On November 1, Turkey’s president, Recep Erdogan, scored a resounding victory in the country’s general election when his ruling AKP party won 317 of the 550 seats in the Turkish Grand National Assembly.
In doing so, his government earned the right to form a government on its own.
Good news for investors, right? After all, a majority government brings greater certainty and clarity.
Not so much.
While investors in Turkey would have cheered the news 10 years ago, it’s not the same today.
Erdogan proved to be a good steward of the economy when he began his period in office back in 2002. But he’s lost his way since then.
His economic management over the past few years leaves much to be desired, and Turkey’s economic prospects remain clouded.
However, the country boasts some compelling upside…
A Speculator’s Dream
On the face of it, Turkey’s economy looks pretty decent.
It’s growing, with the International Monetary Fund (IMF) forecasting continued modest expansion of around 3% in both 2015 and 2016.
Dig a little deeper, though, and it looks more troubled.
The IMF also projects a current account deficit close to 5% of gross domestic product (GDP) and continued inflation in the high single digits.
In a year when Turkey has benefited immensely from the decline in oil prices and seen its currency decline by 24% against the dollar, that’s very unimpressive and suggests liquidity problems to come.
Add in the significant fact that Turkey is involved in the conflicts of the world’s nastiest neighborhood, and it’s a brave soul who ventures into Turkish investments.
Brave… but not stupid. As long as you play the situation right…
Turkey: From High to Low
There’s no question that when Erdogan came to power in 2002, he was an improvement on the secular big-spending socialists who had gone before.
He cut back the size of the state, reduced corruption, and encouraged Turkish businesses to thrive – as they did.
Turkey’s debt declined as a percentage of GDP and its budget moved towards balance.
By 2007, Turkey appeared to be a model emerging market.
Then came the financial crisis of 2008-2009, which threw Turkey off balance.
GDP slumped by 4.8% in 2009 and the country’s external deficit became difficult to finance.
Erdogan responded with loose credit and fiscal stimulus, pushing the central bank to lower interest rates when inflation was already close to 10%.
The measures served their purpose as a quick hit, with a rapid economic recovery. But once the rush wore off, 2011 saw a balance of payments deficit of 9.7% of GDP, which bumped up against the limits of Turkey’s financing capacity.
Spend or Save?
Since then the budget deficit has shrunk to 1.9% of GDP this year, but the balance of payments deficit remains high.
At the same time, growth has slowed, although the fall in oil prices has improved matters somewhat.
However, the lira’s big drop against the dollar over the past year is a doubled-edged sword. While it’s made Turkish exports more competitive, it’s also reawakened inflation fears.
Inflation is down from last year’s 9%, but The Economist still forecasts it to run uncomfortably hot at 7.5% this year.
The new government now faces a choice…
Either cut the budget deficit further and allow the central bank to increase interest rates, or embark on a course of populist public spending, and hope that continued favorable international markets will allow the country to borrow its way out of trouble.
With short-term interest rates currently over 11%, they’re still high enough and sufficiently far above inflation to suggest that further monetary stimulus ought not to be immediately suicidal.
For bold investors with an eye for some compelling speculation, this situation offers an intriguing opportunity…
Your Best Bet on a Turkish Turnaround
The best (and safest) way to play Turkey is through the iShares MSCI Turkey ETF (TUR).
Like many emerging market funds, it’s delivered a frankly woeful performance in recent years – down 44% over the past five years.
But if you believe in buying low (and I assume you do), that’s resulted in a price-to-earnings (P/E) ratio of 10, making it a bargain in today’s markets. The $370 million fund also boasts a 2.7% yield and a competitive 0.62% expense ratio.
Granted, Turkey’s economic picture is complicated by the fact that it sits in the world’s most troubled region – right next door to a three-way civil war in Syria.
Traditionally, Turkey has opposed Syrian strongman Bashar al-Assad and favored the moderate rebels against his rule. But Turkey is also reluctant to allow Syrian and Iraqi Kurds to set up their own state – a move that could destabilize Turkey’s Kurdish minority.
On the plus side, Erdogan shares a good relationship with Vladimir Putin, who’s taking an increasingly aggressive role in the region. But the twin dangers of further violence in Turkey itself, as well as demands for additional military spending, could cloud the fiscal and economic picture.
So keep in mind that there are tangible risks here.
But as far as the prospects of a turnaround go, Turkey has a stout economy and a government that at least knows how to govern economically competently and isn’t committed to fallacious Keynesian doctrines.
Moreover, the iShares MSCI Turkey ETF looks cheap right now.