A Capitulation Indicate Inward Turkey?
August 15, 2018
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If the media too financial marketplace consensus is to live believed, Turkey is currently inward the midst of a veritable financial crisis. Yet inward truth, in that location is no such crisis at introduce - at to the lowest degree non yet - too although 1 is for certain possible, that outcome is far from assured. What nosotros genuinely receive got at the 2nd is merely a crisis of confidence (and, perhaps, inward domestic civil/political liberties), too for the former, is 1 that may already live unopen to peaking. While it is impossible to definitively telephone phone whatever sort of capitulation point, the below nautical chart of the USD/TRY for certain appears to betoken to me that nosotros are either at or real unopen to the proverbial capitulation point.
It is hard to observe a unmarried media article at the 2nd that has anything at all positive to say on Turkey - the narrative is instead profoundly too unrelentingly negative. This is frequently an first-class opposite indicator. Indeed, the coverage is so one-sided at introduce that it is piffling wonder leaders of sometimes-rogue nations such every bit Turkey's are occasionally mislead into thinking in that location is some form of Western conspiracy at play attempting to engineer the country's downfall.
The truth is that, similar whatever complex issue, careful, nuanced, too balanced thinking is required, too every bit is frequently the case, in that location are 2 sides to every story. This does non hateful many of the concerns popularly referenced almost Turkey are incorrect or invalid - it is just that they don't tell the total story.
Background to the electrical current malaise
So what the hell is going on inward Turkey? In curt - believe it or non - the root motility of the work is that province has been growing also fast (for the comfort of financial markets). Turkey's economic scheme grew almost 7% final yr - amongst the fastest inward the terra firma - although is already sharply slowing. This has created concerns because Erdogan has insisted on keeping the gas-pedal firmly to the floor, too has shown a too-relaxed mental attitude towards controlling inflation too rising external imbalances. Pointedly, he has resisted the implementation of drastically tighter monetary policy. Inflation, which averaged an already-elevated high-single-digits over the yesteryear decade, has of late increased to 15%. These pressure level points are also beingness exacerbated yesteryear a strengthening USD, rising rates too tightening dollar liquidity.
Erdogan has non helped matters yesteryear arguing that the key to battling inflation is lower rates, non higher rates - something that has farther undermined confidence - peculiarly because Erdogan's recent efforts to entrench himself inward powerfulness volition brand his removal difficult, fifty-fifty if he steers the province into the proverbial abyss. Erdogan has also of late used his strengthened travelling steal on powerfulness to appoint relatives too those sympathetic to his views to of import financial posts (notably his son-in-law every bit the government minister of finance), too cardinal depository financial establishment independence is directly also widely believed to receive got been undermined/politicised. A hyperinflationary doom loop is feared.
In addition, rapid economical growth over the yesteryear decade has resulted inward an increment inward the country's all-important electrical current concern human relationship deficit to 6% of GDP, every bit good every bit the accumulation of corporate unusual indebtedness of some 30-40% of GDP. Reflecting this sizable too persistent electrical current concern human relationship deficit, Turkish depository financial establishment LDRs (loan to deposit ratios) are mostly inward the 110-140% attain - below the 100% comfort even out - too banks so receive got some reliance on international wholesale funding markets to comprehend the gap. If access to these markets were to live all of a abrupt cutting off, a domestic credit compaction could live triggered every bit banks scramble to shore-up liquidity to repay maturing wholesale funding lines. In addition, corporates could create produce to repay foreign-denominated debt, causing a surge inward non-performing loans too bond defaults. Analogies to the Asian Financial Crisis inward 1997-98 appear stark.
Furthermore, Erdogan's increasingly autocratic tendencies too the undermining of domestic liberal democratic norms has also rattled confidence - peculiarly due to Erdogan's background every bit an Islamist - every bit he has pushed to undermine Turkey's hitherto secular formal institutions too values. Recently, headlines were made after Turkey detained a US of America pastor every bit well, too refused to repatriate him dorsum to the US. This has provoked diplomatic sanctions from the US, too may also receive got contributed to Turkey beingness singled out for higher aluminium too steel import tariffs yesteryear Trump inward recent days every bit well. All these negative headlines receive got added to the pervasive feel of malaise.
The work with the media
The work with the media is that it frequently presents a real unrepresentative catch of what is genuinely going on, too promotes an accentuated focus on isolated or close term events that several years from directly volition live long forgotten. Sensational headlines catch eyeballs, but they don't necessarily reverberate reality inward an impartial, balanced way. An obvious illustration is the fact that the incidence of vehement offense has halved inward most places inward the terra firma over the yesteryear 20yrs, too yet the media reportage of vehement offense has remained the same. Consequently, many people's perception of the incidence of vehement offense is out of line with the reality. Many people also fearfulness expiry yesteryear terrorist laid on or bird crash to a greater extent than than they produce cancer or a motorcar accident - a statistical irrationality that reflects biased media reporting.
Failure is also frequently to a greater extent than spectacular than success. Success is frequently a long, drawn out procedure of incremental improvement sustained over a long catamenia of time, whereas failures, accidents, or setbacks tin frequently live abrupt too dramatic. Human beings are also risk averse too so are attuned to pay attending to danger. This is why the media is total of stories almost civil wars, illness outbreaks, financial turmoil, vehement offense too terrorism, despite the fact that the terra firma has been getting steadily richer too safer, too nosotros receive got seen a tape decline inward poverty too illness over the yesteryear 20-30 years.
