Turkey/Erdogan: bad policies spawn bargains

Here is a career tip for newly hired Turkish central bank governors: whatever happens, do not raise interest rates. Naci Agbal ignored that pointer. He was dismissed by President Recep Tayyip Erdogan this weekend.

Agbal tried to tame mid-teens percentage inflation with successive interest rates increases. He had raised the policy rate by nearly 9 percentage points to 19 per cent since November. Turkish gyrations in borrowing costs reflect local conditions rather than a looming problem for all emerging markets.

Politicians should hate rising inflation. It irritates voters and spooks foreign investors. But the autocratic Erdogan worries less about the next election than the average leader. He wants to boost the economy at almost any price.

Markets reacted badly to another sacking at the central bank. The Turkish lira collapsed about 9 per cent versus the dollar and euro. Local share prices fell at twice that rate in hard currency terms.

That said, emerging equity markets have had a powerful bull run. They now look overbought. MSCI’s emerging market index recently touched a historical high after surging nearly two-thirds over the past year.

Turkish equities are still up around two-fifths in a year. But performance looks less stellar through a valuation prism. Stocks traded last week at just over six times forecast earnings. Relative to other emerging markets, Turkish valuations have not been so depressed for at least a decade.

The best bargains may be found in the fixed income market. Turkey’s 10-year dollar 11.7 per cent coupon bond this week offers close to a 17 per cent yield. That suggests a duration (sensitivity to interest rate movements) considerably lower than its UK gilt equivalent. That should get the antennas of some opportunistic portfolio managers twitching, even with heightened political risk.

Longstanding investors will feel less sanguine about this latest bout of lira weakness. European banks have the most exposure. Spanish institutions lead the pack, says RBC Capital Markets, with loans worth $82bn or 6 per cent of its gross domestic product. BBVA’s large stake in Turkey’s Garanti Bank is emblematic of the alliance.

Turkey’s new central bank governor, Sahap Kavcioglu, has been echoing Erdogan’s unconventional view that rate rises stoke higher prices. If Kavcioglu cannot find another way to restrain them, the phrase “Roaring Twenties” will apply — but only to the inflation rate.

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