A few thoughts on Turkey

Has Turkey effected a rapprochement with Russia?

After a violent incident between Turkey and Russia in 2015, when the Turkish army shot down a Sukhoi Su-24M, which resulted in reciprocal economic sanctions, the relations between the two countries rapidly returned to normal, despite their profoundly different policies on the war in Syria. Has Putin changed his stance? We think so. Otherwise, how can we explain that the Turks invaded a Kurdish portion of Syria without the green light from Washington (which supports the Kurds) and with the tacit agreement of the Russians (who still support Assad)? Even though it looks very much like an alliance of convenience, a rapprochement does seem to have taken place between Russia and Turkey.

Is a divorce between Turkey and the West possible?

Turkey is still a member of NATO but we are seeing rifts with the United States and Europe. We have identified three fundamental factors:

1. The United States and France are helping the Kurds and giving less support to the so-called moderate Islamists, who are supported by Turkey and Qatar. By allowing Turkey to establish a buffer zone in the Kurdish area along the border, Russia is appeasing Erdogan, as tensions rise between Turkey and the rest of NATO.¹
2. Erdogan is convinced that the failed coup attempt in 2016 was down to Gulenists (followers of Fethulla Gulen, a former ally of the Islamist AKP, the party now in power). It is unlikely that the United States will extradite Gulen, age 77, to Turkey, so we believe this source of frustration and distrust of the Americans will not abate anytime soon.²
3. After the 2016 coup attempt, the Erdogan regime became increasingly totalitarian; it made thousands of arrests and abruptly fired more than 100,000 people.³ Recently, nepotism has been added to the signs of the paranoia gripping the powers that be; the new Minister of Finance is none other than the President’s son-in-law.⁴ In this context, it has become imperative that Erdogan not only take control of his army but also his military infrastructure. Turkey’s proposed acquisition of Russia’s S-400 anti-aircraft weapon system is incompatible with the purchase of U.S. F-35As, and is perceived by the United States and the other NATO members as a betrayal. Moreover, such a purchase would probably involve providing the Russians with sensitive military information on U.S. arms (if only to configure the systems). That was enough for sanctions to start piling up. And merely threatening to impose sanctions on an unbalanced and fragile economy like Turkey’s is self-fulfilling.⁵

In this context, we have to consider a scenario in which Turkey distances itself from the Western governments.

Has Turkey become an investment opportunity?

In our opinion, the financial markets can live with a dictatorship but not with an unstable regime. Erdogan realizes the economic power of sanctions, to his great chagrin. It is possible that he will suddenly bend to avoid a catastrophe, but his latest statements give the impression that he has not yet taken that path. Will Russia succeed in drawing Turkey into its orbit? It is easy to close ranks in the face of U.S. sanctions, but we must remember that Russia and Turkey are enemies of long date and that many factors continue to put them at loggerheads.

Beyond the geopolitical risks, we see macroeconomic risks in Turkey: our indicators are pointing to a strong risk of recession for the Turkish economy, with or without U.S. sanctions. Massive stimulus for an economy that was already growing rapidly has been accompanied by a rising current account deficit, which now stands at more than 6% of GDP according to Thomson Reuters. Spurred by economic growth and the increase in the oil price, inflation has spiralled upward. The Turkish lira has depreciated by more than 40% since the start of the year, and the short-term effects on the economy (higher inflation and more costly imports) should be negative.

The macroeconomic outlook is therefore too negative for us to consider the Turkish market an investment opportunity.

Should we be concerned about contagion?

We believe there is some risk of contagion. The Turkish currency’s nosedive, coming after that of the Argentine peso, should prompt investors to wonder which currency will be next. Already, some observers are pointing the finger at countries with a current account deficit: South Africa, Indonesia and, to a lesser degree, India. Even though the economic situations in these countries are not comparable to Turkey’s, the increased volatility of their currencies is connected with Turkey’s lira crisis.

As for emerging market debt, international investors hold a great deal of it. A prolonged crisis in Turkey could undermine sentiment further, causing investors to review their positioning in this asset class and drawing other countries into the turmoil.

Given the instability of the regime, the geopolitical tensions, the macroeconomic risks and a possible contagion effect, we are inclined to favour a cautious approach to the Turkish stock market and the country’s currency.