Flat reaction to flat inflation with Turkey on edge awaiting Erdogan’s election ‘defeat’ decision

Flat reaction to flat inflation with Turkey on edge awaiting Erdogan’s election ‘defeat’ decision
Ekrem Imamoglu, the opposition candidate who appeared to win Istanbul in the weekend local elections but is waiting to see whether officials attempt to invalidate his victory, was on April 3 in Ankara visiting Ataturk's mausoleum with his family. / Cumhuriyet.
By Akin Nazli in Belgrade April 3, 2019

Turks on April 3 remained fixated on whether their strongman president will be able to stomach the results as they stand from the weekend local elections. There was little appetite to discuss anything else but the day also brought the latest inflation news for their recession-beset nation, so first things first.

Turkey’s official annual consumer price index (CPI) inflation very slightly edged up to 19.71% in March from 19.67% y/y in Februarythe Turkish Statistical Institute (TUIK) announced.

Bloomberg saw the headline figure as in parallel with its surveyed expectations while Reuters reported that it was worse than what its respondents expected.

The official inflation data for March also showed a 2.44% m/m rise in food prices, which have the biggest weight in the CPI basket at 23.29%. Consequently, food inflation officially rose from 29.25% y/y in February to 29.77% in the third month.

It was notable that annual inflation given for alcoholic beverages and tobacco—which have just a 4.23% weight in the basket—remained stuck at 2.71% despite tax hikes.

For the second month running, the biggest inflation increase was recorded for healthcare prices, with 3.48% given as the March figure. Healthcare prices have the second lowest weight, of 2.58%, in the inflation basket. Official annual healthcare prices thus rose at a rate of 19.72% in March compared to 17.89% in February. The health ministry last month hiked the fixed exchange rate for imported pharmaceutical products by 26.4%.

In March, the average prices of 33 items in TUIK’s inflation basket of 418 items remained unchanged while those of 270 items increased and those of 115 items decreased. It is notable that official figures have pointed to widespread rises in CPI basket item prices while the impacts have not been felt in the headline inflation figure.

Official domestic producer price inflation (PPI) in March also edged up after falling for five consecutive months in a row. It was recorded at 29.64% y/y, slightly higher than the 29.59% y/y seen in February, TUIK said in a separate press release.

Lira “remains vulnerable to shocks”
Jason Tuvey of Capital Economics said in a research note on the March inflation data: “Recent developments show that the direction of monetary policy will be heavily dependent on what happens to the lira. Following a recent currency sell-off, the central bank suspended liquidity provision via its one-week repo facility, causing 3m interbank rates to rise by 225bp. While Turkey’s current account position has improved markedly since last year’s currency crisis, we’ve noted before that the lira remains vulnerable to shocks. Geopolitical tensions with the US are building again and the direction of policymaking remains a key concern for investors. This is likely to limit the scope for monetary easing which might otherwise be warranted by a further decline in inflation.” 

Seker Invest expects the central bank to keep rates on hold at its policy meeting on April 25 and continue to determine the cost of funding through liquidity management, Serkan Gonencler of the Istanbul-based brokerage house said in a research note entitled “High food inflation continues to be a drag on disinflation process”.

Seker’s base case remains that the central bank will initiate a rate cutting cycle from June or July onwards. Needless to say, this would be dependent on there being no swift TRY depreciation. Should the TRY not depreciate in an orderly fashion—i.e. the TRY reaches 6.0-6.5 against the USD by the summer months compared to the 5.60s levels it traded at more or less continuously on April 3—Seker would continue to expect end-2019 CPI inflation of around 13.5%. That’s below market estimates, which range between 15-17%.

Seker’s below-consensus inflation estimate basically depends on its expectation of a greater GDP slowdown/contraction for 2019 at 2.0% and it assumes a stabilisation of the TRY. Its estimate also assumes that food inflation will be roughly 14-15% by year-end (the central bank expects 13%), it said on April 2 in its macro outlook for April.

“Could have been worse”
“[Turkey’s March CPI is a] kind of non-event…,” Timothy Ash of BlueBay Asset Management said in an emailed note to investors, adding: “I guess given FX vol in the run up to elections, the data could have been worse.”

Bne IntelliNews has been reporting since September that given the size of the lira depreciation which is directly hitting costs in a heavily import-dependent economy, actual inflation in the economy is dramatically worse.

