The hope for foreign investors is that the opposition candidate, Kemal Kılıçdaroğlu, wins the presidential election on 14 May, and reverses the unorthodox economic policies and concentration of power of incumbent President Erdogan (ie a shift back to a parliamentary system).
Kılıçdaroğlu's average opinion poll lead is 10 percentage points, albeit the sample size in these polls is very small – c1,600.
The risks to this outcome are that, while the opposition pact around 'anything but Erdogan' and a preference for parliamentary supremacy, the ideologies it spans are diverse and contradictory – left and right, secular and Islamist, pro- and anti-Kurdish – and the candidate it has chosen – 74-year-old Kılıçdaroğlu – lacks campaign charisma.
Restoring orthodox economic policy will be painful
If the opposition were to win, apart from the difficulties of maintaining its internal cohesion, it would face the challenge of how to reverse course after years of unorthodox economic policy without prompting a collapse in economic growth or the currency.
Erdogan's policies have pushed growth, while trying to restrain FX depreciation via regulatory measures and capital controls, and unleashed hyperinflation. The real interest rate is currently negative 47%.
The policy rate hikes required to tame inflation would likely crush real GDP growth, which is forecast at 3% over 2023 and 2024 by the IMF.
Although the currency is theoretically cheap relative to the 10-year median real effective exchange rate (implying close to 40% upside in the spot FX rate), any move towards a more freely traded currency regime and the removal of friction in repatriating capital flows would likely prompt a sizeable devaluation (ie further overshoot).
We think the government and central bank will do what it takes to keep the currency steady ahead of the elections but, after May, we are likely to see either a sharp currency adjustment and/or a policy adjustment to defend the currency (or some combination of the two).
If Erdogan wins the election, this will likely take the form of increasingly archaic capital and import controls to reduce FX demand coupled with a gradual tightening of fiscal policy, but further FX depreciation will still be inevitable as it gets increasingly difficult to hold the line with his toxic and unorthodox policy mix.
If the opposition wins, the adjustment will likely take the form of a sharp tightening of monetary policy, which may renew confidence in the currency and limit the need for FX depreciation, especially if the non-gold non-energy current account surplus remains strong (it rose from US$37bn in 2021 to US$50.8bn in 2022, a stark contrast to the deterioration from US$7.2bn to US$48.8 on the overall current account deficit over that period, with US$55.4bn of the deterioration driven by gold and energy).
If there is a split outcome (eg the opposition wins the presidency but not parliament, or vice versa), the currency and policy adjustments are likely to be less orderly, whether unorthodox (eg liraisation measures/capital controls) or orthodox (eg policy tightening) routes are pursued.
The usual foreign investor playbook in the transition from macroeconomic crisis to recovery is eurobonds first, then local currency bonds, and, last, local currency equities. That should be applicable in a scenario where the opposition wins the election.
Eurobonds over local currency bonds and equities
Equities
Turkey equities (Borsa Istanbul 100 index) are on a forward PE of 4.3x, which is a 30% discount to the five-year median, alongside a 3.6% dividend yield. A 30% devaluation, for example, would cut that discount to 10%, before any hit to earnings forecasts.
There is sufficient value on offer elsewhere in mid-size global emerging markets (eg Saudi Arabia, Thailand and Mexico), without the same binary risk, as well as in other Europe EM (eg Hungary and Poland), and even in other distressed parts of EM that are closer to recovery (eg Sri Lanka).
Bonds
We retain our Sell recommendation on TRY and local currency government debt and Hold recommendation on Turkish eurobonds – see related reading section below for more detail.
Related reading
Turkey currency stability is an aberration (Curran), Feb 2023
Turkey earthquake (Curran), Feb 2023
Declining Democracy, Feb 2023
Turkey: Crisis is a matter of 'when' rather than 'if' (Curran), Nov 2022
Turkey's electoral reform improves the prospects of ruling AKP, Apr 2022