Turkey is turning itself into Argentina. The main factor is Erdogan’s complete lack of understanding of macroeconomics.Jan Dehn , head of research at emerging-markets specialist Ashmore Group.
The economic ravages of the Covid-19 pandemic have not spilled over into a financial crisis in any large emerging market, yet. Turkey seems hellbent on becoming the first.
Investors can be handsomely compensated for risking the country’s galloping inflation and disappearing currency reserves. Sovereign bonds are paying around 7% annually in dollars and 13% in lira. The iShares MSCI Turkey exchange-traded fund (ticker: TUR) has crashed below its previous nadir in mid-2018.
Fund managers are steering clear anyway, figuring things will have to get worse still before strongman president Recep Erdogan does anything to make them better. “Turkey is turning itself into Argentina,” says Jan Dehn , head of research at emerging-markets specialist Ashmore Group. “The main factor is Erdogan’s complete lack of understanding of macroeconomics.”
Turkey, with its chronic high inflation, low savings and dependence on foreign capital, was destined to have a tough pandemic. One hard currency earner, manufacturing exports, was hit hard by the recession in Europe. The other, tourism, suffered catastrophically; arrivals this summer were down more than 80%.
But instead of battening the hatches, Erdogan stepped on the financial gas. Banks have been coerced and cajoled into massive credit increases. House purchases have more than doubled from last year, notes Kieran Curtis, who monitors Turkey at Abderdeen Standard Investments. The central bank, stacked with Erdogan loyalists, is holding a headline interest rate three percentage points below inflation, forcing what savings the population does have out of lira into dollars.
Results: The state is basically broke, holding negative net currency reserves when you figure in central bank swap lines with commercial banks, and the lira has kept tanking even as other emerging market currencies rallied since March.
“Every aspect right now is pointing in the wrong direction,” says Aaron Hurd, senior currency portfolio manager at State Street Global Advisors. “If inflation bumps from 11% back to 15%, you’re going to get a shock decline in the currency.”
Erdogan is courting conflict with his biggest customer and investor, the European Union, sending warships into gas-rich Mediterranean waters claimed by EU member Greece. A sanction from Brussels on EU bank lending, for instance, could quickly tip their overleveraged Turkish counterparts into a “genuine balance-of-payments crisis,” Dehn says.
On the bright side, Erdogan has been a master at getting himself out of the trouble he creates. Exhibit A is August 2018, when the lira plunged 30% in three weeks among similarly overheated conditions. A rate hike to 24% pulled it back into a prolonged rally that made fat profits for alert investors. Financial sleight-of-hand has shifted the most precarious debt burdens onto banks and large industrial combines, leaving the Turkish government reasonably frugal on its face, owing in the 40% range of gross domestic product.
“People have been expecting a balance of payments crisis in Turkey every year for the last 20 years,” says Yong Zhu , portfolio manager for emerging markets debt at DuPont Capital Management. “To me, 7% on the dollar bonds isn’t that bad.”
Most are holding back until outright calamity forces Erdogan’s hand again, though, if it does. “The only institution that can still borrow is the government,” Aberdeen’s Curtis says. “If you know they need to issue, you can always wait for a higher spread.”