On the market frontlines, the thinking is often woolly. Commentators are trying to match up the surprise local election news and developments in Ankara’s rows with the US, and even the inflation data release, with the lira’s oscillations. But the currency has been under pressure since mid-November, and, since last week, the Battle of the Turkish Lira—triggered by the Erdogan administration’s ill-advised attempt at battling traders looking to short the lira by withdrawing offshore liquidity—has been raging.

Waiting on Erdogan
Meanwhile, markets await news of the strategy strongman President Recep Tayyip Erdogan will decide upon in the wake of March 31 municipal poll results that threaten to dissolve his air of invincibility. Will the Ankara and Istanbul defeats be overturned by election officials declaring they have detected irregularities? The air is thick with tension and then there is the small matter of the F-35 jets/S-400 missile system row with the US that seems to be coming to a head.

US officials said little about relations with Erdogan in the week before election day, but on April 1 they were busily briefing, offering both carrots and sticks when it comes to persuading Ankara that it has to drop its order for the Kremlin’s missiles if it seriously expects to get its hands on its ordered F-35s. The US offers a conciliatory tone in public while unnamed sources weigh in with the sticks in anonymous updates given to reporters.

Where threats to fair election results are concerned, the US is also now not keeping its counsel. "Free and fair elections are essential for any democracy. That means acceptance of legitimate election results, which is essential. We expect nothing less from Turkey, which has a long, proud tradition in this respect,” US State Department spokesman Robert Palladino said at a press briefing.

Ash on April 3 asked the most appropriate question: “Just wondering about US response if the AKP [ruling party of Erdogan] ‘takes’ Istanbul, but still goes on to buy [alternative US missile system] Patriots and F35s.....”

Erdogan officials: refrain from meddling
Palladino’s comments were drawn on by Erdogan officials as a useful tool in pushing their theme that the US is against the president. “We urge all parties, including foreign governments, to respect the legal process and refrain from taking any steps that may be construed as meddling in Turkey’s internal affairs,” Fahrettin Altun, Erdogan’s communications director, said on Twitter in response to the remarks.

“No country has the right to intervene in the election results of another country in a way that is far from law and democracy and to see itself as a source of legitimacy of the results," Erdogan’s spokesman Hami Aksoy said in a written statement. 

Erdogan will be in Moscow on April 8 to meet Russian ally Vladimir Putin, according to TASS.

The Turkish leader’s son-in-law and finance minister Berat Albayrak is on the same day also expected to deliver a PowerPoint presentation under the banner of “Normalization”, while he is set to be in Washington from April 12 for a week of meetings, including with the IMF.

State trolls, who enjoyed their finest hour with the overthrowing of PM Ahmet Davutoglu in May 2016, have been orchestrating a massive campaign to overturn the local election results, while there is speculation that some factions of the AKP and Erdogan’s governing coalition are contemplating accepting the poll outcome.

While the president’s courtiers dwell on the best way forward, media loyal to Erdogan have gone so far as to claim that coup-plotters supported by some external powers and a clutch of terrorist organisations are angling to take over the AKP’s municipalities rather than accepting that the public no longer deems them capable of achieving any such thing, meaning their machinations have little effect on public opinion.

“Markets seem content AKP lost”
“Markets seem ‘content’ with the line that the AKP lost Ankara and Istanbul, but has accepted the result, and that this affirms Turkey's democratic credentials. I think a successful challenge to these results would reverse this positive spin, and would un-nerve markets. It would I guess also risk instability domestically, with claim and counterclaim from both sides....better for the country just to move on now from these elections....,” Ash observed.

Allegedly invalid ballot papers are currently being re-checked in eight Istanbul districts following AKP objections, Turkish election board chief Sadi Guven told reporters on April 3, adding that the result of the recount should be accepted by all parties.

Ash suggested most people would have reckoned with a big sell-off in a scenario in which the AKP lost Istanbul, which it hadn’t done during all of Erdogan’s 16 years at the top of Turkish politics. People positioned themselves pre-election for a bad outcome, he said. The economic reform plan to be announced and the Nato summit currently being held in Washington are now key, he wrote on Twitter.

Although he said on April 1 in an emailed note to investors that he would be a buyer of Turkey for a trade if there were a 5-10% leg-down in the lira, Julian Rimmer of Investec seemed on April 2 to have changed his mind.

In his observations in a note to investors on April 2, Rimmer said: “The Turkish mkt made a decent fist of discounting the slapstick comedy/elaborate financial mousetrap laid by [Erdogan] in the swaps and currency markets. It dropped roughly 10% while the lira [rose] from 5.46 to 5.90 before stabilising at a still indecent 5.57 level [on the morning of April 2].

