COMMENT: Markets are completely missing Turkish economy’s risks

COMMENT: Markets are completely missing Turkish economy’s risks
Turkish central bank's new governor, Murat Cetinkaya.
By Emre Deliveli in Istanbul April 20, 2016

I recently returned from a gruelling week at the annual Spring Meetings of the International Monetary Fund and the World Bank Group at Washington, DC.

While the actual meetings traditionally take place among country officials from Friday to Sunday, there are seminars, press conferences and many other events focusing on the global economy, international development and the world's financial system throughout the week. Think-tanks use the conglomeration of academics, bureaucrats, government officials and executives into town as an opportunity to hold their own events on the side. In addition, several investment banks have investor conferences, where they go over different themes and countries.

The Spring Meetings are a great way for me to see what is bugging policymakers and international institutions. This year, unsurprisingly, the Syrian refugee crisis and the UK’s potential exit from the EU (Brexit) were heading the agenda. The latter was deemed as one of the major risks facing the world economy this year, not only by the Fund in the latest version of its regular “World Economic Outlook” report, but also by the financial community during the investment bank meetings.

I also use the Spring Meetings to get a sense of how investors see the Turkish economy. I found them to be surprisingly positive on Turkey, even though the country was in the backseat for a change: Most of the emerging markets discussion was on Venezuela, South Africa and Russia in addition to, as always, China. Turkey analysts are forecasting Turkish growth to remain robust, the current account deficit to continue shrinking and inflation to keep on falling. Moreover, they expect the strong fiscal stance to continue and are happy with the new central bank governor. I would argue that this rosy stance reflects a shallow look, which seems to be correct at first glance, but the details reveal a different picture.

Underlying truths

As I explained in my last bne IntelliNews column, the recent sharp fall in annual inflation has been mainly on the back of food prices, whereas core and service inflation continue to be sticky. In fact, after falling in April, and potentially in May as well, I expect inflation to pick up during the summer months and end the year well above the Central Bank of Turkey’s target of 5%.

Similarly, the fall in the current account deficit, deemed as the country’s Achilles’ heel by many, has been driven by falling energy prices more than anything else. In fact, the annual non-energy deficit has roughly been constant over the past few months. Moreover, I noticed during the Spring Meetings that many Turkey analysts are underestimating the loss in tourism revenues because of the row with Russia and recent terror attacks at $5bn. The actual damage, as evidenced by the 30-40% drop in reservations, is likely to be around twice that amount.

While the share of tourism in the economy is not that huge, it is linked to many sectors such as food, beverages and furniture. Moreover, it is a major employment-generator, and early reports point to significant job cuts in the sector during the summer months. The loss of jobs, in turn, could dampen the boost to consumption, and therefore GDP, that analysts expect from the minimum wage hike from TRY1,000 to TRY1,300 at the beginning of the year.

It seems that economists looking at Turkey have also been persuaded by last year’s strong growth turnout. While the 4% headline figure was indeed impressive, it was also based entirely on private consumption and government spending. Moreover, even consumption growth was hardly broad-based: “transport and communication” made the largest contribution by far to consumption on the back of strong car purchases. This is unlikely to repeat in 2015.

On the other hand, the expenditure growth in recent budget statistics is hinting that the government will again try to boost growth this year. While Turkey’s fiscal stance does look robust compared to peers, I noticed at the Spring Meetings that analysts have yet to pencil in the recent pork barrel spending items such new public sector hires. I also observed a growing interest on contingent liabilities in emerging markets during the Spring Meetings, with China being the country mentioned the most. Markets seem to be totally unaware of the recent surge in Turkey’s contingent liabilities, such as payment guarantees to recent projects like the new Istanbul airport and the Bosphorus bridge, at the moment, but it will be only a matter of time before these hit investors’ radars.

Last but not the least, I got the sense that the new central bank governor, Murat Cetinkaya, has been very well-received by the markets. A recent research note from investment bank JP Morgan states that, “he is seen as an experienced central banker who could potentially withstand political demands towards easing the monetary policy in a radical way. The markets have also been encouraged to see that Prime Minister Davutoglu and President Erdogan reached such a compromise solution so smoothly”.

Cetinkaya’s CV reveals a super fast-track finance and policymaking career despite any formal education in economics or finance. His finance experience is at one state bank and two Islamic finance institutions. And his central bank involvement is limited to his four-year stint as a deputy governor, where he was appointed in 2012, shortly after bank rules were changed to relax the requirement to have an economics or related degree for the post. However, despite his apparent lack of the necessary credentials and experience for the job, all of the several people I talked to, who have worked with him, described him as smart and hardworking. In any case, I don’t see him as a compromise candidate at all, but a President Erdogan appointee. The fact that he is an “insider” does not make him less so.

Long, hot summer head

He will certainly be tested in the next couple of months. While most of the finance community is pretty sanguine about the Turkish economy, a few are already well aware of the risks I outlined above. A London hedge fund manager who has worked as a Turkey economist in the past told me that the only thing preventing her from shorting the lira was the high overnight interest rate, which was 11% at the time – before the central bank cut its overnight lending rate 0.50 percentage point, as widely expected, at Cetinkaya’s first monetary policy committee (MPC) meeting on April 20.

Since it was already priced in, the cut did not lead to a sell-off in Turkish assets – on the contrary, both the lira and government bonds rallied. But policy rates 1.0-1.5pp lower by early summer, in addition to the deteriorating current account, growth and inflation outlooks, may be enough to sway investors from their bullish Turkey outlook. They’ll also eventually figure out that the fiscal stance is not as strong as it looks, and that Cetinkaya is not as “sensible”, as one banker described him during the Spring Meetings, as they take him to be. A hot summer is ahead for Turkish assets.

Emre Deliveli is a freelance consultant and economist. Follow him on  or at Twitter @EmreDeliveli.