Turkish Wealth Fund is a game changer
We tend to think that the currency market has been temporarily stabilized. In other words, we do not foresee another shock to the Lira/ USD or Lira/EUR path in the next month. There may be some kind of disturbance ahead of the referendum, which is expected to be held in early April but it will be nothing lik we have already witnessed. On the other hand, the U.S. economy is now a shifting ground, and even if half of what Mr. Trump has promised is realized interest rates will rise following a secular trend. We factor in at least two FFR hikes this year, and a third move will not come as a surprise. The relocation of American capital to America requires incentives that should come hand in hand with rising public expenditures. Since financing expenditures through tax increases does not look a viable option, given Mr. Trump’s background as a businessman and his party’s ideological stance, the only way to finance them is through rendering fixed income and capital markets returns attractive. Now this has happened twice in U.S. economic history in the last 40 years or so.
In the first the interest rate dif- ferential channelled European and other funds to U.S. Treasuries between 1981 and 1985, an episode that has ended with the Plaza Accord. The USD/Pound Sterling rate was at par in 1985, and the dollar lost value against the DM only after the multilateral intervention in 1985. On September 22, 1985 G-5 finance ministers gathered at the Plaza Hotel in New York City upon Secretary Baker’s invitation.
Dollar’s 4 percent fall in a day
Although the initial intention was to keep this rendez-vous secret, extensive exchanges were all the same held in Tokyo and in the other capitals during the three months prior to the summit. G-5 finance ministers declared that the dollar was too strong and that it was not reflecting the “fundamental economic conditions”. They called for an “orderly appreciation” of the major currencies against the dollar and the US agreed to take full part in the co-ordinated exchange market intervention. The impact was instantaneous. The dollar fell by 4 percent in a single day! The av- erage dollar depreciation between September 1985 and February 1986 was %35 and the dollar/mark rate reduced from 3.47 to 2.25 in the same period. In the second, the stock market “bubble” lasted for almost five years between 1996 and 2000, an episode that ended with the 2001 recession when the bubble finally burst.
Tendency will become visible
Ray C. Fair from Yale has demonstrated more than a decade ago that the exceptionally high P/E ratio was a one-off albeit a long-lived one. S&P 1996-2000 data shows how foreign transactions lifted up stock market multiples. Foreign investments accounted for almost all the difference that was observed in the historically very high P/E ratios at that time. Could these two episodes, or a combination of them, be repeated goips, but the tendency will become visible in the next few months in our opinion.
What does this imply for Turkish government bonds and the corporate debt market? Clearly there is a pattern here and a path of rela- tively high interest rates and overall borrowing costsemerges slowly but surely. The “new neutral” may come to an end, and real rates may increase along with rising inflation and nominal rates.
The recent Turkish Wealth Fund is in fact a move that shows the sea-change has already been anticipated since the new arrangement will be used to raise funds for large-scale projects. Part of the funds will be provided through already existing domestic saving ch annels, but it is also expected that by putting –for the time being- at least two of the largest Turkish public banks’ receivables as guarantees into the new Fund overseas investments can be attracted. Now a SWF is ordinarily a vehicle for transferring current excess oil revenues towards future generations.
Fund based on a different idea
The Turkish Wealth Fund is based on a totally different idea; it embodies already existing public assets as collaterals into a giant centrally administered network. Now, whatever this may other-
wise entail, it also underlines a necessity to convince foreign creditors through huge asset collaterilization to finance infrastructure and other large projects here. If this works, there will be ample opportunity for FDIs also as typical government or PPP contracts involve revenue gurantees and a protection against the Lira depreciation, factors that please foreign investors.
‘X factor’ may change everything
We tend to think the referendum will deliver a ‘Yes’ vote. In any event, a ‘Yes’ vote is more likely than a ‘No’ vote. The opposition is too fragmented to convince the undecided voters, and except for the June 2015 elections has never been able to act in relative harmony. The cultural and political fault lines of the country, and the existing sociological alliances render such harmony almost completely elusive. And then, there is the ‘X factor’, a parameter that sometimes changes everything.
