Turkey macro rebalancing: halfway there?

October 8, 2024

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After 15 years of policy missteps and time in the economic wilderness, change is afoot in Turkey. Warren Hyland looks at the country’s economic and political journey and assesses whether now is a good time to consider Turkish corporates.

The attraction of Turkey as an investment destination is clear. Straddling two continents, Europe and Asia, it serves as a natural bridge for trade and cultural exchanges between Europe, Asia and the Middle East.

Its strategic location connects key waterways and energy routes, granting it significant influence in global trade, energy security and military strategy. The country also benefits from favourable demographics, with a median age of 32¹ compared to 44.5 in the European Union,² and annual population growth of 1.3% versus the EU average of 0.1%.³

The private sector is sophisticated and resilient, benefiting from a customs union with the EU, its largest trading partner. Turkey's banking sector is robust, with a strong record of managing economic turbulence and foreign exchange volatility. And its democratic government has maintained a long history of moderate budget deficits and manageable levels of public debt.

Like many other nations, in the aftermath of the Global Financial Crisis (GFC), Turkey adopted a growth-oriented policy by artificially lowering the cost of funding and encouraging accelerated credit growth.⁴ In the short term, this approach proved effective in stabilising an economy impacted by an external macroeconomic shock. However, the country became addicted to this method of economic management.

Growth at all costs

A failed coup attempt in 2016 and a series of poor election results for the ruling AK Party culminated in the loss of its parliamentary majority and control of key cities like Istanbul and Ankara. As a result, the government doubled down on a "growth at all costs" strategy in an attempt to boost its popularity. As this approach became increasingly unsustainable, the central bank's independence was questioned.

With the onset of COVID-19, when global central banks adopted ultra-accommodative monetary policies, including quantitative easing, to boost growth and confidence, Turkey had little room to follow suit. Its macroeconomic imbalances had reached a critical point, where a reversal was needed to avoid collapse.

By 2021, Turkey had become virtually uninvestable for all but a niche group of specialists. The erosion of institutional independence, implementation of negative real interest rates, and promotion of credit growth prompted foreign investors to withdraw. Meanwhile, concerned local investors accelerated the process of dollarisation, shifting their wealth from the Turkish lira to US dollar assets.

Nothing in reserve

At this stage, currency depreciation should serve as a release valve, but the central bank attempted to defend the lira, making it increasingly overvalued and depleting its reserves. As a result, the central bank’s foreign exchange reserves, its savings, fell to dangerously low levels, with net reserves turning negative.

This imbalance fuelled a surge in inflation and imports of foreign goods that, combined with Turkey’s dependence on energy imports, widened the current account deficit. With historically low savings, the economy had long relied on foreign capital to fund maturing external debt and the current account deficit. This now became unsustainable. A sovereign crisis appeared inevitable.

In 2023, after years in the monetary wilderness, the catalyst for change began to emerge. The AK Party performed poorly again in the general election, and its leader, Recep Tayyip Erdoğan, was forced into a second-round vote in the presidential race, narrowly winning with just 52%.⁵

Inflation had become the primary source of voter dissatisfaction (Figure 1). The central bank, facing dangerously low levels of foreign exchange reserves and struggling to curb local investors from dollarising their assets, introduced currency-protected deposits (KKM, or Kur Korumalı Mevduat).⁶

This policy effectively compelled the central bank to accelerate money printing, further fuelling inflation. At the same time, supportive Middle Eastern sovereigns grew increasingly reluctant to offer unconditional financial backing.

A return to orthodoxy

The government's toolbox of unorthodox policies had failed and, if continued, could lead to losing office and, worse, bankrupting the country. After the May elections, the government made the tough decision to restore full control to the central bank, allowing it to adopt conventional monetary policies. This marked the beginning of macroeconomic rebalancing.

