Turkey remains scare story for investors

Battle cry: president Recep Tayyip Erdogan's attempts to secure more executive control have left investors in a quandary

The fall in Turkey’s risk score in Euromoney’s country risk survey last year continued during the first quarter of 2016, and preliminary data for Q2 – scheduled for release early next month – show the country still struggling to convince economists and political risk experts.

Economic prospects are not too bad. GDP increased in real terms by 4.8% year-on-year during the first quarter of 2016, underpinned by strong domestic demand.

Private consumption in particular handed the government a boost, signalling that domestically at least there has been no lack of confidence caused by the global outlook, or from regional instability.

Yet exports are struggling and the lira is susceptible to volatility caused by capital withdrawal, given the prospect of higher US interest rates and renewed political risk aversion.

None of the credit rating agencies seems to agree on Turkish creditworthiness. Fitch and Moody’s rate the sovereign their lowest investment grade, but Fitch is a stable rating and Moody’s is negative. S&P’s rating of BB+ was recently revised from negative to stable.

Yet the opinion of risk experts is clear from Euromoney’s survey data.

Turkey ranked 53rd out of 186 sovereign borrowers when we last remarked on its falling score trend in September 2015. It now ranks 58th, barely a 10th of a point higher than Brazil, another notable concern, and it could edge further downwards, with 55th-placed Romania on the rise.

The negative trend is reflected in five-year CDS spreads now showing a slightly higher risk of sovereign default for Turkish compared with Russian debt. Turkey’s implied debt-insurance has loosened to 253 basis points; Russia’s is 251bp.

Political concerns

Turkey’s problems are largely political in nature. Last month’s row between Justice and Development Party (AKP) president Recep Tayyip Erdogan and his then prime minister Ahmet Davutoglu seeking greater independence on policy but leading to the latter’s departure, might have blown over.

However, it has left investors in a quandary, as Erdogan attempts to secure more executive control.

Amid the ongoing threats posed by Kurdish separatism, and contagion from the doorstep turmoil in Syria, Erdogan’s new prime minister Binali Yildirim is a worry to the financial markets.

Investor favourite, deputy prime minister Mehmet Simsek, remained in place, calming the market reaction, but his powers are curbed by Yildirim, who is also ignoring pressure to improve the rule of law which has been demonstrably violated to exercise a crackdown on private business and put pressure on opponents of Erdogan and his party’s direction.

The political environment is not conducive to the structural reforms that are necessary to maintain Turkish growth and deal with its underlying problems, not least to tackle high unemployment and inflation, and address the twin fiscal and external deficits.

The current account is predicted to be 4.8% of GDP this year, according to the European Commission, with other forecasters in the same ballpark. This deficit is moreover vulnerable to rising import costs from a mini-recovery in oil prices, and portfolio outflows threatening financing.

The fiscal deficit is still below 2% of GDP, and gross sovereign debt at 33% of GDP is reasonable. Yet inflation is high (8% to 9%), and so is the share of external debt, including foreign currency-denominated corporate sector debt, which has grown sharply, at a pace second only to China.

Peter de Bruin, ABN Amro

Commenting on the first quarter growth, Peter de Bruin, senior economist in emerging markets at ABN Amro, says: “Such a strong performance is most likely not sustainable for Turkey in the longer run.”

More recent data for Q2 show this to be the case, with industrial production declining on a monthly basis in April, and slowing rapidly year on year. Tourism is also around 30% down due to terrorism fears, causing hoteliers and tourist operators to offer discounts.

Political risks add another dimension of concern, believes de Bruin, arguing that more power in the hands of Erdogan would “erode the checks and balances in Turkey”, adding: “Such a move risks giving rise to civil unrest.”

Turkey’s risks are unlikely to be resolved quickly, and in that light Romania seems the safer bet.

This article was originally published by ECR. To find out more, register for a free trial at Euromoney Country Risk.