Istanbul - Turkey’s botched coup and an apparent lurch towards authoritarianism is ratting investors and threatens to throw into reverse the hundreds of billions of dollars that have flowed to this once-booming emerging market. In the years after its 2001-2002 financial crisis, Turkey rode a wave of bullishness towards emerging markets, and while estimates vary, the Institute of International Finance reckons overseas investors poured more than $150 billion into Turkish stock and bond markets since end-2003.
The IIF, one of the most authoritative trackers of capital to and from the developing world, also calculates bricks-and-mortar direct investment (FDI) into Turkish factories and property at $163 billion. Much of that success was down to game-changing reforms by President Tayyip Erdogan’s Islamist-rooted AK Party from 2003. After sweeping privatisations, fiscal discipline and banking reforms, Turkey’s old problems - military coups, soaring debt and crawling growth - seemed firmly consigned to history. Now, suddenly, they may be back.
What’s more, many are unnerved by the ferocity of Erdogan’s response to the coup, with tens of thousands of soldiers, civil servants, judges and academics fired, arrested or suspended in the past week and a state of emergency imposed. There is concern also about economic growth collapsing and surging inflation, as the lira weakens against the dollar. The political shock will complicate Turkey’s fragile balance of payments picture as its $30 billion-plus annual deficit requires a steady inflow of foreign money. “The risk of capital flight remains unless the measures adopted during the state of emergency are revealed clearly,” said Ozlem Derici, chief economist at Deniz Invest in Istanbul. The issue is potentially serious because Turkey’s funding gap is largely plugged with portfolio capital, dubbed “hot money” due to the speed at which it can move between markets.Derici said that Turkey’s investment-grade credit rating, gained only in 2013, was in danger; its loss will drive capital outflows from conservative, rating-constrained funds while making it costlier for companies and banks to raise finance. Aviva and GAM were among foreign investment funds that used Monday’s temporary bounce in the lira to cut back on Turkish holdings, while many banks, including Morgan Stanley, Societe Generale, BNP Paribas and Citi suggested reducing exposure. Others such as Standard Life, Ashmore and Lombard Odier told Reuters they made no changes because their Turkey holdings had already been below its weight in indexes.
Patrick Mange, head of EM strategy at BNP Paribas Investment Partners, has been negative on Turkish assets and plans to leave them in “the underweight box” until there is more clarity. “Turkey’s risk premium is on the rise and there could be repatriation of funds for some time,” Mange said. “When you speak of hot money you speak of something that’s quite volatile and this is one of our worries.”
Turkish stocks, 64% of which are in foreign hands according to official data, had outperformed other emerging markets prior to Friday’s putsch with dollar-based returns in excess of 15%. They have slumped now into the red as both the lira and blue-chip local equities have been whacked. But not everyone sees recent developments as unambiguously negative - asset managers Aberdeen, Baring and Berenberg said recent price falls could represent an opportunity to buy back newly cheap assets, given Turkey’s longer-term potential.
Turkey remains a preferred emerging equity market for UBS Wealth Management which says that share valuations are cheap compared to other emerging markets and already contain a price premium for the risks. That’s reflected in equity risk premia - the excess returns stock market investments offer over government bonds - of 190 basis points, versus a long-term 120 bps average, UBS says.
Many other funds will be cautious however, especially those which do not typically invest in emerging markets but have in recent years been lured into the sector by high bond yields. Such funds often require credits to be rated investment-grade by at least two big ratings agencies. For them, decisions by Fitch and Moody’s agencies next month will be crucial, because a third, rival organisation, S&P Global, already rates Turkey as “junk”. JPMorgan, which runs the most widely used emerging debt indexes, reckons a rating downgrade will force funds to dump around $10 billion worth of Turkish bonds. Over 10% of hard currency Turkish debt would be at risk of forced selling, it added. Of Turkey’s $80 billion-plus lira-denominated bond market, 18.8 percent is in foreign hands, JPM said, and up to $1 billion of this is ratings-sensitive. But even funds with leeway to invest in junk-rated credits may take fright as their holdings are whacked by weakness in the lira. The lira is down 7% this week to around 3.07 per dollar but more weakness is likely ahead - some analysts predict the currency as low as 3.25 per dollar in coming months.