Turkey: US sanctions versus strategic ties

  • As Turkey moves into northeast Syria, we consider the balance of top-down risks for investors in Turkish assets.
  • US rhetoric appears particularly inconsistent on the Turkey-Syria issue.
  • At this stage, we do not believe this will materially alter the investment case.
Turkey: US sanctions versus strategic ties

As Turkey begins moving into northeast Syria, we consider the balance of top-down risks from such a move for investors in Turkish assets. Since US President Trump's tweet threatening economic reprisals should Turkey over-reach in Syria, the Turkish FX rate has dropped 2.4%, the local Borsa Istanbul 100 equity index is off 2% and the yield on the Turkey 7.625% April 2029 US$ sovereign bond (B1/BB- rated by Moody's/ Fitch) has increased to 6.805% (from 6.621%). These are appropriately modest moves in our view.  

We regard the worst-case scenario following a deeper Turkish incursion in northeast Syria as unlikely: US sanctions in the near term, which restricts foreign capital inflow and weakens the currency, and an intractable and expensive military campaign in the long term, which results in high fiscal and domestic political costs. Despite public turbulence in the relationship between the US and Turkey in recent years, Turkey remains too important in a region where the US would strategically wish to deploy less of its resources and needs an aligned Turkey to leave behind a regional balance of power. Turkey's incursion is likely sufficiently well-defined (in terms of mission goal) and resourced (in terms of military capability) to avoid a quagmire. 

We expect the investment debate in Turkey to continue to be driven more by the tension, on the one hand, between declining interest rates, looser liquidity and cheap valuations in the context of a global search for yield and, on the other, the build-up of medium-term inflationary pressures (from Turkey's non-orthodox monetary policy assumption that high interest rates cause high inflation and vice-versa), FX rate pressure should global risk appetite contract and domestic political challenges should economic growth disappoint.  

US rhetoric appears particularly inconsistent on the Turkey-Syria issue 

US President Trump's action and rhetoric, in the past week alone, has been very inconsistent: 1) authorising the withdrawal of the small number of US troops in the area; 2) warning Turkey on any over-reach and most recently; and 3) highlighting Turkey's value as a trading partner and NATO member. 

Republican Senator Lindsey Graham, who has an inconsistent record of public comments on both President Trump (a fierce critic before 2017 and a supporter thereafter) and on the Kurdish People's Protection Units (YPG) in Syria (described now as a loyal US ally in the fight against ISIS but previously referred to a group the US should be mindful of being perceived by the Turkish government as terrorists armed by the US) in recent years, has issued a stark warning on sanctions and challenging Turkey's NATO membership. 

The inconsistencies in this rhetoric reflect the multi-faceted and complex relationship between the US and Turkey, the current process and personnel formulating and communicating US foreign policy, and domestic election cycle underway in the US. Ultimately, the importance of the Turkish relationship to the US (the Incirlik air base, NATO membership and ballast against Russia, a key piece in any ultimate balance of regional power involving Iran, Israel and Saudi) limits to what degree it can be sanctioned.

Turkey's defence expenditure should remain within the 2-2.5% of GDP range of the past decade 

Turkey's expenditure on defence as a percentage of GDP was 2.5% in 2018. Fiscal deficit was 3.6% in this period. 

Assuming that any Turkish action has been flagged to the US and Russia and, given Turkey's credible ground forces, we would expect its military ambitions to be well defined and likely achievable. At this stage, we do not see a risk of the sort of protracted conflict that followed, for example, Saudi Arabia's war in Yemen since 2015 (impeded by a lack of ground forces under its direct control). 

This is, of course, not the same as arguing that there is any resolution in sight of the broader conflict in Syria, where all of the major international powers (the US, Russia, Turkey, Iran, Israel) have conflicting agendas nor the narrower conflict between Turkey and Kurdish militants inside or near its borders.

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