Lira enjoys “Get Out Of Gaol Free card”
“The worst-case will not materialise. The lira is being given a Get Out Of Gaol Free card by sagging US bond yields and now that the election is over (well, we think it's over) [E]rdogan has ratcheted down the 'rhetoric' (if you can call his spittle-flecked, fist-shaking vituperations that) and the domestic political drama should now detensify (a word of my coinage.)

“There will be many still bearish on the lira, (Gentle Reader, I number myself among them) but the appetite to short the lira just now, even as swap rates fall to less stratospheric levels, is probably reduced by recent shenanigans and most importantly, the drive for locals to dollarise savings appears to be losing momentum…

“Turkey's political risks now shift to the intl arena but even there [Erdogan] will most likely strike a less abrasive and more conciliatory note now there's no need for grandstanding. Regardless of the mayoralty disappointments, [E]rdogan still won >50% of the vote [nationwide] in partnership with the MHP [ultra-nationalists] which makes you wonder [what could make Erdogan’s people] shift allegiance?”

Rimmer suspected that the lira would still weaken from here but not materially in the near-term. “Slippage to the 5.70-5.80 channel has probably already been factored into equity prices,” he wrote. Purely from a short-term trading perspective, “one can tentatively explore a few punts starting with, as always, a bank (Garanti Bank always the best), Turkcell and maybe an airline”, he added.

Turkish Airlines has fallen to lows but there are risks with the new mega airport outside Istanbul which make Rimmer stay his hand and perhaps opt for Pegasus Airlines which he said has a good model and the same kind of operational recovery profile.

If one is buying for a longer timescale and is the kind of player that just buys an EM consumer stock and builds a position piecemeal over time, then retailer Migros looked very cheap to Rimmer, below 5x ev/ebitda with a mid-teens 3yr CAGR. 

Rimmer renounced Koza Altin on 3x ev/ebitda and a huge discount to international peers, and was not attracted by Soda Sanayi as its primary allure is now fading.

He waved a fond farewell to Ulusoy Elektrik shares at TRY18.21, the outperformance of which, he said, has been startling and gratifying in equal measure.

“Long-term, make no mistake, Turkey is still irredeemably doomed, heading into the future as Absurdistan, weighed down as it is by its historical baggage and the backwardness inculcated by centuries of sinister, destructive religion,” Rimmer concluded.

Seker picks carmakers
Seker Invest saw the March data on fallen domestic vehicle sales as Positive for carmaker Tofas, Negative for carmaker Ford Otosan and Strong Negative for importer Dogus Otomotiv, Mehmet Mumcu of the Istanbul-based brokerage house, said on April 4 in a research note.

Tofas’ recent strong performance in passenger cars resulted in the company becoming the second largest player on the domestic light vehicle market after Renault with Dogus Otomotiv moving to third place as of Q1, Vladimir Bespalov of VTB Capital said on April 2 in a research note. Ford Otosan continued to outperform the market in the LCV segment, which is a key source of cashflow and profitability for the company on the domestic market, he also noted.

VTB Capital reduced its 12-month target price by 8% for DP Eurasia shares to TRY120 but kept its Buy recommendation, the Russian investment bank said on April 3 in a note on the Turkey and Russia Domino’s Pizza franchisee’s 2018 financials.

“Turkey carry attractive after elections,” Raiffeisen Research said on April 1 in its global strategy update.

“After the strong start, one and a half weeks were enough to burn off almost the entire annual profits of the BIST 100, which seems to have put the Turkish stock market back down to earth. The collapse of the BIST 100 is a reflection of the structural weakness as well as the currently prevailing uncertainties about Turkey's future domestic and economic policy,” Raiffeisen Research said on April 2 in a research note entitled “Turkish stock market – Back down to earth – Drop follows strong start – Valuation favourable – Political risks dominated”.

Stock market: Raiffeisen sees nothing to sustain new gains
Although the Turkish stock market appears to be of interest primarily from a valuation point of view following the recent correction, Raiffeisen believes that there are currently no factors that would enable a sustained price increase.

“In the longer term, the Turkish economy could begin to recover in H2 2019, which, assuming no further political misconduct, should lead to a return to growth of 3-4% in 2020—which basically speaks for the stock market. At the same time, however, the next downturn in the US economy is likely to start pricing in towards the end of 2019, which means that stock markets in general are likely to face more headwinds.”

