20 December 2017, 09:29 GMT
The Turkish Central Bank (CBRT) missed a golden opportunity yesterday to rebuild their battered credibility and boost investor confidence as we head into 2018. Instead they made a costly policy mistake.
Battling with sky high inflation, an overheating economy, a widening current account deficit and a spiralling currency, yesterday’s MPC decision offered the Turks a chance to get ahead of the curve again. With the country’s real policy rate now negative, investors had been hoping for some pragmatism and a recognition that monetary conditions were too loose. The market’s expectation for a token +100bps hike of the Late Liquidity Window (LLW) seemed both modest and politically achievable. Instead it seems the government once again heavily influenced the decision and yesterday’s tame +50bps hike to 12.75% reaffirmed the CBRT’s rather clumsy approach to setting interest rates.
Seasoned EM watchers will be familiar with Turkey’s long history of market crises over the years, often sparked by Central Bank policy errors. Years of overly loose monetary conditions have heavily contributed to a persistent structural current account deficit as savings have remained low and high growth has sucked in imports. The CBRT only need to look back at periods of extreme market dislocation in 2006, 2015 and late 2016 to remind themselves of the importance of high real policy rates in a country like Turkey.
It’s not all doom and gloom however and Turkey does have some redeeming qualities. The base effects on inflation over the coming next 4-5 months are large and should, in theory, help drag current 13% YoY CPI much closer to single digits. On the currency side the Lira’s Real Effective Exchange Rate is at all-time lows while very high nominal rates and benign market positioning are also in Turkey’s favour. However, investors will need more than just this to encourage them to place their money in the country. The market will want to see evidence of the declining inflation trajectory first and will watch closely to see what the large MoM CPI prints from Q1 this year will be replaced with in 2018. Brent oil priced in Lira continues to rise and will only add to price pressures as the country’s energy import bill remains uncomfortably high. Growth, meanwhile, is unsustainably high and the dual stimulus of loosening fiscal and zero/negative real interest rates is adding to the already high external imbalances. Until real policy rates get closer to +300bps (EM average: +220bps) investors will likely stay away.
As for portfolio construction, we currently see more value in Turkey’s external hard currency bonds rather than domestic debt. Turkey’s 10yr US Dollar government spread of T+285bps screens favourably versus similarly rated BB+ peers, trading +40bps wide to South Africa for example. Furthermore, Turkey’s proven track record of high willingness and ability to pay its sovereign external debt over the past 35 years is flawless, even during the country’s severe banking crisis in 2001. On the local market side however we remain cautious, waiting for further dislocation in the Lira before considering adding any more risk.
Date issued: 15 December 2017