The central bank has allowed the Turkish lira to depreciate (Figure 2), easing pressure on the financial system. It has also raised interest rates to 50%,⁷ creating a positive real interest rate (where interest rates exceed inflation) to help anchor inflation expectations. To curb excessive credit growth, a cap on bank lending tied to debt growth has been implemented. Under this policy, banks must ensure their total stock of outstanding loans does not grow by more than 2% per month (Figure 3 ).⁸

The toll on the economy has been evident, with growth slowing from 4.5% in 2023 to a forecast of 3% this year.⁹ Notably, growth stagnated in the second quarter, increasing only 0.1% quarter-on-quarter (QoQ) after expanding by 1.4% in Q1.¹⁰ Inflation spiked, peaking at 83%,¹¹ but has since sharply declined and is expected to end the year close to the central bank’s projection of 38%.¹²

However, signs of rebalancing are also clear. Local investor dollarisation has reversed, and international investors have begun to return, significantly improving the central bank’s foreign exchange reserves (Figure 4). Based on the International Monetary Fund’s assessing reserve adequacy metric — which captures capital flight, debt rollover, and external demand risks — foreign exchange reserves could reach the standard safety level of 100% coverage by the third quarter of 2024.¹³

Meanwhile, the country’s current account posted surpluses in June and July,¹⁴ driven by reduced demand for consumer imports and strong tourism receipts. The current account deficit for 2024 is forecast to be half the size of 2023’s, at 2%¹⁵ compared to 4.1%.¹⁶ The labour market remains resilient, with unemployment at 8.8% in July,¹⁷ close to cyclical lows, although a slight increase is expected as the tourist season comes to an end.

Portfolio positioning

Overall, we estimate that macroeconomic rebalancing is more than halfway complete and are actively looking to increase our exposure to Turkish corporates in the coming months.

Turkish securities account for nearly 3% of the emerging-market corporate index,¹⁸ with an even split of banks and non-financial corporations. In the banking sector, we prefer to invest in the largest institutions, focusing on senior-secured debt. Loan books are expected to deteriorate as higher interest rates are applied to loan resets. While we believe this should be manageable, the trend of non-performing loans is unlikely to improve in the short term.

In the non-financial sector, our preferred sector is transportation, where we see opportunities in port and airport businesses. These benefit from Turkey's strategic location and growing tourism industry. Additionally, the country’s young workforce has created opportunities in the auto sector.

What next?

Looking ahead, inflation remains a key variable. The central bank has set ambitious targets of 14% for 2025 and 9% for 2026.¹⁹ To achieve these goals, credit growth must remain contained, and policy interest rates need to stay positive in real terms. Any deviation from or loss of discipline in monetary policy would be disappointing and make these objectives unattainable.

For the government, the key event to watch is the minimum wage negotiations, which impact millions of workers and the broader economy due to their inflationary effects. The drop in inflation over the summer can be partly attributed to the government’s decision not to implement a mid-year minimum wage hike. Negotiations typically take place in Q4, with the new wage taking effect on January 1. In our view, an agreement for a c.20% increase would be well-received by investors, demonstrating the government's commitment to economic rebalancing. However, this will be challenging for the labour force, as it could result in a decline in real incomes.

Finally, if rebalancing is achieved over the next 18 months, Turkey’s underlying sovereign credit metrics suggest the country could be rewarded with multiple upgrades from credit rating agencies. In September, the country received its second credit rating upgrade in six months from Fitch Ratings (from B+ to BB-), highlighting improved external buffers and a significant increase in reserves. This aligns Turkey’s rating with countries like South Africa, Armenia and Jordan. A BB+ rating, which was attained in 2013, is within reach.

Figure 5: S&P's Turkey credit rating over last 30 years

Source: Trading Economics, Standard & Poor’s, Turkey credit rating, as of 19th July 2024. For illustrative purposes only.

The month in credit

September saw another positive month of returns in EM credit. Sovereigns slightly outperformed corporates, boosted by strong performance in the distressed segment (El Salvador, Argentina and Pakistan).

