It’s no secret that it has been a shaky year for emerging economies. The staple emerging economies of Brazil, China, and South Korea, have all posted largely underwhelming performance, with Turkey being no exception.
Several factors have hindered – and will continue effecting the performance of Turkish equities in 2018.
Setting Political Tone
The 2017 constitutional referendum in Turkey set the tone for a pivotal election year in 2018. The result of the referendum included several amendments to the constitution of the country which would change the electoral and governing process in the country; these amendments included changes to the role of the President of Turkey, giving the position power to rule by decree. As part of the successful referendum, a new election date was set for November 3rd, 2019. However, due to deteriorating economic circumstances in Turkey – or out of pure interest of impeding opposition support before the set date - the election was ultimately held on the 24th of June, 2018. The outcome was President Recep Tayyip Edrogan’s rule would last at least another five years.
The Turkish Lira has so far devalued as much as 27% against the Euro since the start of 2018. Turkish citizens and foreign investors all have looked towards President Erdogan in hope of shedding some light on the currency, and bring back fiscal stability. On July 10th, President Erdogan announced his selection for the Minister of Finance and Treasury, Berat Albayrak, former CEO of Çalık Holding, and son-in-law of the president.
President Erdogan has regularly interfered with the Central Bank of the Republic of Turkey in adjusting interest rates. His stance against interest rates coincides Sharia law, which prohibits interest rates in Islamic Finance and Banking. Banks have taken upon themselves to increase interest rates on business and mortgage loans to levels that have suppressed business activity in the nation. Due to the devaluation of the currency banks have been forced to negotiate debt-restructuring agreements with corporations unable to meet interest payments on foreign currency debts.
At a glance; $100,000 borrowed in July 2017 was worth 352,000 TRY, one year later the same amount is worth 478,000 TRY. If revenue remains relatively unchanged – without debt restructuring most fail to meet interest payments.
While the new Minister of Finance has acknowledged the need for increased fiscal austerity, many remain skeptical as to where Berat Albayrak’s interests lie; with his father-in-law, or with the independence of the central bank?
Corporate Turkey continues to suffer under the current political and economic regime. Turk Telekom, burdened by over $4 Billion of debt, was bailed out earlier this month by Turkish and international banks in order to prevent a crash of Turkey’s largest telecommunications provider, the firm is now in the hands of it's original lenders. Another company, Ozensan Taahhut, filed for bankruptcy on the 22nd of July, unable to meet their foreign debts.
Fitch Ratings has recently downgraded Turkey's Long-Term Foreign-Currency Issuer Default Rating (IDR) to 'BB'. Turkish officials have responded to the downgrade by stating a desire to create their own credit rating agency.
Sentiment and Performance
Investor sentiment is poor. Many international investors are scared of investing in the Turkish economy while President Erdogan remains in power. Turkey has for a long time been a great candidate for accelerated growth investing, but most of its growth over the last 5 years has been as a result of the foreign loans that Turkey is now failing to repay. As a result, to combat the uneasiness that foreign investors feel, President Erdogan has implemented state loan guarantee initiatives and has created the Turkish Wealth Fund, a sovereign wealth fund that has collateralised state-owned assets. Regardless, investors still remain pessimistic.
[caption id="attachment_623" align="aligncenter" width="759"]
An old institutional favorite, Turkey Ishares MSCI ETF. The exchange-traded fund has lost 35% of its value, YTD.[/caption]
The Istanbul Stock Exchange is mostly capitalised by the Turkish banking sector (accounting up to 50% of the market cap). TUR, iShares MSCI Turkey ETF, which has been used as a great tool for gaining exposure to the public equity market, is also weighted 32% in the banking sector. Turkey’s banks are facing pressure to restructure their existing loans or writing off great losses, and dealing with an increase of non-performing loans. Coupled with the decreasing demand for new loans puts a squeeze on banks once again.
While the Istanbul 100 Stock Exchange index appears to show only a decrease of 10.68% over the last 12 months, the normalized index return – when adjusted for the Turkish Lira’s performance against the dollar, shows a decline of close to 40%. The currency and debt crisis has pushed the valuation of the index to lows that makes it a value for investors with lower risk aversion, and a turnaround investment style.
One company listed on the Istanbul Stock Exchange continues to grab investors’ attention. Türk Hava Yolları, a.k.a. Turkish Airlines, has achieved a return of 70.12% TTM. While the return is spectacular in normal ramifications, it shouldn’t come to be a surprise that in an economy with a rapidly devaluating currency share prices go up faster (and fall just as fast). The true value of the airline company’s growth is 41% when adjusted for USD value.
On the YTD scale, Turkish Airlines has managed a return of 6.16%. However, applying the USD valuation to the performance history shows that the shares may look as if they are increasing in value, but not fast enough to circumvent the increased devaluation of the currency.
Should the government of Turkey prioritise combatting inflation and the rapid devaluation of the Lira, foreign investors would find themselves at an advantage to in invest in weak Lira-denominated Turkish shares of companies such as Turkish Airlines. Turkish Airlines is also subject to benefit quite greatly from Turkey’s latest project, the New Istanbul Airport – set to open on October 29th, 2018.
The Bottom Line
Turkey was once a largely successful emerging market, full of investment possibilities in financial and construction sectors. However, due to mismanagement of fiscal policy, a loose leash on banks, and an autocratic regime where loyalty earns authority - these are all factors that have contributed to a disheveled economy unfit for traditional FDI. Devaluation, poor loans, decreases in corporate and consumer spending, and a strong outflow of investments have raised concerns as to the attractiveness of investing in Turkish assets and the sustainability of President Erdogan’s autocratic regime. Until investors see the effects of actual policy, one can only guess whether the end of this bear market is near, or it’s only getting started.