Some Brief Thoughts on Turkey

new turkeyTensions between the US and Turkey are rising.  Taken together with poor economic fundamentals, we believe Turkish assets are likely to continue underperforming.


The US suspended visa services for tourists from Turkey.  This came after an employee at the US Consulate in Istanbul was arrested.  Turkey responded with a similar move on visas for US travelers.  Frankly, this sort of spat between NATO allies is highly unusual but caps off months of escalating tensions.  The visa ban puts Turkey in the same group as Chad, Iran, Libya, North Korea, Syria, Venezuela, and Yemen, which have all had travel restrictions imposed this year by the US.

This is just the latest chapter, as relations between the two nations have worsened since the July 2016 coup attempt.  President Erdogan blames exiled cleric Gulen for the coup attempt, and has asked him to be extradited by the US.  For lack of evidence, the US has refused.  Some Turkish officials have even accused the US of direct involvement in the coup attempt.

Poor relations with the US and the EU have pushed Turkey closer to Russia.  This is remarkable coming after years of tensions stemming from Turkey shooting down a Russian plane in its airspace.  Turkish troops are preparing to deepen their involvement in Syria, where Turkey is planning a joint mission with Russia and Iran to create a combat-free zone in the province of Idlib.

Iraqi Kurds voted overwhelmingly for independence last month.  This is also keeping regional tensions high, with President Erdogan concerned that Turkish Kurds may take similar actions.  US support for Syrian Kurds has been a sore point for Erdogan.



According to Turkey’s tourist authorities, around 37,000 from the US traveled to Turkey in 2016.  This is less than 2% of the total but still down sharply from 88,301 US visitors in 2015.  Overall foreign arrivals contracted sharply y/y in 2015 and 2016 due to ongoing security concerns, but have risen y/y over the past five months.

With regards to the potential trade impact, the US is Turkey’s fifth biggest export market.  For the US, Turkey is not even in the top 15 export destinations.  Bottom line:  Turkey stands to lose more than the US does if the tensions spill over into the economic arena.  More importantly, we think that the post-coup crackdown measures taken by Turkey have basically killed its chances to enter the EU.  The impact of the tourism spat will most likely pale in comparison to the lost potential benefits of EU integration.



The lira continues to underperform, as it did in 2016.  In 2016, TRY fell -17% vs. USD and was ahead of only the worst performer ARS (-18%).  So far in 2017, TRY is -5.3% YTD and is ahead of only the worst EM performer ARS (-9.0%).  Our EM FX model shows the lira to have VERY WEAK fundamentals, so this year’s underperformance is likely to continue.

Foreign reserves have steadied after falling over the course of 2015 and 2016.  At $91.5 bln in September, they cover nearly 4 ½ months of import but account for only half of the stock of short-term external debt.  This is the amongst the worst in EM.  Indeed, there are only a handful in EM whose reserves are smaller than short-term external debt.  Besides Turkey, these include Malaysia, Ukraine, and South Africa.  Furthermore, so-called usable reserves (which net out commercial bank FX deposits at the central bank) stand at only $28.8 bln currently.

USD/TRY couldn’t sustain a break below 3.40 last month and turned higher.  The low for this move was recorded on September 11.  Break of the 3.73 area sets up a test of the all-time high from January near 3.94.  In between is the April 7 high near 3.75.  We think the high carry currencies that were so popular earlier this year will continue to fall out of favor now that the Fed will start shrinking its balance sheet and continue hiking rates.

Turkish equities are outperforming EM after underperforming in 2016.  In 2016, MSCI Turkey rose 4% vs. 7% for MSCI EM.  So far this year, MSCI Turkey is up 29% YTD and compares to 28% YTD for MSCI EM.  This outperformance should continue, as our EM Equity model has Turkey at an OVERWEIGHT position.

Turkish bonds have performed poorly this year.  The yield on 10-year local currency government bonds is +2 bp YTD.  This is amongst the worst in EM, behind only the worst performers Czech Republic (+95 bp), China (+63 bp), Korea (+31 bp), India (+26 bp), and Chile (+8 bp).  With inflation likely to continue rising and the central bank likely to fall further behind the curve, we think Turkish bonds will start underperforming even more.

Our own sovereign ratings model showed Turkey’s implied rating worsening a notch for the second straight quarter to B+/B1/B+.  We think Turkey continues to face strong downgrade risks to its BB/Ba1/BB+ ratings.