A ‘Turkey’ shoot — what happened?


A combination of external developments and domestic events hit investor sentiment and capital flight from financial assets related to Turkey.

Sanctions by the Trump administration on Turkey (50% tariffs on Turkish steel and 20% on Turkish aluminium) and a loss of confidence in the Erdogan administration’s ability and willingness to deliver market-friendly and pro-business measures triggered the crisis.

The Turkish lira has collapsed more than 29% against the US dollar since the start of August. Month-to-date, the currency is down slightly more than 16% against the green- back (as of Aug 17, 2018).

The lira has plunged more than 15% against the ringgit.

Yields of Turkish sovereign bonds and credit default swap spreads on them have risen as market participants panicked over the latest developments.

The 10-year US dollar-denominated government bond has seen its yield rising from 7.38% to 8.41%, while the local-currency 10-year bond saw its yield surging by a total of 268 basis points (to 21.18%) within just six trading sessions!

Turkish equities did not suffer a brutal collapse but have been weak since the start of the second quarter (2Q). Year to date, the Istanbul 100 Index is down 21.7% in lira terms (as of Aug 16, 2018).

Turkish equity-based exchange-traded funds (ETFs) plunged heftily last week, with the iShares MSCI Turkey ETF listed on the NASDAQ gap- ping down and closing more than 10% within the Aug 13 trading session last week. This movement was largely driven by the fall in the Turkish lira.

The lira crisis signals a loss of confidence in the Erdogan administration and market

action last week was just an exacerbation of a deteriorating economic situation in Turkey.

Turkey suffers from a “twin deficit” of budget and current account deficits. While politically difficult to administer, fiscal tightening measures are needed in order to restore confidence in the Turkish government and to allay investors’ concerns.

The country’s external position has been gradually deteriorating for more than a year, as the current account deficit continues to rise and came in at -6.3% of overall gross domes- tic product at the end of 1Q.

This “twin deficit” situation has naturally led to a decline in the country’s nominal exchange rate as economic logic assumes.

The collapse in the Turkish currency should bring about positive adjustments to the current account as import demand falls following a weakening of corporate and consumer purchasing power and exports become more competitive.

This cannot be considered a proper panacea for current woes. Inflation in Turkey has been higher than desired.

Monetary policymakers have to tighten policy to bring inflationary pressures within control, and this is all the more pertinent given inflation is expected to be rampant given the lira’s fall in value.

No matter what the option (whether fiscal and/or monetary tightening occurs), economic growth momentum is expected to decline as corporations grapple with new government policies and household consumption is affected.

Investors should note that Turkey remains a relatively small weightage in the emerging market (EM) space, and as such, the near-term impact is mainly due to general risk-aversion.

Sell-offs in the currencies and asset of certain EMs (such as Latin America) may be overdone given they have little economic connections to Turkey.

Certain eurozone banks from the periphery with expo- sure to Turkish assets may be slightly affected should the situation deteriorate.

However, the wider macroeconomic effects or impact to the eurozone are likely to be limited at this juncture.

Policy missteps by the Turkish government, however, will come at a severe cost.

Investors should not panic, and in fact, welcome the panic in markets as a better entry point to add risk to attractive assets and market segments they like.