Media coverage tin also resultant inward narratives beingness taken to the extreme, every bit echo-chambers develop. Turkey is a acre of 80m people, most of whom teach upward every day, buy the farm to work, too run businesses. The long term value of all this economical activity is non all of a abrupt impaired yesteryear 5-10% due to the US of America protesting the detention of 1 US of America pastor (something that tanked the currency too Turkish markets to just about that degree). That is zilch but dissonance inward the broader scheme of things, too it promotes a focus on relatively trivial issues to the neglect of the bigger picture.
The best way to counter this biased narrative is to facial expression at the raw facts/data, too to consider the counter-arguments. I receive got attempted to produce so below. It doesn't hateful the bearish narrative volition bear witness incorrect - it simply agency that it might prove wrong, which is a fundamental difference. Importantly, I receive got non seen whatever of these arguments appear inward a unmarried widely-circulated media article or commentary/analysis on Turkey of late. This fact solitary suggests to me Turkey is probably oversold.
So why are markets (potentially) wrong?
Financial crises almost invariably require the banking organization to buy the farm insolvent or illiquid. Without depository financial establishment failures, it's non genuinely a crisis - just (at worst) a patently vanilla recession. So what are some of the pertinent facts with honour to the Turkish banking sector?
Firstly, Turkey's banks currently receive got relatively good for you lot working capital alphabetic character ratios too high levels of organic profitability. Despite the putative crisis (albeit that the total bear upon is yet to live felt), most booked tape profits inward 2Q18, solid asset character trends, too buy the farm on to pay good for you lot dividends. Furthermore, importantly, many of the largest, most systemically of import Turkish banks are backed yesteryear strong shareholders - many of whom are also of import sources of related-party wholesale financing. Turkiye Garanti Bankasi, for instance, is bulk owned yesteryear Spain's BBVA, who has provided them with wholesale funding lines, spell Yapi Kredi is bulk owned yesteryear Italy's UniCredit too domestic conglomerate KC Holdings. The latter is inward a internet cash seat at the asset society level, too Unicredit too KC receive got of late already injected additional working capital alphabetic character into Yapi. BBVA has already publicly stated that it has no concerns almost Garanti's financial condition.
One of the primary vulnerabilities of the banks comes from their high LDRs (loan to deposit ratios) - frequently inward the 110-130% range. However, close term maturities of international wholesale financing are non significant, too noted, several banks receive got the capacity to tap wholesale lines from their European parents (most of whom receive got also much liquidity). The crisis would only introduce if those parents pulled their wholesale lines, but why would they? LDRs also produce non include shareholders equity - the most stable cast of financing of all. LDRs autumn materially when equity is included amongst deposits.
Another vulnerability is that currency depreciation volition increment banking organization RWAs (risk-weighted assets) every bit Fx loans are redenominated into lira. Set against a relatively stable working capital alphabetic character base, this volition potentially pressure level working capital alphabetic character ratios. However, a lot of the Turkish banks receive got working capital alphabetic character buffers (as good every bit Fx hedges) which volition assist mitigate the impact, too it's non yet clear where the lira volition settle after electrical current financial panic recedes. And inward a worst case, working capital alphabetic character raisings ought to live possible, given the strong financial status of both the largest banks too their key shareholders.
Lastly (with honour to the banks), what almost the repayability of foreign-denominated debt lent to their customers? That remains to live seen. However, much depends on who it was lent to (exporters or domestic-focused businesses?), too how much of it is hedged. The gross exposure of 30-40% of gross domestic product almost never has netted from it the even out of hedged borrowings, including natural hedges that come upward from offshore revenues. Turkey is a meaning exporter into Europe (and has many real competitive, good run companies operating inward the export space), too many of the country's largest listed companies who receive got foreign-currency borrowings receive got either meaning export revenues and/or fabric hedges inward house against existing debt (or unusual debt levels that are relatively depression compared to the inwardness cash-flows of their domestic businesses). Opacity hither is high, but it is at to the lowest degree possible that fears of massive defaults are overstated. In short, in that location is a decent risk Turkey's major banks non only live the cycle, but arrive through profitably every bit well.
This is peculiarly the illustration because the leverage of many of the Turkish banks is genuinely quite low, too their even out of inwardness profitability quite high. Turkiye Garanti Bankasi, for instance, is leveraged only 7x (vs. closer to 15-20x inward the developed world), too its annual pre-provision operating profits are 6.5% of its loan book. The society could in that location write off almost 20% of its loan volume over 3 years too nevertheless operate at pause fifty-fifty levels. The society has also been reducing its Fx lending for the yesteryear 5 years. Asset character harm volition receive got to live grave indeed to imperil its survival.
Moving on, what almost Turkey's (perceived) lack of willingness to tighten domestic monetary policy? Quickly forgotten has been the fact that the cardinal depository financial establishment tightened yesteryear 600bp inward April, too curt rates are currently 17.75%. That's non just loose, too it is nevertheless higher upward the charge per unit of measurement of inflation (i.e. existent rates are nevertheless positive). Market's reacted inward July to the cardinal depository financial establishment keeping rates apartment every bit if they had aggressively cut. And yet what politico anywhere inward the terra firma would wish to hammer the electorate too domestic economic scheme with significantly higher involvement rates than are strictly necessary?
