The failed coup attempt in Turkey, resulting in one of the largest purges in democratic society’s history, has not changed the regional economic outlook to any meaningful degree, a UBS research piece noted. Its still a buy based on valuation among other issues, as the Swiss-based investment bank reiterates its original overweight rating. Other banks are not so certain, taking a more wait and see attitude while recognizing the potential value play.
Authoritarianism no concern to UBS, who says Turkey a buy
Turkey, a traditionally secular nation amid a majority Islamic population, is a statistical rarity. Turkey has been one of the rare majority Islamic nations in the world. At least in theory the democracy supported journalistic free speech, a trend of freedom that changed under Islamist-backed President Recep Tayyip Erdogan. Not only did he crack down on free speech – the country is among the world leaders in jailing journalists, famous for restricting social media access – but a new level of corruption was said to have taken place under his leadership.
Earlier in the year a coup against Erdogan had been previously discussed in independent research analysis and press reports. Perhaps most on point is the New York Times in a July 5 piece by Sabrina Tavernise that foretold a leader who was “”seizing the title of president for life.”
Not only was Erdogan in a raw power grab, but there was a growing financial component. The level of corruption around Erdogan and his children was said to have reached epidemic proportion, with the arrest of Reza Zarrab pointing to a relative independent judiciary in Turkey. The arrest follows a December 17 raid by Turkish law enforcement officials that included prominent figures in Erdogan’s government, including detaining sons of the ministers. Authorities in separate cases had questioned Erdogan’s sons.
As a result of an independent judiciary – a cornerstone of democratic principles – Erdogan was reported to have become pensive and increasingly suspicious of a coup attempt. He worked hard to mute independent journalism and subdue an independent judiciary. With the recent coup attempt, those moves are in high gear.
The death toll in the coup attempt is currently estimated at over 250, including 24 coup plotters. In the failed coup attempt’s aftermath 8,000 police officers had their authority removed and are under suspicion in the coup plot. Thirty regional governors and 50 high-ranking civil servants were also dismissed.
Erdogan blamed a 75 year-old exiled Iman, Fethullah Gulen, for the coup and then locked down the US base in Turkey – one that contains nuclear missiles. Erdogan then appeared to directly confront the US before officials were quick to put a damper on the outburst.
Erdogan is on a roll. A historic purge of not just government officials but democratic principles is underway. From an investing standpoint, none of this race to authoritarianism seems to matter to UBS. The nation that currently holds more Middle East war refugees than any, Turkey, is a buy.
UBS likes Turkey based primarily on valuation issues
The early analysis from UBS is generally positive. The July 18 report titled “Turkey: what’s next after the coup attempt?” took the politically correct look at the situation. This view of the world scrubs the word’s “authoritarianism” from the vocabulary and doesn’t directly consider the economic impact growing dictatorial forces might have on free markets in the region. Nor is there any analysis of the early bluster from Erdogan in appearing to confront the US.
“We stay Overweight in Turkey,” the report touts as it doesn’t seem much investment impact in the near term. “Macro fallout from these events is unclear but seems likely to be limited,” the report said. There are numerous points of hedging in the analysis, and outside the “cheapness” of equity valuations, the long-term outlook might not be as rosy.
“The subsequent easing of tensions over the weekend may result in most of these losses being recouped,” the report said of a near 5% early slide in certain Turkish assets. “However we expect any outperformance to soon dissipate, given sequential current account deterioration, a dovish central bank backdrop, and waning growth momentum. In rates, Turkish bonds have seen strong foreign inflows in recent months and the market does not screen as particularly attractive under our debt scorecard framework.”
Like Donald Trump, Erdogan likes low interest rates
Erdogan has been a strong advocate of low interest rates and has been reported to work to impinge the independence of its central bank. He was reported to have “backed off” central bank confrontation last year. Without specifically mentioning any of the history Erdogan has publically jawboning and privately arm twisting central bank officials, UBS thinks stimulus, a move Erdogan backs to keep interest rates low, might be a future possibility path.
There are two “important areas of uncertainty” that frame the analysis. Will the coup generate a “visible” shift in military support towards Erdogan? Will this failed coup attempt result in Erdogan successfully implementing “a shift to an executive presidential system.” In other words, a move away from democracy.
This appears a polite method of saying authoritarianism is increasing. Perhaps the most interesting question to consider is impact an increasing authoritarian system has on economic growth? In other words, is the “cheap” level of Turkish market valuations a way of pricing in the authoritarian risk and potential policy shift away from the US? UBS didn’t go there.
Jefferies takes a more nuanced look at the world, downgrades Turkey
Jefferies chief Global Equity Strategist Sean Darby and Quantitative Strategist Kenneth Chan downgraded Turkey from “Modestly Bearish” to “Bearish” in the firm’s global asset allocation.
“Well before the coup, Turkey has been one of the biggest beneficiaries of the drop in crude oil prices since mid-2014 but this had been to some extent offset by much weaker tourism numbers due to geopolitical concerns and portfolio outflows on domestic politics,” the July 18 report said. “The risks for Turkey are asymmetric – capital inflows in the past have supported the real economy while any pronounced weakness in the currency will adversely affect the banking system, which is once again heavily indebted to foreign investors and where the majority of the debt is denominated in foreign currencies.”
In their Daily Bulletin, Burgan Securities was muted if slightly upbeat. “The BIST-100 Index is likely to make a negative start, as investors will assess the long term damage and question geopolitical stability. Some recovery is possible, after the post-coup fallout today.”
Deutsche Bank looked at Turkey’s impact on markets, which it forecast will increase the spotlight on the region. “We expect Turkey to be a focus of the markets this week,” a July 18 report said. “We think the biggest risk for European Banks in Turkey may come in the form of currency volatility, as well as concerns for knock-on effects on the economy.”
Goldman Sachs, for its part, wasn’t so sure about the coup’s impact. Like Deutsche Bank, Goldman thinks the Turkish banking sector will come under pressure.
Turkish banks under GS coverage (except Halk -9%) are up 24% ytd on average and may see some selling pressure post outperformance vs. MCSI EM EMEA. Akbank (Buy on CEEMEA FL) and Garanti (Buy) screen as relatively stronger on our ‘4Cs’ framework but are likely to give up some of their ytd gains especially as they now trade above book value. We view Vakif (Sell on CEEMEA FL) and Yapi Kredi as more vulnerable to mediumterm sector pressures due to their relatively weak capital and provision buffers. Moreover, Vakif screens as the most sensitive to higher TL deposit costs given its higher reliance on net interest income and TL funding.
Goldman, for its part, sees an initial market dip but the future appears less clear with a potential recovery. “We expect the weekend’s events to weigh negatively on Turkish markets on Monday (July 18) as investors will likely incorporate higher risk perception and in turn, a higher cost of equity.”
Capital Economics opines:
The key point from an economic perspective is that Turkey has a low domestic savings rate, making the economy reliant on capital from overseas to finance investment and improve the capital stock. That in turn requires a stable and predictable political environment and improvements in the business environment. (See for example our Focus, “Why Turkish savings need to rise”, 15th July 2013.) It’s notable that the improvements in governance seen in the early 2000s coincided with faster and steadier growth, as well as lower inflation, compared with the politically-tumultuous 1980s and 1990s. The current direction of Turkish politics implies a slower and more volatile growth path.
• For now, we are sticking to our growth forecasts, which at 2.5% in 2017 and 2.8% in 2018, were already right at the bottom of consensus range. But we will revisit these as the dust settles.