A shift towards more orthodox policies and less political interference is necessary for there to be a change to investor sentiment towards Turkey
Recep Tayyip Erdoğan has now been elected as president of Turkey for another five years, until 2028, when he will not be eligible for re-election according to the constitution. All eyes are now on the composition of the president’s new economic team, the nature of the initial policy response and a road map for macroeconomic reforms.
There seems to be some market expectation of a positive policy shift, based on rumoured market-friendly appointments, such as Mehmet Simsek as minister of finance, which has contributed to the strong performance of Turkish bonds since the election. Only time will tell if this is a case of buy the rumour, sell the fact.
However, given Mr Erdoğan’s choice of unorthodox policies over his last two decades in power, it is hard to see him implementing any material changes despite some views about his ability to be pragmatic. In 2021, Naci Agbal, the last orthodox central banker to serve under Mr Erdoğan, was sacked only four months into the job for raising rates aggressively. Also, with municipal elections in March 2024, it would be unlikely that Mr Erdoğan would want negative news such as rate hikes or foreign exchange (FX) volatility ahead of those elections, so it will be interesting to see what, if any, positive policy shifts the rumoured market-friendly appointees can effect.
From a corporate investor perspective, the extremely low reserves level in Turkey (gross reserves are $101.6bn, with net reserves -$60bn), remains a concern which limits investment appeal. It incentivises the government to adopt desperate measures which could put additional pressure on the companies such as directives to repatriate FX cash for exporters, caps on price increases on goods/services to fight inflation, and maybe in more desperate times even actions such as retrospective tax bills/fines or even asset appropriation.
We have also seen the central bank asking local lenders to reduce their daily foreign currency purchases on the interbank market, as it continues to try to manage depreciation pressure on the lira. Lenders were also asked to direct firms’ demand for hard currencies to non-deliverable forwards. Historically, a high level of dollarisation has been driving significant FX sensitivity of Turkish credits to lira fluctuation.
For banks, however, there has been a notable regulatory push to reduce the level of FX penetration in the system, whereas corporates have been either hedging their FX exposures or tried to minimise the mismatch via expanding their international business or growing their exports.
Despite the unsettled macro backdrop, over the years Turkish companies have been largely resilient and post-election we expect them to continue to attempt to run their operations as best they can given the macro backdrop. Over the last year or so, Turkish corporates were largely able to adjust their operations to the high inflation environment, passing though some of the cost increases to the end customers.
While there has been a slight increase in leverage in the first quarter of 2023, overall debt levels remain broadly stable. Looking to history as a guide for Turkish corporates, even under previous significant currency weakening episodes, companies in Turkey have remained broadly resilient, with net leverage not exceeding five times for most of the issuers. Banks have been maintaining their sizeable capital buffers. At the same time, somewhat weak appetite for lending has kept NPL ratios manageable.
Turkish corporate credit spreads have widened since the beginning of the year and are currently just inside the spread levels of single B segment of the index. The broader market’s negative bias towards the Turkey complex unless there is a shift towards orthodox monetary policy is likely to limit any significant upside in the trading levels. Whereas normalisation of monetary and fiscal policies post-election could drive some repricing as investors could look to reduce their underweights.
Only time will tell if this time is different to after other recent Turkish elections. But it is difficult to be optimistic on Turkish corporate risk assets without a solid sovereign anchor. As highlighted above, the main concern is that the government resorts to desperate measures which impeded the ability of the corporate issuers to service their hard currency debt obligations, such as restricting FX transactions for individuals or corporates, as they try to control the exchange rate, as has been seen in Argentina.
Omotunde Lawal is head of emerging markets corporate debt at Barings
