- The unorthodox policy which prioritises GDP growth over all else is leading Turkey into trouble once again
- Either a sharp slowdown or rate hikes are needed to tame accelerating inflation, and both imply a weaker FX rate
- Turkish corporates are resilient and their equity valuations are cheap, but undermined by unorthodox macro policy
Inflation is accelerating again in Turkey (11.39% yoy in May, following 10.94% in April). A policy mindset that is loathed to hike interest rates means that inflation is only going to be tamed after a sharp slowdown (which is possible as Covid-19 disruption runs its course) or after late (and therefore, larger) interest rate increases. In either event, further pressure on the FX rate is likely.
Cheap but challenged equities
Turkish equities, measured by the Borsa Istanbul 100 Index, are down 15% ytd (in total US$ return terms), almost entirely due to the 13% FX depreciation. This is not much worse than MSCI EM, which is down 12%.
Trailing PB is 0.9x (for 11% ROE), a 20% discount to the 5-year median (compared to a 15% discount for MSCI EM). Forward PE is 9.4x (for 7% aggregate earnings decline), an 18% premium to the 5-year median (similar to the premium on this metric for MSCI EM). There are many Turkish companies that screen well on trailing value metrics (PB below 1.5x, PE below 15x, DY above 3%).
All of this undermined by the consequences of Turkey's unorthodox macroeconomic policy. Therefore, in the wider Europe part of our small emerging markets universe, we prefer Kazakhstan (cheap, reforming and with more constructive geopolitical relations).
Inflation a prime risk among others
There are a number of top-down risks facing Turkey, but the one that really matters now is the first one, namely inflation:
Unorthodox economic policy (where high interest rates are regarded as a cause rather than a cure for inflation).
Declining FX reserves and increasing external debt.
Competition for the export sector from lower-cost competitors with equally free access to the EU.
Political preservation of President Erdogan and the division this creates within his AK Party (the next general election is in 2023).
Geopolitical "frenmity" with the US, EU and Russia and the resulting upward pressure on military spending.
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