Fund managers warn it will be a “grotesquely difficult” task to rebuild Turkey’s economy and regain credibility among foreign investors, regardless of which party wins this month’s disputed elections.
Kemal Kılıçdaroğlu, who leads a coalition of six opposition parties, has vowed to embark on sweeping reforms to attract foreign capital that has fled over the past decade if he ousts Turkey’s longtime leader Recep Tayyip Erdoğan in a May 14 presidential election.
But while fund managers say change is needed, some warn that even if the opposition wins, investors will stand on the sidelines until the coalition proves it can make lasting change.
Turkey has “a lot of variables that are in the wrong place and getting them in the right place is going to be grotesquely difficult,” said Paul McNamara, director of investments focused on emerging markets at fund manager GAM in London. “Is the money out there? Absolutely yes. Will people be in a hurry to insert it? I do not believe.
The cautious investor sentiment comes as Erdoğan fights his toughest re-election campaign after two decades in power. Polls show that Kılıçdaroğlu and Erdoğan are engaged in a very close battle just days before the election, with voters betting on the economy as central.
Erdoğan’s unconventional economic policies, including a long-standing objection to raising interest rates, helped send inflation above 85% in October, while the lira tumbled nearly 60% in the last two years to an all-time low against the dollar.
Concerns about Turkey’s economic trajectory and an ever-increasing number of measures to ease pressure on the lira have investors fleeing. “This is a market almost completely abandoned by foreigners,” said Emre Akcakmak, a senior advisor at East Capital, a fund manager specializing in emerging markets.
Less than 1% of Turkey’s domestic public debt is owned by foreigners, down from about a quarter a decade ago. The banking system, including domestic banks and Turkish affiliates of foreign lenders, now owns nearly 80 percent of the stock of local sovereign debt up from less than 50 percent in 2013, finance ministry data show.
A similar trend has taken hold in the Turkish stock market, where international investors have grabbed $7.3 billion over the past decade, according to Goldman Sachs.
“Investor allocations in Turkey have rarely been lower,” said Kieran Curtis, head of emerging markets local currency debt at UK-based asset manager Abrdn.
Akcakmak said Turkey was approaching a “breaking point” under current policies, especially as the central bank’s foreign exchange reserves were “almost depleted”.
The central bank has burned through reserves, economists say, while politicians have tried to support the lira. Net foreign assets, a gauge of the size of Turkey’s foreign currency war chest, are minus $10 billion even after accounting for more than $30 billion of funds borrowed from local banks through short-term loans known as “swaps”. ”, data from the Turkish central bank and shows from Goldman Sachs.
Some analysts expect Erdoğan to switch to a more conventional economic policy if he wins the election. This speculation has been reinforced by the president’s recent courtship of Mehmet Şimşek, a former deputy prime minister who is well regarded by foreign investors but who left the government in 2018 when Erdoğan installed his son-in-law as finance minister.
“Self [Erdoğan] was to change his point of view and adopt a more conventional policy, it will be very well received,” said a senior capital markets banker focused on emerging markets at a major Wall Street bank, adding that if Erdoğan wins, he could “realize that now is the time it can pivot and attract foreign funds again.
Curtis added that “the market, it really doesn’t matter who is making the policy, it’s a matter of them making the policy.”
Kılıçdaroğlu told the Financial Times last month that one of his priorities would be to turn the Turkish economy around, including creating an independent central bank rather than the current system where Erdoğan effectively controls interest rate policy .
Investors worry that a major policy adjustment, while important in the long run, will be painful in the short term. Curtis said many investors expect Turkey’s benchmark interest rate will have to be raised over time from 8.5% today to as high as 40% to show the country is making a credible effort to tame inflation.
An interest rate hike of that magnitude would trigger a major sell-off in Turkey’s domestic bond market, Curtis said, something that would be “pretty dire for foreign investment” in the near term. “You have to be patient,” she said. McNamara said this process will also hurt national banks as they now own such a large share of local bonds.
The Erdoğan administration has also increasingly relied on other tools to stabilize the lira, including introducing special savings accounts in 2021 that repay depositors if the lira weakens against foreign currencies. These accounts have been instrumental in keeping local residents from buying dollars, and many analysts and investors say this is one of the main reasons the lira has remained broadly stable in recent months.
These accounts hold $102 billion, according to Turkey’s bank regulator, and economists say they could pose a big risk to the government’s budget if the lira depreciates rapidly, as depositors would be repaid if the currency were to default. . Similarly, liquidating these accounts could prove difficult because holders could choose to buy dollars and euros en masse, which would send the lira plummeting.
“All the steps of the opposition [would] pursuing it (to fix the economy) will put obstacles in the way,” Akcakmak said, who added that investors “are waiting for turning points in the economy and economic management” before deciding to exit the sidelines.
“Whatever happens, it will be a difficult time for Turkey,” Curtis said.
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