Raiffeisen therefore left its rating for the Turkish stock market at Hold.

“In hard currency the BIST 100 even slipped back into the red. Now that no further impulses can be expected from US monetary policy for the time being, the initial euphoria seems to have disappeared. Not only is the Turkish economy in recession, but the domestic political situation also remains difficult. In view of continuing high inflation and rising unemployment, the government has made every effort to prevent at least another collapse of the currency before the election date. Turkish banks have been instructed not to lend money to foreign business partners—a measure that creates mistrust among international investors,” Raiffeisen also noted, adding: “The combination of political risks and mismanagement in economic policy is a big challenge for the currency and the Turkish stock market. While global stock markets continue to be driven by the positive news flow of recent weeks (US monetary policy, trade conflict) and solid fundamentals continue to provide support, political uncertainties and economic concerns dominate in Turkey.”

The temporary easing on the capital market was due, among other things, to the Turkish central bank, which, contrary to Erdogan's will [at least his publicly stated will—Editor’s note], drastically increased the key interest rate on account of the country's economic and financial weaknesses and the lack of investor confidence, thereby stopping the currency's decline for the time being, according to Raiffeisen.

However, the political uncertainties resulting from the local elections are putting the currency under renewed pressure. In general, Raiffeisen continues to see geopolitical and domestic risks, which can cause increased volatility in the lira, as a challenge for investors in hard currency.

“Turkish credit default swaps are a good proxy for country risk and have a high correlation with the Turkish equity market. The same applies to the volatility of the Turkish lira. The rise in both the CDS and the volatility of the currency accordingly implies that the market prices a high degree of risk.”

GDP forecasts revised downwards
The after-effects of last year's currency crisis continue to be felt in the country's economy, with the result that Raiffeisen expects a further economic contraction in 2019. While the consensus initially estimated GDP growth forecasts for 2019 at a relatively high and constant level, the forecasts have been gradually revised downwards due to the worsening economic problems.

“Turkey also shows persistent weaknesses in terms of debt, with corporate debt, which has been rising for years, playing a particularly significant role. In particular, the high level of foreign debt of Turkish companies and the associated sensitivity to currency fluctuations are becoming increasingly problematic for the Turkish economy,” Raiffeisen said.

Although the ongoing structural economic problems coupled with political risks currently offer little support for sustainable equity performance, Raiffeisen also sees positive factors. The BIST 100 for 2019e now has an impressive dividend yield of 4.9%, which makes it interesting from a valuation point of view. Although the difference between dividend and bond yields has improved noticeably in recent months, due to the massive upward surge in government bond yields in 2018, it remains low in the negative range.

On the basis of several multiples, the BIST-100 is also trading well below the average of the last 10 years. The market is thus valued at a significant discount to established stock markets and other emerging markets, the bank added. “Although a discount is appropriate due to the structural problems, it is currently too high from our point of view. In this respect, Raiffeisen believes that the Turkish equity market is well supported from a valuation perspective,” it also noted.

In a strategy report for April, Seker said: “TRY-based assets decoupled negatively from their peers in March, amid domestic market turbulence… the BIST partly covered its losses with reactionary buybacks towards the end of the month… The Fed’s tone was read as quite dovish [at the latest rate-setting meeting held in March]; its impact on the EMs, however, remained rather limited, even turning negative later, due to the downward revision of growth expectations on global growth concerns. Investors will primarily be following US-China trade talks in April, which have so far been continuing progressively.

“Meanwhile, the main theme in the markets will continue to be global growth. Hence, growth related macroeconomic data from major economies like China, US and the EU will bear utmost importance; the markets’ sensitivity to weak data in this regard is expected to be high. While weaker-than-expected data from major economies may trigger sell-offs in the financial markets, positive and better-than-expected data could be expected to reflect somewhat positively.

“In short, global risk appetite may remain rather weak over the coming weeks. Global risk appetite is expected to strengthen should the US and China reach a trade deal; this would also be supported by the Fed’s dovish stance, if maintained. Although the Fed has strengthened its dovish tone, the EMs had decoupled negatively, and they may continue to do so in April as well.” 

Albayrak’s roadmap
Seker also advised: “The Minister of Treasury and Finance Mr. Albayrak’s announcement of an economic roadmap will be closely followed. Positive steps in the application of this roadmap could lead to a rapid recovery in TRY-based assets. In addition to the forthcoming announcement of an economic roadmap, another important topic on investors’ agenda in April will be the development of political relations with the US, especially regarding the impact of the S-400 air defence system purchases.

