Wednesday, 15 August 2018

Shifting equilibrium

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Investors flocked to Turkish assets in the second half of last year, seeing the country as a direct proxy for Russia minus the sanctions. Yet they’re departing now in droves, worried by a troubled economy, a rudderless government and yet more political uncertainty.

Life, as the class-cutting film character Ferris Bueller once noticed, moves pretty fast. Blink, and you could miss it.

The same is true of modern flows of institutional money. Capital these days falls in and out of love with sovereigns, and the assets held and listed within them, with the pace and fickleness of hormonal teenagers. One minute, fund managers are having a love-in with a country’s debt and equity securities; the next, they’re being tossed into a garbage can marked “hazardous: do not touch”.

Turkey knows the feeling all too well. Last year, investors flocked to domestically domiciled assets, snapping up Turkish debt and equity securities. Some funds used the country as a direct hedge against a Russian government struggling to temper rising inflation and Western sanctions stemming from its Ukraine misadventures. As oil prices tumbled, more capital flooded in to benefit from Turkey’s energy-scarce economy.

“Most investors liked Turkey going into the [new] year,” said Marcus Svedberg, chief economist at emerging market investment manager East Capital.

Yet that positive story has reversed remarkably quickly, with investors becoming unsettled by inflation, flagging growth, and a new bout of political uncertainty ahead of general elections slated for June 7.

“Sentiment changes rapidly in high-beta markets like Turkey,” Svedberg said. “During the second half of last year, investors increased their exposure to Turkey on the back of the falling oil price and smooth political transition. We have seen the reversal of that now.”

There is still time for the equilibrium to shift again and for investors to return, particularly if the US Fed opts to delay any decision to move towards a tighter monetary policy. Yet the signs point to a period of renewed turbulence, as investors continue to pull away from assets across developing nations.

Turkey CDS spreads widened by more than 40bp between October and mid-April, according to data from Markit. The lira tumbled by 25% against the US dollar over that period, reflecting declines in other prominent emerging market currencies such as the Brazilian Real (down 34%) and the South African rand (off 14%).

Guillaume Tresca, senior emerging market strategist at Credit Agricole, said foreign sentiment towards Turkish assets had “changed, turning more negative than [it was] two years ago”. He traced that deterioration back first to May 2013 and the Fed’s first mention of attempts to pare back government bond purchases, and second to rising expectations of a looming US rate hike.

External vulnerabilities

Both themes had cooled investors’ ardour for domestic assets. One prominent analyst pointed to the country’s “serious” external vulnerabilities, notably a large current account deficit. Others pointed to the feud between President Recep Tayyip Erdogan and his acolytes in the ruling AKP Party, and central bank chief Erdem Basci as another factor that continued to weigh upon the lira.

Political uncertainty is another factor giving investors pause for thought. If the AKP fails to secure a two-thirds majority in the June poll, it will leave the country with a president with little genuine power, yet who may be inclined to continue to press and pull the economic levers.

That ambiguity, said Selim Kervanci, HSBC head of capital financing, MENA and Turkey, had forced investors to adopt a “wait-and-see” approach to Turkish assets.

“When it comes to overall investor behaviour on Turkey, we’re seeing investors becoming more cautious, monitoring political developments in the run-up to the June 7 elections,” he said. “Factors such as the profile of the new government and economic administration will obviously be taken into account by investors post-election.”

Kervanci tipped activity to pick up after the election across “a range of sectors and products”, so long as political uncertainty subsided.

Sporadic scattering

There are, then, reasons for hope, albeit of the cautious variety. Deals small and large continue to scatter the markets. In April, privately owned development bank TSKB’s second incursion into the debt market, a US$350m, five-year 2020 Reg S bond issue at 375bp over mid-swaps with a 5.125% coupon, was a notable success.

In the final week of April, Global Ports Holding opened the books on its Istanbul IPO, but as this report went to press, the company threw in the towel on its plan for a TL641.8m–TL760.5m (US$236.5m–$280m) largely local Istanbul listing. The announcement came despite an institutional books covered message and a same day message that the European Bank for Reconstruction and Development would participate in the flotation.

The EBRD said it was taking up to 20% of the IPO, with a cap of US$60m. Bankers working on the transaction said although books were covered, there was not a level of subscription that provided comfort for the aftermarket. With local demand lower than had been expected, an attempt to rescue the deal took place over the weekend of May 9, but ultimately the decision was taken to cancel.

Global Ports will now look at strategic and private equity funding options.

Debt and equity capital market bankers say there is good reason to expect a steady rise in dealflow, once the election is out of the way.

“We are getting a lot of enquiries when it comes to IPO listings. The number of active discussions has tripled in three years as more issuers look to broaden their financing options,” said Julian Macedo, co-head of ECM, CEEMENA, at Barclays.

Many eyes in the equity space are now on the flotation of Borsa Istanbul, which could take place this year, valuing Turkey’s leading stock exchange at between US$1bn and US$2bn.

“We hope this IPO will send a very clear signal about what sort of deal government and regulators would like to see from the private sector,” said Baris Efe, director, Turkey and Central Asia, at Barclays. “It should reflect potential for growth in Turkey and in the wider region.”

It is to these and other prevailing factors that fund managers look when seeking reasons to believe in the country’s near and long-term potential. At around 3%, economic growth is lower than it should be, but a far sight better than the pace of expansion found anywhere across the eurozone. Unemployment and inflation remain concerns, as does a widening capital account deficit, but domestic dealflow continues, if sometimes somewhat belatedly.

Yet factors continue to work in its favour, not least a strong regulatory fabric and lower input costs. Oil prices, despite rising through the early spring, remained at around US$65 a barrel in mid-April.

It is this factor that encourages Kathleen Middlemiss, UBS head of emerging EMEA and Latin America credit research, to describe Turkey’s prospects as “neutral to moderately bullish”.

“The thing impacting on Turkey positively is low oil prices,” she said. “They are good for Turkey, and until that turns around, investors will continue to retain an appetite for Turkish assets.”

Others cling to the hope that the pace of reform, which has slowed markedly in recent years, will accelerate again following general elections in June.

“Structural reforms,” said Credit Agricole’s Tresca, “should lead to a narrowing of the current account deficit, reducing pressure on the budget and boosting, if only mildly, foreign investor appetite for domestic assets.”

HSBC’s Kervanci notes that Turkey, for all of its diverse and scattered concern, remains the third-largest destination for global institutional capital, after Russia and South Africa, in Central and Eastern Europe, the Middle East and Africa. That, Kervanci said, “offers room for further outperformance given the relatively lower weight of global emerging markets equity funds”.

“Structural reforms should lead to a narrowing of the current account deficit, reducing pressure on the budget and boosting, if only mildly, foreign investor appetite for domestic assets”

And for those willing to wipe the fog from their eyes, it’s worth remembering what Turkey is, and what it stands for: a large and largely well-run economy perfectly positioned to serve Europe and Asia, Russia and Africa, and an emerging Iran. Funds from the Middle East and Asia are becoming regular buyers of Turkish debt and equity securities, joining European and North American institutional buyers.

At its heart, said Jean-Patrick Marquet, director, Turkey, at the European Bank for Reconstruction and Development, this remains a “big, attractive market with rising energy needs, a well-capitalised banking system, and a consistent policy over big-ticket investments. The business environment is solid, particularly when it comes to major infrastructure projects. And there is enough liquidity in the system.”

The last few months have been tough going for Turkey’s economy, but many see good news around the corner, with rising issuance, a return to political normalcy and a pick-up in the pace of reforms.


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