What frequently happens inward markets is that complex issues are distilled downwards into a simpler, proxy issue. Instead of looking at it inward a balanced way, people volition say: (1) no July hike = no cardinal depository financial establishment independence too coming hyperinflation = sell; too (2) a hike = cardinal depository financial establishment independent too currency stability = buy. In reality, the province of affairs is non that dark too white. As noted, existent rates are already positive, too investors are paying no regard to domestic political realities, including the genuine hardship significantly higher rates volition impose on domestic households too businesses.
We saw the hypocrisy of the West quite starkly during the GFC - during its ain crisis, the West refused to swallow the same medicine it had happily prescribed to emerging countries over the prior decades. Rather than implementing financial austerity too high existent rates that exacerbate economical weakness too create a punishing recession, every bit the International Monetary Fund has routinely required emerging countries inward tough times to do, the West cutting rates to zero, printed money, too engaged inward massive financial stimulus. Compared to the western response, what Turkey has done is child's play - they receive got 'only' hiked rates an emergency 600bp! It's different, it seems, when the shoe is on the other foot, because Western commentators are to a greater extent than aware of (and empathetic to) the actual suffering caused to people yesteryear severe recessions too chore losses (and the political realities of that). There is a fairly callous disregard of that when it is other countries experiencing the pain, too an apparent ignorance of domestic political constraints.
What almost Ergodan's unrelenting wish to 'go for growth'? Only a few years ago, the terra firma was gripped with a fearfulness of inadequate demand too hence deflation. The terra firma was 'turning Japanese', investors feared. Now markets are terrified of Turkey's excess demand. Any sort of imbalance is seen every bit a motility for certain, impending doom, instead of simply beingness an imbalance. It calls to heed Peter Lynch's bright observation almost market's frequent vogue towards 'glass is one-half full' macro fears - 1 hateful solar daytime markets are worried fossil oil prices are going upward so nosotros are going to receive got a recession, too the adjacent hateful solar daytime markets are worried fossil oil prices are going downwards so nosotros are going to receive got recession!
Markets would prefer Turkey grew at 3% with 5% inflation than at 6% with 10% inflation, too yet both outcomes teach you lot to the same house - 1 simply twice every bit fast every bit the other (two years for the former, 1 yr for the latter). This highlights a profound work of 'framing'. Inflation is important, too all else constant, is a negative, but it is non the only thing that matters.
In addition, inflation is currently beingness exacerbated yesteryear a weakening lira (imported inflation) too rising fossil oil prices - pressures that volition recede inward fourth dimension if too when the lira stabilises. Imported inflation has a much greater bear upon on emerging marketplace inflation rates than inward the developed world, every bit developed economies receive got a higher percentage of gross domestic product comprised of domestic services, where prices are mostly unresponsive to currency movements, every bit compared to tradeables (food, energy, etc). Brazil's inflation, for instance, brutal from 11% to 2% during 2016-18 every bit the Real stabilised too recovered.
What almost Erdogan's insistence that lower rates are the key to lower inflation? Inflation is the resultant of aggregate demand exceeding aggregate supply, so inward truth in that location are genuinely 2 ways to preserve inflationary pressures - lower demand or increase supply. Aggressive investment to address provide shortfalls is a legitimate long term way to fight inflation, too affordable funding is essential to the maintenance of high rates of investment. By contrast, crunching demand is the best short term way to fight inflation. Most financial marketplace participants only attention almost the curt term, so it is clear what they would prefer. However, for somebody with a long-term travelling steal on powerfulness too whose legitimacy with the electorate rests on his hope to boost living standards, it is understandable why Erdogan would prefer to lean towards a supply-side rather than demand-side solution.
What almost US of America sanctions? Quite frankly, I run across the US of America response to the detention of a US of America pastor every bit punitive too hard to justify. How would the US of America react if the US of America arrested a Turkish muslim cleric inward the US, too Turkey demanded his liberate too render forthwith, too threatened harsh sanctions for non-compliance. The US of America would say, 'screw you lot - this is our province too nosotros brand our ain rules too produce what nosotros like, cheers real much'. No 1 likes beingness bossed around too Erdogan's defiant response is alone understandable - indeed real much the human norm inward the human face upward of a unusual civilisation trying to forcefulness you lot to acquit they way they would similar you lot behave. The US of America has no jurisdiction to forcefulness other countries to implement policies too laws that they deem satisfactory.
Trump's announced additional tariffs on Turkish steel too aluminium imports are also ill-conceived too hard to justify. While it is understandable that the US of America may seek to answer to 'competitive devaluation' of currencies to commencement US of America tariffs with higher tariffs still, this policy is wholly unjustified inward the illustration of Turkey. This is because (1) the lira is falling due to marketplace forces, non policy intervention (indeed, the Turkish regime produce non wish the lira to fall); too (2) because Turkey has its ain imbalances to correct, inward the cast of merchandise too electrical current concern human relationship deficits, rather than mercantilist surpluses.
This sort of US of America unilateralism - next on the heels of merchandise policies too its withdrawal from the Islamic Republic of Iran nuclear deal, risks a backlash from traditional allies such every bit Europe, which mightiness good side with Turkey. Erdogen's response that 'you're trading a NATO ally for a pastor' is quite pointed. Irrespective, Turkey's exports to the US of America are relatively limited - Turkey exports mostly into Europe - so these headlines are mostly just that - headlines.