For a student of Turkish political history, delineating the image of a generic leading politician will be key in the future. The subject matter of such a study would be the nature of Mr. Erdogan’s political leadership and its impact on the Turkish political life with respect to Turkey’s fundamental political and ideological dynamics. With the image of a politician –at least seemingly- relatively distant from the apparent power-laden traditional elites, an image that helped him appear to be the advocate of the “popular cause” more often than not, Mr. Erdogan looks destined to have impregnated Turkey’s politics and left an indelible dent in the minds of many observers watching the tectonic shifts this country has been experiencing for the last forty years in the incessant interplay of modernisation, continuity and change. At least this much can be said and he is more likely to win than anytime now, barring a surprise.
Aftermath of the referendum
In the occurrence of a ‘yes’ turnaround, the government will have time and room enough to tend to the needs of the economy, once domestic politics will disappear from the agenda for two years, until the 2019 elections. Furthermore, the government lowered the VAT for consumer durables and some other items, and based on tax elasticity calculations expects an additional TL 10 bn spending at discounted prices ahead of the referendum, a factor that might influence the outcome in its favour.
For a sea-change that would revitalize the domestic demand-driven growth model of Turkey, we should await the aftermath of the referendum. Will it be any different than what we have already had in the last 15 years? Hard to guess, but consider this, at least as food for thought. The graph depicts important post-1960 turning points. 1965 is the first peak year, but momentum is immediately lost. A momentum of the same magnitude is observed c. 1973 due to sharply rising workers’ remittances.
1973-77 is an interesting period: the consequences of the oil shock were not translated into domestic prices, and the Cyprus Operation took place. The US embargo took off in 1975. 1977-80: the slippery slope towards the economic decisions of January 24 and the coup d’état. The economy dived down and rebounded after Özal. This momentum ended in 1989, and the capital account was opened up.
The second through, though not as deep as 1980, occurred in 2001. As AKP decided to implement the Derviş-IMF programme in 2003, the economy jumpstarted in a way reminiscent of Özal’s heyday. The AKP momentum dies off in 2006. After Lehman enters the third through. The amplitude is not as large as the previous two crises, but it is everybit as real. After 2008, per capita income flattens. Hence; (1) The 1965 momentum was due to import substitution and the first Five Year Indicative Plan, but did not last long enough. (2) Switching from import substitution to outward looking policy was debated in 1971, but no decision came out. Instead, in lieu of exports workers remittances entered the picture in 1972. The 1973 momentum was “manna from heaven”. (3) 1980, the beginning of Özal reforms; the whole world outlook changes, and so does the economic spirit. 9 years. (4) 2001; end of another era. Derviş steps in. 4 years of momentum. (5) 2008: end of the Derviş programme. The Turkish economy had already lost stream. (6) No new programme, no renewed momentum. Per capita income stagnates.
This is Turkish economic history in a nutshell. Nonetheless, it sends us one clear message. Regardless of whatever economic ideology it might have been cast into and developed therein, a new economic programme is a sine qua non for restetting the odds. Because total loans increased at breakneck speed between 2003 and 2006, there was a consumption boom that wasliterally unprecedented. Consumer loans started from scratch in 2003, and house & car loans jump-diffused between 2003 and 2006. Annual rates of increase reached 300400% at that time. A phenomenon that will never occur again.
Yesterday’s credit boom is unlikely
After the May-June 2006 turmoil their annual rate of increase dropped from 70% to 20% and equilibrated at around 35% until 2008, but still growth rates weere respectably high. After Lehman there has been another sharp decrease, and equilibration occurred in the vicinity of 30%. Recently, the authorities have been talking about 15% as the new balanced path, and this is what we can expect most. A repetition of yesteryears’ credit boom and consumption-based growth is highly unlikely, especially given the funding cost path we envision going forward.
We do not concur with doomsayers. However, we expect modest growth, again high single digit inflation, benchmark TL government bond rates that hover around 11%, and c. 2.5% GDP growth in tandem with 12-15% loan growth this year. Nothing dramatically wrong, but nothing exceptionally brilliant either. We shall look forward to see what the newly established Wealth Fund will aim at because it is a game changer, at the very least because of its sheer size.