Sweet dreams are made of this

TURKEY - Forecast 28 Jul 2019 by Murat Ucer and Atilla Yesilada

Fed’s dovish pivot, ‘constructive ambiguity’ around the S-400 tensions between Turkey and the US, and last but certainly not least, the usual market complacency gave Turkish assets a fairly unexpected boost lately. Since our last quarterly report (of May 10, 2019), Turkey’s risk premium (CDS) has declined by some 100 bps, benchmark interest rate rallied by around 800 bps, the MSCI Turkey index rose by some 20%, while the USD/TL remained steady, despite a bold 425 bps cut by the CBRT on July 25th.

Ironically, however, developments since then have largely been in line with our baseline macro scenario: growth indicators point to lackluster growth at best with little sign of a solid recovery; credit crunch conditions persist, the fiscal anchor is unmoored, monetary policy is now fully politicized and the bad debt problem, especially pertaining to construction and energy sectors, awaits a well thought-out and financed solution, which Ankara shows no sign of delivering.

True, inflation is falling, and the annualized current account deficit has more or less disappeared, but this is hardly a cause for celebration. Inflation inertia, fiscally-driven price hikes, further currency shocks – and last but certainly not least data quality concerns cloud the inflation outlook, while external adjustment as such is a reflection of the economic malaise, more than competitiveness gains, and hence, is ultimately unsustainable.

In fact, further slides in Turkey’s rating deeper into junk territory in recent months confirm this divergence between market sentiment on the one hand, and the reality on the other. We insist that this will end as the latter eventually reinstates itself, as it almost always does, sometime before the end of this year, with Ankara finally facing crunch time.

Triggers – or how exactly this would happen and things play out -- are difficult to fathom with any degree of precision, but a highly risky political and geopolitical context, together with Ankara being desperate for growth -- and monetary policy levers having, de facto, shifted to the Palace – the moment of truth will probably arrive fairly soon.

Notwithstanding the current favorable sentiment then, we see no reason to change our baseline macroeconomic scenario. That is, we still don’t see how Turkey could manage to ‘muddle through’ for much longer with the economy more or less ‘normalizing’ on its own, i.e. credit flowing back, growth resuming, domestic demand picking up, inflation continuing to fall, the CBRT getting away with even deeper cuts – which no doubt is the intention at the moment – and capital inflows picking up.

In short, we still think we’ll reach that proverbial fork on the road sometime within the next 6 months, at which time the Palace – more likely than not – will make the right choice, simply because the alternative would be so irrational, and would mean economic and political ruin.

Now read on...

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