And lastly, what almost Erdogan's increasingly authoritarian regime? In truth, from an investing/financial perspective, illiberal political regimes only affair from the perspective that it is to a greater extent than hard to take ineffectual leaders from power. This is a major number if you lot are a citizen of a country, every bit the stakes are real high, but every bit an investor, you lot tin accept your losses too displace on.
From the dot of catch of economic science too investment, what genuinely matters is non the cast of political representation, but what actual economical policies teach implemented, too autocracies genuinely savor some advantages inward this honour every bit they tin (1) implement policies rapidly without needing to win a broad-based coalition of back upward that caters to minority constituencies (such every bit the environmental lobby); too most importantly (2) they tin retrieve long term. The major failing of democracies is that they promote curt term, populist policies that are focused on winning elections, too long term planning/leadership is frequently lacking. PRC has demonstrated what tin live achieved with an powerfulness to implement policies quickly, decisively, too with long term planning inward mind.
Erdogan's legitimacy also rests mostly on his economical accomplishments. Since coming to powerfulness inward the early on 2000s, Turkey's economic scheme has grown considerably too the average Turk is much amend off economically than they were xx years ago. This probable lies behind Erdogan's 'go for growth' policies. This is important, every bit inward the long term, interests are aligned betwixt investors, the citizenry, too Erdogan's political career. There is every possibility Turkey's economic scheme outperforms expectations over the adjacent 10 years every bit a result.
And this is before mentioning the positives?
Furthermore, all of the higher upward arguments - none of which I receive got seen characteristic inward a unmarried media article - are simply potential refutations/balancing points that counter the negative narrative. Notable is that they don't fifty-fifty address whatever of the potential positives inward Turkey.
The Lira, on a PPP (purchasing powerfulness parity) basis, was already inexpensive at 3.5 to the USD. A expert friend of mine travelled to Istanbul before this yr too was amazed at how modern the house was; how efficient the infrastructure; too how remarkably inexpensive the cost of living was. The currency is directly at 7.0 - twice every bit inexpensive again! A inexpensive currency too the meaning recent depreciation is going to live a meaning economical stimulus to the Turkish economy, which has a large export sector focused on selling into the European Union (an export market, yesteryear the way, where the economic scheme continues to produce relatively well), too also a growing tourism industry. An undervalued currency is probable to contribute to a meaning decline inward the electrical current concern human relationship deficit inward coming quarters, too a booming export sector.
Also neglected to yell is the fact that a lot of Turkey's electrical current concern human relationship deficit has gone into financing infrastructure too other productive activities. It is 1 thing to borrow for consumption; it is quite some other to borrow to invest, too it is genuinely non clear why it ought to live considered such a profound negative for a rapidly growing, working capital alphabetic character hungry province to run a electrical current concern human relationship deficit. Investors are focusing only on the visible imbalances (foreign borrowing), spell ignoring all the productivity-boosting investments that borrowing has enabled. The electrical current concern human relationship deficit has also of late been inflated yesteryear higher fossil oil prices, but if fossil oil prices buy the farm on to moderate from recent levels of US$80/bbl, this volition also assistance Turkey's external imbalances.
Lastly, so far at least, Turkey has non resorted to working capital alphabetic character controls or trying to peg the lira too preclude its depreciation, every bit emerging marketplace nations experiencing liquidity stresses too unusual currency turmoil are sometimes wont to do. This toleration of 'exchange charge per unit of measurement flexibility' is a huge positive. Furthermore, despite all the criticism Erdogan's eccentric views on involvement rates receive got garnered, every bit good every bit some of his recent appointments, both the stated economical policy goals of Turkey, every bit good every bit what they receive got genuinely implemented to appointment (rather than simply talked about), genuinely accommodate much to a greater extent than closely to orthodoxy than the impression the pop press would receive got 1 believe.
Conclusion - so what now?
A recession is belike coming inward Turkey, too a crisis is also far from impossible. But despite the unequivocation beingness expressed yesteryear markets, the truth is that neither outcome is assured - peculiarly the latter. Markets receive got predicted nine out of the final iv recessions, so the saying goes, too faux alarms are common. With that said, Turkey's imbalances are peculiarly high; its policy response unpredictable; too the Fed is also tightening liquidity, so disaster is for certain possible. Events are also somewhat path dependent. It so remains to live seen how things play out, too similar most complex phenomena/systems, defies hard predictions.
So is this a buying opportunity? In my opinion, yes, even though nosotros don't yet know what the outcome volition live too meaning losses are quite possible, because inward my sentiment the probabilities are beingness mispriced on concern human relationship of an excessively one-sided narrative. When people are only focusing on the negatives, the probability of investors/commentators beingness positively surprised is significantly greater. Given the sentiment extremes that currently prevail, it probable volition non accept much for the lira to recover 10-20% - fifty-fifty a 100bp cardinal depository financial establishment hike at this dot mightiness good produce the trick. You would receive got to imagine that they volition live seriously considering implementing at to the lowest degree a token hike at introduce given the events of the yesteryear few days. And fifty-fifty if they don't, meaning existent currency depreciation volition probable shrink the electrical current concern human relationship deficit anyway, which volition facilitate greater currency stability.
There are a lot of good managed companies inward Turkey, including several well-run banks, too in that location is a expert risk many of them non only survive, but genuinely thrive inward coming years. I receive got been accumulating shares inward Turkiye Garanti Bankasi, KC Holdings, too Turkcell, inward recent sessions, too receive got a combined portfolio exposure to Turkey of almost 2.5-3.0% at present.
