The key factors behind Turkey’s economic success story

Global emerging markets have bounced back from lows since February, and it seems risk appetite will continue to stay strong for a while

 
Author: Murat Pakün and Burak Baskurt, Garanti Asset Management
July 12, 2016

There are some important factors that led to the recent recovery in risky assets. The first important reason is the dovish bias of the US Federal Reserve about monetary policy normalisation and additional monetary stimulus from other major central banks. Concerns about global growth outlook at the beginning of the year and an already stronger US dollar (USD) pushed the Fed to take a more cautious approach about rate hike policy. As a result, the USD lost some of its value against several currencies in emerging markets last year. For instance, the Turkish Lira has lost 20 percent of its value against the USD throughout 2015, and recovered four percent year-to-date in 2016.

The second important reason is the easing concerns about China’s economic slowdown and its impact on commodity prices that have weakened significantly in 2015. This is actually great news for emerging markets, since many countries are commodity exporters. Although Turkey is a net energy importer – mainly oil and natural gas – the country is still benefiting from a recovery in commodities that are still very low compared to recent years. In fact, one major structural problem of the Turkish economy is its current account deficit (CAD) improved significantly and 12-month trailing CAD fell to $30.5bn (4.2 percent of GDP) in February 2016, thanks to lower energy prices. This corresponded to the lowest deficit since 2010. As a comparison, CAD was almost 7.9 percent of GDP at the end of 2013.

Another key reason is valuation and positioning. Global Emerging Markets (GEM) were sold off aggressively since the Fed’s 2013 tapering signal. Emerging markets equity index (MSCI EM) lost almost 40 percent of its value in less than two years on the back of deleveraging from risky assets. During the same period, the emerging markets’ currency index weakened by more than 20 percent. The foreign ownership of Turkish local currency bonds fell from 26 percent to 20 percent.

A consumption-driven impetus is still the playground for the Turkish economy, and current trends are supportive for the long-term fundamentals of
the country

Positive results
On top of a supportive global backdrop, Turkish markets also benefited from a better inflation outlook and GDP growth beyond expectations. With the help of global tailwinds, the Turkish Lira has rallied by more than five percent since mid-January, and long end rates compressed by more than 160bps since then. Despite some geopolitical – mainly Syria – and domestic security risks, five-year credit default swap spread receded by 70bps, signalling a lower risk premia for Turkish assets (see Fig. 1).

GDP growth accelerated beyond expectations to 5.7 percent in Q4 2015, bringing YOY growth up to four percent and keeping Turkey’s relatively strong economic performance compared to its peers in the GEM universe, despite two elections in 2015, and domestic concerns about security measures. On the other hand, the market is still optimistic about growth in 2016, with the performance of three to 3.5 percent levels on the back of better demand from the EU, and healthy domestic demand.

Another positive surprise is the improvement in inflation. Annual headlines on the consumer price index decelerated by 1.3 percent to 7.5 percent in March, and reached its lowest level since August 2015. The decline in two months’ time reached a total of 2.1 percent. All core indicators displayed a decline in annual basis. Specifically, the central bank of Turkey’s favourite core index (I index) slightly decelerated to 9.5 percent from 9.7 percent, and thanks to recent appreciation of Turkish Lira, a faster downward move is expected on the core inflation side as well. Annual food inflation subsided to just 4.1 percent yoy – the lowest level since December 2012.

As a result of an optimistic global backdrop and increased risk appetite, global volatility indices VIX and MOVE index fell as well, and supported additional risk taking. All of the above mentioned points helped the Turkish central bank to start cutting rates for the first time in March, meeting by 25bps and 50bps in April, and the top side of corridor rates came to 10 percent from 10.75 percent. Financial markets welcomed these cuts, and Turkish Lira actually strengthened afterwards. In fact, another 50 to 75bps cuts are currently priced as inflation expectations keep improving and risk on sentiment prevail. Global tailwinds and falling interest rate levels in local markets have resulted in Turkish equities starting to gain ground as well. Since the beginning of 2016, the index gained 20 percent in nominal terms, outperforming the MSCI EM index by almost 13 percent.

Turkey inflationGoing forward, current levels of the Turkish equity market may seem stretched after the strong rally, but, looking at the bottom-up prospects and operational performance of companies, one may still stay on the optimist side. To start with, the earnings growth from the banking sector looks quite appealing when compared to emerging market counterparts. EPS growth for the major banks – that constitute almost 35 percent of the index – in 2016 will be more than 20 percent, whereas the EPS growth for EM banks are still running close to low the teens. This earnings growth may also accompany macro-prudential and regulatory easing from the central bank and regulatory authorities. Briefly, the immense pressure on ROE levels during the last few years may take a breather. On the non-financials side, the operational performance of Turkish industrials remains strong, and the current industrials’ index is running at historically high levels.

Strong growth ahead
From a long-term perspective, Turkey still offers significant growth opportunities. According to World Bank data, the population will grow with a one percent compound annual growth rate for the next five to 10 years. But, more interestingly, urbanisation-related household formation rates exceed the population growth rate by a
wide margin.

The number of urban households in Turkey is expected to have a compound annual growth rate of 2.5 percent in the next eight years, according to the Turkish Statistics Institute. Considering the country is already a consumption-driven economy – with consumption making up more than 70 percent of the current GDP – one should assume the sustainable growth rate for the country will stay above a certain threshold for the foreseeable future.

This trend is quite supportive for many sectors such as discretionaries, staples, airlines and financials. Even specific industrials are feeling the tailwinds – construction and related sectors are good examples. According to the Association of REITs in Turkey, annual need for new housing is around 650,000 units per annum, forcing different sectors such as steel and cement production. The sector data states demand for steel and cement had a compound annual growth rate of 6.2 percent and five percent during the last four years, respectively.

A consumption-driven impetus is still the playground for the Turkish economy, and current trends are supportive for the long-term fundamentals of the country. Therefore, our house remains optimistic on the long-term investment prospects of Turkish assets and tries to offer local expertise through different investment vehicles such as diversified multi-asset products with specific focus on Turkey, Luxembourg-based SICAV funds purely on Turkish equities or fixed income, and discretionary portfolio management services for high-net-worth individuals.

For more information visit www.garantiassetmanagement.com