“Should relations with the US turn negative, volatility in TRY-based assets may continue, and they may continue to decouple negatively from their peers. However, should they develop positively, one would expect the TRY to stabilize and the BIST and other TRY-based assets to recover their recent losses. The strengthening of the global risk appetite and the Fed’s maintenance of its dovish stance would also support such a recovery at the BIST. However, the BIST, along with other TRY based assets is likely to remain volatile in the month of April.”

The Istanbul-based brokerage house maintained the weight of bonds in its portfolio at 60%, FX at 20% and equities at 20%.

“For the January-February period, we witnessed around a 59% YoY decline in auto sales (-53% YoY in 4Q18) and 35% YoY decline in consumption goods imports (-44% in 4Q18), which indicates that private consumption will most likely continue to take its toll on 1Q19 GDP growth. Manufacturing sector PMI also remains in contractionary territory...

“On the other hand, credit momentum, as identified by the 13-week average annualized credit growth, turned positive recently, although this is most likely related to firms’ working-capital needs, instead of supportive domestic demand. All in all, while we have as yet little data with which to shape 1Q19 GDP growth expectations, we initially think we might witness a similar GDP contraction in 1Q19 [as was the case in 4Q18],” the equities house also said on April 2 in its macro outlook.

“With the ongoing weakness in economic activity (as suggested by sectoral [confidence] indices), the seasonally adjusted unemployment rate is likely to rise further for a few months more (above 13.0%), with some potential contribution from the industrial sector, too,” it added.

Banks again net debt payers
Banks were net debt payers through loans once again, as they redeemed a net USD2.2bn in February, with the rollover ratio for long-term loans remaining at a mere 31%, Seker said.

It added: “Banks’ total net debt (loan) redemption since May reached USD17.0bn, with an implied rollover ratio of 66% during the period (the rollover ratio since August is actually lower at 53%). The corporate sector managed an 84% rollover ratio in new loans, which led to a mere USD0.16bn capital outflow (including short term loans). Nevertheless, corporates managed to keep the rollover ratio (for long-term loans) at slightly above 100% between August and January, leading to a mere USD78m inflow, but this points to a significant worsening compared to the USD5.8bn inflow (150% rollover ratio) registered between January and July, last year.

“Recall that the corporate and banking sectors together reduced debt by USD14.5bn over the past 12 months, compared to the USD13.9bn net borrowing of 2017. This deleveraging process also helps explain the ongoing growth slowdown. The constraints in external funding also make a Vshaped recovery less likely going forward, in our view.”

Turkey’s current account deficit is likely to continue shrinking over the next few months, dipping at $2-3bn or possibly reaching a small surplus by July 2019, Seker forecast, adding: “The downward trend is likely to reverse in 2H19, but would only bring end-2019 C/A deficit to about USD11-12bn (1.8% of GDP) or probably slightly higher. This downward trend in the C/A deficit might also support the case for stabilization in TRY, and indirectly help inflation.”

Turkey’s 12-month rolling primary budget deficit according to the IMF’s definition reached TRY87bn in February, equivalent to around 2.3% of GDP and the worst reading in history, Seker also noted, adding that the weakness in consumption tax collection persisted in February.

Slowing economy complicates budget targeting
Restraining the budget deficit would not be an easy task in a slowing economy, as budgetary improvement is highly dependent on tax revenues, rather than on a constraint in expenditures, with there actually being very little discretion on the spending side, the brokerage also said.

The government pledged TRY76bn worth of budgetary savings in 2019. Nevertheless, Seker believed that this may be hard to implement amid a slowing economy.

For example, the government’s allocation for total investments in 2019 is just TRY 64bn vs. the TRY105bn realisation in 2018, implying close to a 50% reduction in real terms. Seker saw this as almost impossible to materialize, as this alone might wipe out a significant percentage from GDP growth, probably 1.0- 1.5%.

Indicating Seker might be on the right track with its argument, the government allocated TRY15bn for investments in January alone, which is almost a quarter of the full-year allocation. The brokerage concluded: “A projected 5% YoY improvement in tax revenues (in real terms) for 2019 may also be hard to achieve in a slowing or contracting economy. Therefore, the government may require a significant amount of additional non-tax revenue sources to meet the 1.8% budget deficit target in 2019.”

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