LT3000
Disclaimer: None of the higher upward should live construed every bit investment advice or an investment recommendation. Please produce your ain inquiry too consult your financial adviser before taking whatever investment action.
It is hard to observe a unmarried media article at the 2nd that has anything at all positive to say on Turkey - the narrative is instead profoundly too unrelentingly negative. This is frequently an first-class opposite indicator. Indeed, the coverage is so one-sided at introduce that it is piffling wonder leaders of sometimes-rogue nations such every bit Turkey's are occasionally mislead into thinking in that location is some form of Western conspiracy at play attempting to engineer the country's downfall.
The truth is that, similar whatever complex issue, careful, nuanced, too balanced thinking is required, too every bit is frequently the case, in that location are 2 sides to every story. This does non hateful many of the concerns popularly referenced almost Turkey are incorrect or invalid - it is just that they don't tell the total story.
Background to the electrical current malaise
So what the hell is going on inward Turkey? In curt - believe it or non - the root motility of the work is that province has been growing also fast (for the comfort of financial markets). Turkey's economic scheme grew almost 7% final yr - amongst the fastest inward the terra firma - although is already sharply slowing. This has created concerns because Erdogan has insisted on keeping the gas-pedal firmly to the floor, too has shown a too-relaxed mental attitude towards controlling inflation too rising external imbalances. Pointedly, he has resisted the implementation of drastically tighter monetary policy. Inflation, which averaged an already-elevated high-single-digits over the yesteryear decade, has of late increased to 15%. These pressure level points are also beingness exacerbated yesteryear a strengthening USD, rising rates too tightening dollar liquidity.
Erdogan has non helped matters yesteryear arguing that the key to battling inflation is lower rates, non higher rates - something that has farther undermined confidence - peculiarly because Erdogan's recent efforts to entrench himself inward powerfulness volition brand his removal difficult, fifty-fifty if he steers the province into the proverbial abyss. Erdogan has also of late used his strengthened travelling steal on powerfulness to appoint relatives too those sympathetic to his views to of import financial posts (notably his son-in-law every bit the government minister of finance), too cardinal depository financial establishment independence is directly also widely believed to receive got been undermined/politicised. A hyperinflationary doom loop is feared.
In addition, rapid economical growth over the yesteryear decade has resulted inward an increment inward the country's all-important electrical current concern human relationship deficit to 6% of GDP, every bit good every bit the accumulation of corporate unusual indebtedness of some 30-40% of GDP. Reflecting this sizable too persistent electrical current concern human relationship deficit, Turkish depository financial establishment LDRs (loan to deposit ratios) are mostly inward the 110-140% attain - below the 100% comfort even out - too banks so receive got some reliance on international wholesale funding markets to comprehend the gap. If access to these markets were to live all of a abrupt cutting off, a domestic credit compaction could live triggered every bit banks scramble to shore-up liquidity to repay maturing wholesale funding lines. In addition, corporates could create produce to repay foreign-denominated debt, causing a surge inward non-performing loans too bond defaults. Analogies to the Asian Financial Crisis inward 1997-98 appear stark.
Furthermore, Erdogan's increasingly autocratic tendencies too the undermining of domestic liberal democratic norms has also rattled confidence - peculiarly due to Erdogan's background every bit an Islamist - every bit he has pushed to undermine Turkey's hitherto secular formal institutions too values. Recently, headlines were made after Turkey detained a US of America pastor every bit well, too refused to repatriate him dorsum to the US. This has provoked diplomatic sanctions from the US, too may also receive got contributed to Turkey beingness singled out for higher aluminium too steel import tariffs yesteryear Trump inward recent days every bit well. All these negative headlines receive got added to the pervasive feel of malaise.
The work with the media
The work with the media is that it frequently presents a real unrepresentative catch of what is genuinely going on, too promotes an accentuated focus on isolated or close term events that several years from directly volition live long forgotten. Sensational headlines catch eyeballs, but they don't necessarily reverberate reality inward an impartial, balanced way. An obvious illustration is the fact that the incidence of vehement offense has halved inward most places inward the terra firma over the yesteryear 20yrs, too yet the media reportage of vehement offense has remained the same. Consequently, many people's perception of the incidence of vehement offense is out of line with the reality. Many people also fearfulness expiry yesteryear terrorist laid on or bird crash to a greater extent than than they produce cancer or a motorcar accident - a statistical irrationality that reflects biased media reporting.
Failure is also frequently to a greater extent than spectacular than success. Success is frequently a long, drawn out procedure of incremental improvement sustained over a long catamenia of time, whereas failures, accidents, or setbacks tin frequently live abrupt too dramatic. Human beings are also risk averse too so are attuned to pay attending to danger. This is why the media is total of stories almost civil wars, illness outbreaks, financial turmoil, vehement offense too terrorism, despite the fact that the terra firma has been getting steadily richer too safer, too nosotros receive got seen a tape decline inward poverty too illness over the yesteryear 20-30 years.
