Lira market poised for news on new AKP government

Solomon Teague
Published on:

The AKP’s surprise victory last weekend added momentum to a lira relief rally that had begun in the run-up to the election, with some investors punting a strong government will kick-start reforms stalled since Turkey’s last election in June – but the rally is likely to prove short lived unless PM Davutoglu makes reputable appointments in key economic posts.

Turkey election Erdogan Davutoglu-R-600

The collapse in the price of oil should have set the scene for a year of outperformance for the lira and the Turkish economy generally, given its status as an oil-importing emerging market. It has certainly provided some respite.

October figures put its current-account deficit at $163 million, the lowest since 2009, while Fitch states it will narrow to 4.6% of GDP from 5.8% in 2014. GDP growth has been better than expected too, with a 3.8% rise in Q2 2015 relative to the same period in 2014, while corporate earnings have also beaten expectations.

Yet despite this, the lira has suffered alongside commodity-exporting currencies such as the Brazilian real and the Russian rouble. The single biggest reason for this is the political risk investors see in Turkey – with two elections in the space of six months – which has deterred foreign investors, given a lack of clarity over the country’s economic and political model.

Actual and expected inflation (%)
Other problems have also contributed. Inflation has been creeping up: the central bank’s (CBRT) latest forecast in October put it at 7.9% for the end of this year, and 6.5% for the end of 2016.

Lira-denominated loan growth – often indicative of the mood in the Turkish economy, given how responsive this indicator is to changes in its relatively pro-cyclical monetary conditions – has been slowing, suggesting a cooling economy.

After a strong second half of 2014, extending into the early part of 2015, Turkey has found itself caught in a vicious cycle: low confidence has pushed down the lira, which pushes up inflation and then rates, further undermining confidence.

In the run-up to the election, this cycle was broken, with lira gaining ground before and after AKP’s victory. The question is whether this is a temporary blip or whether a more positive feedback loop can be maintained.

HSBC attributes the lira’s initial rally in large part to the lack of foreign positioning in the local market, and the fact Turkey’s current-account deficit has been gradually narrowing. However, the bank is cautious on its prospects in the medium term.

Société Générale is equally cautious in its assessment. Kit Juckes, macro strategist at the French bank, believes the euphoria surrounding the lira will prove "highly unsustainable as long as the CBRT does not follow through with its inflation-targeting mandate and AKP does not prioritize long-overdue structural domestic reform".

Much therefore depends on which AKP, and which president Recep Tayyip Erdogan, is seen ruling Turkey in the coming years: the reformists of their early years, or the autocratic and divisive figures seen of late.

Erdogan will need to demonstrate skilful statesmanship to steer the country in the opposite direction, say analysts.

Stocks are cheap, yields are high, the lira is weak.
So there is scope for this base to build some momentum.
But that can only go so far

Emre Akcakmak, East Capital

Even if the country makes great strides reducing the current-account deficit and inflation, foreign direct investment will quickly dry up if investors fear the prospect of a continued civil strife – given a deeply divided election – or a spike in terrorism.

Market players are, in general, bearish and reckon the lira is set to further depreciate in the medium term. Capital Economics forecasts the lira will weaken to around 3.50/$ by the end of 2017 – bang in line with projections in the forward market – from 2.81/$ earlier this week.

However, Erdinç Benli, co-head of global emerging market equities at GAM, is optimistic that, at heart, Erdogan remains the pro-market force that so impressed investors in the early days of AKP rule.

"Erdogan is still market-orientated since his power also depends on the wealth of Turkish people," he says. "The evidence for this is in the last 18 months, when the economy slowed, inflation increased, the lira fell and he lost votes in June.

"The economy is very important to him and his focus will be on delivering growth. When the economy is good, it gives you room to pursue your political goals."

Emre Akcakmak, portfolio manager at East Capital, says the perception of Erdogan, and AKP, has probably changed more than the underlying reality.

"The perception of AKP depends also on expectations," he says. "When it was first elected, it had no track record and investors had low expectations of it. In the early days, its strong performance on reform and its commitment to the EU accession process surprised on the upside."