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What’s next in Turkey?

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Erdinç Benli (pictured), Investment Director for Emerging Market Equity strategies at GAM comments on the outlook for Turkey

Why was the coup unsuccessful? The Turkish government thwarted an attempt by a faction of the army to gain control of the state at the weekend. Thousands of citizens helped to prevent the mobilisation of the military by following politicians’ calls to gather in public places. The coup also failed to find support with political opposition parties, or to secure widespread military backing. The government now seems to have regained control and thousands of soldiers, high-ranking generals, and policemen involved in the coup have been arrested.
 
What does it mean for the economy? There was already a heightened level of political uncertainty in Turkey and the attempted military coup has only served to increase this. Statements from politicians and commentators indicate that the risk of a snap election is currently low. This would potentially increase the power of AKP and strengthen the move towards a presidential system. Turkey’s economy has performed surprising well recently. However, following the terror attack at Istanbul airport and the attempted coup, Turkey’s economy is expected to decelerate from +3.5% GDP growth for 2016.
 
Tourism was already falling sharply and is expected to continue to do so. New investment projects will most likely be put on hold until the dust settles and the political situation stabilises. Investors will be watching closely whether the government handles judicial proceedings democratically, with respect to the rule of law and institutions.
 
The Turkish Lira will come under pressure due to initial outflows in private as well as institutional portfolios. Should it remain consistently weak, inflation expectations will increase and weaken the currency further. Turkey’s dependence on foreign capital inflows to finance its large current account deficit is a cause for concern. Weaker currency and higher inflation could limit the Central Bank’s ability to lower rates in order to support the economy. According to Deputy Prime Minister Mehmet Simsek, Turkey will let the market find its equilibrium and not intervene to support the Turkish Lira. The Central Bank will provide as much liquidity to banks as needed to ensure that markets continue to function properly. This should help save scarce foreign exchange reserves.
 
What is the effect on equities? Higher political uncertainty increases the risk premia that investors are demanding for investing in Turkish assets. Due to recent accumulation of (geo-) political events, including two elections, a change of government, a conflict at its south-eastern borders, and the dispute with Russia, the question arises whether the risk premia should be structurally higher versus historic average. To counteract this development and regain some investor confidence, the government could now speed up the long awaited structural reforms and handle legal proceedings related to the coup democratically.
 
In the short term, the obvious sector under pressure will be tourism, including listed stocks like airlines, airports and financials, due to higher financing costs. We have no or below average exposure to these sectors.
 
It is too early to judge whether those consumers who were the main drivers of the recent economic growth will change their spending habits. We will be closely watching economic indicators in this area, including whether private households increase their foreign currency holdings at the expense of the Turkish Lira.
 
In order to lower the risk in our portfolio, we reduced our holdings in Turkey. We will also be closely monitoring the government’s actions before revisiting investments in Turkey. For the moment, attractive valuations will not be the main driver for stock price appreciation. But once the dust settles – and the government moves in the right direction – there will be an opportunity to pick up stocks with ample upside.

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