Media coverage tin also resultant inward narratives beingness taken to the extreme, every bit echo-chambers develop. Turkey is a acre of 80m people, most of whom teach upward every day, buy the farm to work, too run businesses. The long term value of all this economical activity is non all of a abrupt impaired yesteryear 5-10% due to the US of America protesting the detention of 1 US of America pastor (something that tanked the currency too Turkish markets to just about that degree). That is zilch but dissonance inward the broader scheme of things, too it promotes a focus on relatively trivial issues to the neglect of the bigger picture.
The best way to counter this biased narrative is to facial expression at the raw facts/data, too to consider the counter-arguments. I receive got attempted to produce so below. It doesn't hateful the bearish narrative volition bear witness incorrect - it simply agency that it might prove wrong, which is a fundamental difference. Importantly, I receive got non seen whatever of these arguments appear inward a unmarried widely-circulated media article or commentary/analysis on Turkey of late. This fact solitary suggests to me Turkey is probably oversold.
So why are markets (potentially) wrong?
Financial crises almost invariably require the banking organization to buy the farm insolvent or illiquid. Without depository financial establishment failures, it's non genuinely a crisis - just (at worst) a patently vanilla recession. So what are some of the pertinent facts with honour to the Turkish banking sector?
Firstly, Turkey's banks currently receive got relatively good for you lot working capital alphabetic character ratios too high levels of organic profitability. Despite the putative crisis (albeit that the total bear upon is yet to live felt), most booked tape profits inward 2Q18, solid asset character trends, too buy the farm on to pay good for you lot dividends. Furthermore, importantly, many of the largest, most systemically of import Turkish banks are backed yesteryear strong shareholders - many of whom are also of import sources of related-party wholesale financing. Turkiye Garanti Bankasi, for instance, is bulk owned yesteryear Spain's BBVA, who has provided them with wholesale funding lines, spell Yapi Kredi is bulk owned yesteryear Italy's UniCredit too domestic conglomerate KC Holdings. The latter is inward a internet cash seat at the asset society level, too Unicredit too KC receive got of late already injected additional working capital alphabetic character into Yapi. BBVA has already publicly stated that it has no concerns almost Garanti's financial condition.
One of the primary vulnerabilities of the banks comes from their high LDRs (loan to deposit ratios) - frequently inward the 110-130% range. However, close term maturities of international wholesale financing are non significant, too noted, several banks receive got the capacity to tap wholesale lines from their European parents (most of whom receive got also much liquidity). The crisis would only introduce if those parents pulled their wholesale lines, but why would they? LDRs also produce non include shareholders equity - the most stable cast of financing of all. LDRs autumn materially when equity is included amongst deposits.
Another vulnerability is that currency depreciation volition increment banking organization RWAs (risk-weighted assets) every bit Fx loans are redenominated into lira. Set against a relatively stable working capital alphabetic character base, this volition potentially pressure level working capital alphabetic character ratios. However, a lot of the Turkish banks receive got working capital alphabetic character buffers (as good every bit Fx hedges) which volition assist mitigate the impact, too it's non yet clear where the lira volition settle after electrical current financial panic recedes. And inward a worst case, working capital alphabetic character raisings ought to live possible, given the strong financial status of both the largest banks too their key shareholders.
Lastly (with honour to the banks), what almost the repayability of foreign-denominated debt lent to their customers? That remains to live seen. However, much depends on who it was lent to (exporters or domestic-focused businesses?), too how much of it is hedged. The gross exposure of 30-40% of gross domestic product almost never has netted from it the even out of hedged borrowings, including natural hedges that come upward from offshore revenues. Turkey is a meaning exporter into Europe (and has many real competitive, good run companies operating inward the export space), too many of the country's largest listed companies who receive got foreign-currency borrowings receive got either meaning export revenues and/or fabric hedges inward house against existing debt (or unusual debt levels that are relatively depression compared to the inwardness cash-flows of their domestic businesses). Opacity hither is high, but it is at to the lowest degree possible that fears of massive defaults are overstated. In short, in that location is a decent risk Turkey's major banks non only live the cycle, but arrive through profitably every bit well.
This is peculiarly the illustration because the leverage of many of the Turkish banks is genuinely quite low, too their even out of inwardness profitability quite high. Turkiye Garanti Bankasi, for instance, is leveraged only 7x (vs. closer to 15-20x inward the developed world), too its annual pre-provision operating profits are 6.5% of its loan book. The society could in that location write off almost 20% of its loan volume over 3 years too nevertheless operate at pause fifty-fifty levels. The society has also been reducing its Fx lending for the yesteryear 5 years. Asset character harm volition receive got to live grave indeed to imperil its survival.
Moving on, what almost Turkey's (perceived) lack of willingness to tighten domestic monetary policy? Quickly forgotten has been the fact that the cardinal depository financial establishment tightened yesteryear 600bp inward April, too curt rates are currently 17.75%. That's non just loose, too it is nevertheless higher upward the charge per unit of measurement of inflation (i.e. existent rates are nevertheless positive). Market's reacted inward July to the cardinal depository financial establishment keeping rates apartment every bit if they had aggressively cut. And yet what politico anywhere inward the terra firma would wish to hammer the electorate too domestic economic scheme with significantly higher involvement rates than are strictly necessary?
What frequently happens inward markets is that complex issues are distilled downwards into a simpler, proxy issue. Instead of looking at it inward a balanced way, people volition say: (1) no July hike = no cardinal depository financial establishment independence too coming hyperinflation = sell; too (2) a hike = cardinal depository financial establishment independent too currency stability = buy. In reality, the province of affairs is non that dark too white. As noted, existent rates are already positive, too investors are paying no regard to domestic political realities, including the genuine hardship significantly higher rates volition impose on domestic households too businesses.
