Turkey Markets End a Big Year With Crucial Election Up Next

Tugce Ozsoy and Inci Ozbek
·4 min read
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(Bloomberg) -- It’s been a tumultuous year for Turkish markets, with stocks the best performers globally and the lira plunging to record lows. With the country set for an election that could end years of unorthodox economic policies, a lot could change in 2023.

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The vote scheduled for June will be a crucial moment for markets, and for overseas investors who have been dumping Turkey’s volatile assets. President Recep Tayyip Erdogan’s unconventional policies — including cutting interest rates to boost growth even as inflation reached more than 80% — caused the lira to slump 29% against the dollar this year.

The benchmark Borsa Istanbul 100 Index has almost doubled in value in dollar terms as domestic investors sought an inflation hedge.

“What Turkey needs is an independent central bank, orthodox fiscal and monetary policy,” said Carlos Hardenberg, a portfolio manager at Mobius Capital Partners, who has about 7% of his approximately $250 million portfolio in Turkish stocks. “If a coalition government would win and introduce prudent economic policies, appoint qualified and credible administrators, we could see a return of capital to Turkey.”

Here’s what investors are watching for next year:

Election

Turkey’s election is the big unknown.

A late November survey by Metropoll showed approval for Erdogan at around 45%, while support for his AKP party was at 36.5%, suggesting he may struggle to win the more than 50% of the vote needed to give him a first-round victory. That gives the opposition alliance the best chance it’s ever had to beat him.

But it’s difficult to predict what may happen in Turkish politics. A Turkish court on Wednesday sentenced a potential challenger to Erdogan — Istanbul Mayor Ekrem Imamoglu — to two years and seven months in prison on charges of insulting the election authority. If the verdict is upheld by higher appeals courts, it will result in a political ban for Imamoglu.

Turkish markets would see a short-term rally in the event of a leadership change, according to Nick Stadtmiller, emerging markets director at Medley Global Advisors in New York. In the medium term, however, things may be bumpy. “There are no easy solutions to fix the imbalances that have built up in the Turkish economy and no one can right the ship without incurring some pain along the way,” he said.

The opposition alliance has yet to name its joint candidate, and many in the country’s conservative provinces remain loyal to Erdogan. If he wins again, Mobius’s Hardenberg said that more lira weakness is possible.

Monetary Policy

Hand in hand with the election is its implications for monetary policy. Guided by Erdogan’s belief that higher interest rates are the cause of inflation, the Turkish central bank has cut its benchmark one-week repo rate by 1,000 basis points in the past 15 months to 9%. That’s left real rates in Turkey at minus 75%, among the world’s lowest.

“Regardless of whoever wins the election, I expect normalization in monetary policy and tightening in interest rate policy,” said Onur Ilgen, the head of treasury at MUFG Bank Turkey.

Abrdn’s Viktor Szabo agreed, saying that the current macro policy framework is not sustainable over the long run.

Inflation

Turkey’s monetary easing cycle — along with rising commodity costs caused by Russia’s invasion of Ukraine — has left the country grappling with the highest inflation since Erdogan took power almost two decades ago.

While the President has said he expects inflation to slow to about 40% “in a few months,” soaring costs have caused widespread discontent among Turks struggling with day-to-day needs and trying to keep businesses running.

“A central bank which pursues a more orthodox policy would likely have a pronounced impact on inflation expectations, which would be lira positive and further weigh on inflation expectations,” said Henrik Gullberg, macro strategist at Coex Partners Limited in London. “A positive feedback loop would quickly assert itself.”

Capital Flows

Overseas investors have sold more than $20 billion in Turkish assets since the 2018 election, leaving foreign ownership of the nation’s stocks at a record low and ownership of bonds near 1%.

For DWS Investment’s Sebastian Kahlfeld, foreign investors will only return if they see more orthodox economic policy. Such a change “may be appreciated by international investors who know about the economic strength and prowess of Turkish corporates,” he said.

(Updates with details on Istanbul mayor’s conviction in the eighth paragraph, capital flows data in the 17th paragraph.)

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