are promising signs that orthodox financial policies are back in place. The central bank is confident enough to welcome foreigners back into lira bonds, and has signalled an end to the monetary tightening cycle that has seen eight consecutive increases in the official interest rate.

Since President Recep Tayyip Erdogan's narrow re-election last May, there’s been a change in economic governance away from his unconventional view that higher interest rates cause higher inflation.

Fundamental to this new approach was the appointment in June of Finance and Economy Minister Mehmet Simsek for a second tour of duty. A former Wall Street banker, Erdogan fired him in 2018 after nine years in the role, and his return is a big positive for market stability.

Friday’s resignation of central bank Governor Hafize Gaye Erkan, appointed the same month as Simsek with a glittering resume, may have undermined that stability were it not for the caliber of her replacement, Deputy Governor Fatih Karahan. He’s been a member of the central bank’s rate-setting panel since July, and previously worked at the New York Federal Reserve and as a principal economist at Amazon.com Inc., as well as holding teaching positions at Columbia University and New York University. In a statement, the Turkish finance ministry said Erdogan “has full confidence and support in our economy team and our program.”

“While sudden leadership changes bring discomfort for investors, we see the new CBRT Governor as positive for disinflation and lira,” JPMorgan Chase & Co analyst Fatih Akcelik wrote in a note to clients. “We expect high rates for longer along with tighter macroprudential measures.”

Simsek emphasised on Wednesday to the Istanbul Chamber of Industrialists that monetary policy is aimed at anchoring future inflation and that the lira is “quite competitive.” The new approach is starting to work; foreign holdings of Turkish government bonds doubled in December

from an all-time low of just $1 billion. Turkish equity holdings by overseas investors have also plummeted, to less than of 10 percent of the market.

The Turkish central bank has hiked the benchmark one-week repurchase rate interest rates to a staggering 45 percent from 8.5 percent in June. This makes the cost of hedging lira exposure eye-wateringly high; taking advantage of such high interest rates is offset by the prospect of substantial currency losses. The relative scale of that trade may now be turning in foreign investors' favour, according to Bloomberg Economics Turkey economist Selva Bahar Baziki. When the Federal Reserve starts cutting US interest rates, prompting a weaker dollar, it will provide fertile ground for emerging markets that could lead to outsized gains in both the currency and domestic securities markets.

Banks including Deutsche Bank AG, BNP Paribas SA and JPMorgan also predict a turnaround for the lira bond market this year. Economists at Goldman Sachs Group Inc. predict that interest rates could fall by 20 percentage points by the end of the year, a view that’s reflected in a heavily inverted yield curve with 10-year yields below 25 percent.

The central bank's focus is shifting to reducing lira liquidity and supporting the currency, given that the economy still faces major problems. Turkey’s current account swung back into deficit at the end of 2023, a long-standing problem that has been marginally improved by the return of tourism. The government’s budget deficit has ballooned following the costs of two horrendous earthquakes. The central bank's foreign-exchange reserves may have increased by $100 billion in recent months, but it’s almost certainly from a negative base. Turkey adopted a smoke-and-mirrors strategy via state-controlled commercial banks in forward-currency swaps to disguise the true nature of its reserves.

Turkey has the most deeply negative real interest rates in emerging markets, after adjusting for a 65 percent inflation rate. Core price measures are increasing by more than 70 percent, and headline inflation will rise above that before it turns lower. Gross domestic product climbed at a near 6 percent pace in the third quarter, up from 4 percent earlier in the year, but this is still too tepid to dig the nation out of its deficit hole. JPMorgan analysts expect the lira to weaken to 36 versus the dollar by year end from about 30.5 currently, though forward currency rates suggest it could be closer to 40.

The regional elections on March 31 keep the political risks alive, and additional fiscal stimulus in the run up to the polls could exacerbate the dire inflation outlook. But the geopolitical atmosphere is improving after

Erdogan acquiesced to Sweden joining the NATO military alliance. Subsequently, the US greenlit the sale of F-16 fighter jets to Turkey.

Turkey is a top 20 global economy with annual GDP in excess of $1 trillion. It sits at the nexus of Europe and Asia, with a large, aspirant middle class. By rights, it should be on the radar of global portfolio managers — but waiting for all of the clouds to disappear may see the lowest-hanging fruit swiped.

Marcus Ashworth is a Bloomberg Opinion columnist. Views do not represent the stand of this publication. 

Credit: Bloomberg