We saw the hypocrisy of the West quite starkly during the GFC - during its ain crisis, the West refused to swallow the same medicine it had happily prescribed to emerging countries over the prior decades. Rather than implementing financial austerity too high existent rates that exacerbate economical weakness too create a punishing recession, every bit the International Monetary Fund has routinely required emerging countries inward tough times to do, the West cutting rates to zero, printed money, too engaged inward massive financial stimulus. Compared to the western response, what Turkey has done is child's play - they receive got 'only' hiked rates an emergency 600bp! It's different, it seems, when the shoe is on the other foot, because Western commentators are to a greater extent than aware of (and empathetic to) the actual suffering caused to people yesteryear severe recessions too chore losses (and the political realities of that). There is a fairly callous disregard of that when it is other countries experiencing the pain, too an apparent ignorance of domestic political constraints.
What almost Ergodan's unrelenting wish to 'go for growth'? Only a few years ago, the terra firma was gripped with a fearfulness of inadequate demand too hence deflation. The terra firma was 'turning Japanese', investors feared. Now markets are terrified of Turkey's excess demand. Any sort of imbalance is seen every bit a motility for certain, impending doom, instead of simply beingness an imbalance. It calls to heed Peter Lynch's bright observation almost market's frequent vogue towards 'glass is one-half full' macro fears - 1 hateful solar daytime markets are worried fossil oil prices are going upward so nosotros are going to receive got a recession, too the adjacent hateful solar daytime markets are worried fossil oil prices are going downwards so nosotros are going to receive got recession!
Markets would prefer Turkey grew at 3% with 5% inflation than at 6% with 10% inflation, too yet both outcomes teach you lot to the same house - 1 simply twice every bit fast every bit the other (two years for the former, 1 yr for the latter). This highlights a profound work of 'framing'. Inflation is important, too all else constant, is a negative, but it is non the only thing that matters.
In addition, inflation is currently beingness exacerbated yesteryear a weakening lira (imported inflation) too rising fossil oil prices - pressures that volition recede inward fourth dimension if too when the lira stabilises. Imported inflation has a much greater bear upon on emerging marketplace inflation rates than inward the developed world, every bit developed economies receive got a higher percentage of gross domestic product comprised of domestic services, where prices are mostly unresponsive to currency movements, every bit compared to tradeables (food, energy, etc). Brazil's inflation, for instance, brutal from 11% to 2% during 2016-18 every bit the Real stabilised too recovered.
What almost Erdogan's insistence that lower rates are the key to lower inflation? Inflation is the resultant of aggregate demand exceeding aggregate supply, so inward truth in that location are genuinely 2 ways to preserve inflationary pressures - lower demand or increase supply. Aggressive investment to address provide shortfalls is a legitimate long term way to fight inflation, too affordable funding is essential to the maintenance of high rates of investment. By contrast, crunching demand is the best short term way to fight inflation. Most financial marketplace participants only attention almost the curt term, so it is clear what they would prefer. However, for somebody with a long-term travelling steal on powerfulness too whose legitimacy with the electorate rests on his hope to boost living standards, it is understandable why Erdogan would prefer to lean towards a supply-side rather than demand-side solution.
What almost US of America sanctions? Quite frankly, I run across the US of America response to the detention of a US of America pastor every bit punitive too hard to justify. How would the US of America react if the US of America arrested a Turkish muslim cleric inward the US, too Turkey demanded his liberate too render forthwith, too threatened harsh sanctions for non-compliance. The US of America would say, 'screw you lot - this is our province too nosotros brand our ain rules too produce what nosotros like, cheers real much'. No 1 likes beingness bossed around too Erdogan's defiant response is alone understandable - indeed real much the human norm inward the human face upward of a unusual civilisation trying to forcefulness you lot to acquit they way they would similar you lot behave. The US of America has no jurisdiction to forcefulness other countries to implement policies too laws that they deem satisfactory.
Trump's announced additional tariffs on Turkish steel too aluminium imports are also ill-conceived too hard to justify. While it is understandable that the US of America may seek to answer to 'competitive devaluation' of currencies to commencement US of America tariffs with higher tariffs still, this policy is wholly unjustified inward the illustration of Turkey. This is because (1) the lira is falling due to marketplace forces, non policy intervention (indeed, the Turkish regime produce non wish the lira to fall); too (2) because Turkey has its ain imbalances to correct, inward the cast of merchandise too electrical current concern human relationship deficits, rather than mercantilist surpluses.
This sort of US of America unilateralism - next on the heels of merchandise policies too its withdrawal from the Islamic Republic of Iran nuclear deal, risks a backlash from traditional allies such every bit Europe, which mightiness good side with Turkey. Erdogen's response that 'you're trading a NATO ally for a pastor' is quite pointed. Irrespective, Turkey's exports to the US of America are relatively limited - Turkey exports mostly into Europe - so these headlines are mostly just that - headlines.
And lastly, what almost Erdogan's increasingly authoritarian regime? In truth, from an investing/financial perspective, illiberal political regimes only affair from the perspective that it is to a greater extent than hard to take ineffectual leaders from power. This is a major number if you lot are a citizen of a country, every bit the stakes are real high, but every bit an investor, you lot tin accept your losses too displace on.
