The opposition finally has a chance to unseat President Erdogan. If they do, we expect a flood of foreign investor interest and see Turkish credit as an effective way of tapping into a country with all the ingredients for success. Read the key takeaways from our recent trip to Turkey.
The emerging market (EM) asset class is in desperate need of a good story. An opposition victory in the May 14th election could be the launching point for Turkey to become the next credit market ‘darling.’ With a strong export base, innovative and resilient private sector, attractive tourism industry, and geographical advantages, Turkey has all the ingredients for success. But twenty years of Presdient Erdogan’s increasingly autocratic rule have left the economy in a tenuous position. Unorthodox monetary policy with deeply negative real rates has caused building internal and external imbalances in the form of elevated inflation and an unsustainable current account deficit. Without a change in policy Turkey risks a balance of payments crisis. Foreign inflows are already dwindling, and current monetary settings risk a run on the domestic banking system. While Turkey’s financial linkages to the rest of the world have declined since 2018, it remains a big enough player that a crisis in Turkey could have spillovers to the rest of the EM universe.
Near-term, credit metrics are set to deteriorate further into the vote as President Erdogan pursues an aggressive stimulus program to boost growth and win the election. However, given ample fiscal space to accommodate a post-election adjustment, investors are willing to look though near-term headwinds in the promise of a more sustainable long-term growth story should regime change occur. The opposition Nation Alliance is a coalition of six disparate parties with varying interests, but they remain united in their stance on Turkey’s need for an independent central bank and orthodox monetary policy. While an opposition government will pursue a broader reform agenda, we believe a restored monetary pillar is sufficient to attract more reliable sources of foreign funding and allow the private sector to flourish.
Despite the devastation of February’s earthquake in Eastern Turkey, we returned from Istanbul with an overwhelming sense of excitement and optimism from our local interlocutors. For the first time in decades the opposition has a real chance to unseat Erdogan, due to both economic mismanagement and a poor handling of the earthquake response. We see Turkish credit as the cleanest way to pre-position for a positive election outcome given the over-valuation of domestic fixed-income assets and a highly volatile path for the Lira immediately after the election. Investors are broadly short Turkish assets, so we see potential for spreads to overshoot fair value on heavy short covering flows if Turks vote Erdogan out. A disputed election outcome is a risk and the view in the West is that Erdogan cannot afford to lose the election. On the other hand, locals believe Erdogan cannot afford to steal it. For the sake of the EM asset class, let’s hope Turkey’s institutions pass their test and the locals are correct.