From the dot of catch of economic science too investment, what genuinely matters is non the cast of political representation, but what actual economical policies teach implemented, too autocracies genuinely savor some advantages inward this honour every bit they tin (1) implement policies rapidly without needing to win a broad-based coalition of back upward that caters to minority constituencies (such every bit the environmental lobby); too most importantly (2) they tin retrieve long term. The major failing of democracies is that they promote curt term, populist policies that are focused on winning elections, too long term planning/leadership is frequently lacking. PRC has demonstrated what tin live achieved with an powerfulness to implement policies quickly, decisively, too with long term planning inward mind.
Erdogan's legitimacy also rests mostly on his economical accomplishments. Since coming to powerfulness inward the early on 2000s, Turkey's economic scheme has grown considerably too the average Turk is much amend off economically than they were xx years ago. This probable lies behind Erdogan's 'go for growth' policies. This is important, every bit inward the long term, interests are aligned betwixt investors, the citizenry, too Erdogan's political career. There is every possibility Turkey's economic scheme outperforms expectations over the adjacent 10 years every bit a result.
And this is before mentioning the positives?
Furthermore, all of the higher upward arguments - none of which I receive got seen characteristic inward a unmarried media article - are simply potential refutations/balancing points that counter the negative narrative. Notable is that they don't fifty-fifty address whatever of the potential positives inward Turkey.
The Lira, on a PPP (purchasing powerfulness parity) basis, was already inexpensive at 3.5 to the USD. A expert friend of mine travelled to Istanbul before this yr too was amazed at how modern the house was; how efficient the infrastructure; too how remarkably inexpensive the cost of living was. The currency is directly at 7.0 - twice every bit inexpensive again! A inexpensive currency too the meaning recent depreciation is going to live a meaning economical stimulus to the Turkish economy, which has a large export sector focused on selling into the European Union (an export market, yesteryear the way, where the economic scheme continues to produce relatively well), too also a growing tourism industry. An undervalued currency is probable to contribute to a meaning decline inward the electrical current concern human relationship deficit inward coming quarters, too a booming export sector.
Also neglected to yell is the fact that a lot of Turkey's electrical current concern human relationship deficit has gone into financing infrastructure too other productive activities. It is 1 thing to borrow for consumption; it is quite some other to borrow to invest, too it is genuinely non clear why it ought to live considered such a profound negative for a rapidly growing, working capital alphabetic character hungry province to run a electrical current concern human relationship deficit. Investors are focusing only on the visible imbalances (foreign borrowing), spell ignoring all the productivity-boosting investments that borrowing has enabled. The electrical current concern human relationship deficit has also of late been inflated yesteryear higher fossil oil prices, but if fossil oil prices buy the farm on to moderate from recent levels of US$80/bbl, this volition also assistance Turkey's external imbalances.
Lastly, so far at least, Turkey has non resorted to working capital alphabetic character controls or trying to peg the lira too preclude its depreciation, every bit emerging marketplace nations experiencing liquidity stresses too unusual currency turmoil are sometimes wont to do. This toleration of 'exchange charge per unit of measurement flexibility' is a huge positive. Furthermore, despite all the criticism Erdogan's eccentric views on involvement rates receive got garnered, every bit good every bit some of his recent appointments, both the stated economical policy goals of Turkey, every bit good every bit what they receive got genuinely implemented to appointment (rather than simply talked about), genuinely accommodate much to a greater extent than closely to orthodoxy than the impression the pop press would receive got 1 believe.
Conclusion - so what now?
A recession is belike coming inward Turkey, too a crisis is also far from impossible. But despite the unequivocation beingness expressed yesteryear markets, the truth is that neither outcome is assured - peculiarly the latter. Markets receive got predicted nine out of the final iv recessions, so the saying goes, too faux alarms are common. With that said, Turkey's imbalances are peculiarly high; its policy response unpredictable; too the Fed is also tightening liquidity, so disaster is for certain possible. Events are also somewhat path dependent. It so remains to live seen how things play out, too similar most complex phenomena/systems, defies hard predictions.
So is this a buying opportunity? In my opinion, yes, even though nosotros don't yet know what the outcome volition live too meaning losses are quite possible, because inward my sentiment the probabilities are beingness mispriced on concern human relationship of an excessively one-sided narrative. When people are only focusing on the negatives, the probability of investors/commentators beingness positively surprised is significantly greater. Given the sentiment extremes that currently prevail, it probable volition non accept much for the lira to recover 10-20% - fifty-fifty a 100bp cardinal depository financial establishment hike at this dot mightiness good produce the trick. You would receive got to imagine that they volition live seriously considering implementing at to the lowest degree a token hike at introduce given the events of the yesteryear few days. And fifty-fifty if they don't, meaning existent currency depreciation volition probable shrink the electrical current concern human relationship deficit anyway, which volition facilitate greater currency stability.
There are a lot of good managed companies inward Turkey, including several well-run banks, too in that location is a expert risk many of them non only survive, but genuinely thrive inward coming years. I receive got been accumulating shares inward Turkiye Garanti Bankasi, KC Holdings, too Turkcell, inward recent sessions, too receive got a combined portfolio exposure to Turkey of almost 2.5-3.0% at present.
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Disclaimer: None of the higher upward should live construed every bit investment advice or an investment recommendation. Please produce your ain inquiry too consult your financial adviser before taking whatever investment action.