EM investment grade (IG) benefited from falling government bond yields, with the yield curve bull steepening (where short-dated yields fall more than longer-dated yields). While the sub-asset class lagged US IG, given its higher weighting in 10+ year duration bonds, it outperformed its European counterpart. Asia and Latin America IG had similar returns, outperforming EMEA, driven by long-dated commodities and Chinese platform securities. Single-As delivered the strongest returns.

The risk-on environment, led by distressed bonds, boosted the high yield (HY) segment and spreads tightened. EM HY outperformed developed market peers. Latin America led the way, largely due to Argentinian corporates and long-dated energy companies. Single Bs were the outperformers by rating.

At a sector level, real estate and consumers were the outperformers, responding strongly to China’s supportive policy measures announced in late September. Financial and autos lagged, with the latter hurt by weak earnings. 

It was a heavy month of primary issuance, with US$61 billion of bonds ²⁰  printed and longer-dated maturities gaining in popularity. Almost half the issuance came from quasi sovereigns – notably the Middle Eastern oil segment. A third was IG-rated, with the largest supply out of Asia, while c. 20% came from HY, the majority from Latin America. Financial and energy companies dominated supply at the sector level. 

China makes a move

On the macro front, the Chinese central bank and securities regulator announced a bigger-than-expected set of policy easing measures to stimulate economic growth and re-energise the property sector.²¹ Indonesia also appears to be struggling with growth as consumer prices rose at their slowest pace in close to three years, increasing speculation the central bank could introduce stimulative measures to combat the economic decline.

On the flip side, South Korean export growth stayed strong on the back of heightened chip demand for semiconductor manufacturers. Meanwhile, ties between Singapore and India appear to be growing closer after India’s Prime Minister Modi visited the island nation to strengthen their strategic partnership.

Over in Europe, Polish concerns continued as September’s inflation print reached a fresh 2024 high, ruling out any interest rate cuts for the remainder of the year. The country was also hit by storm Boris that affected a huge swathe of central and eastern Europe, bringing widespread and catastrophic flooding – the worst in 20 years – raising fears the country will struggle to recover, despite the US$5.6 billion EU funding pledge.  

Rate cutting continued to feature in other areas of Eastern Europe, however, including in Hungary and Czechia. In the same time zone, the South African Reserve Bank cut rates for the first time in more than four years due to the lower inflation outlook.

Moving to Latin America, Brazil’s central bank raised interest rates by 25 basis points – the first hike in two years on the back of fears of runaway inflation. However, persistent currency weakness and fiscal risks were also likely important motivations for the hike. Unemployment has fallen to a historical low, while income has risen, lending further support to the bank’s assessment the economy is running a positive output gap.

Brazil was the outlier with central banks in Mexico, Chile, Colombia and Peru cutting rates. News that Mexico’s senate had approved a constitutional reform allowing judges to be elected proved negative for credit markets. The country is now the only sovereign to elect all its judges.

In Chile, the rate cut was voted for unanimously, with dovish forward guidance providing the central bank with confidence inflation will continue to slow in line with target estimates. On the commodities front, the government cut its copper production forecast for 2024 (the country produces around 25% of world’s supply). ²² However, the country’s mines appeared to be recovering from setbacks that had resulted in a 20-year low in production, with the country registering a c.7% year-on-year in increase in output in August. ²³

Past performance is not a reliable indicator of current or future results.

Market Data - Credit

Past performance is not a reliable indicator of current or future results.

Source: ICE data platform. as of 30th September 2024. EMGB - ICE BofA Emerging Markets External Sovereign Index EMCB - ICE BofA Emerging Markets Corporate Plus Index,  EMIB - ICE BofA High Grade Emerging Markets Corporate Plus Index, EMHB - ICE BofA High Yield Emerging Markets Corporate Plus Index, Q690 - ICE BofA Custom Emerging Markets Short Duration Index, EMRA - ICE BofA Asia Emerging Markets Corporate Plus Index, EMIA - ICE BofA High Grade Asia Emerging Markets Corporate Plus Index, EMHA - ICE BofA High Yield Asia Emerging Markets Corporate Plus Index , EMRL - ICE BofA Latin America Emerging Markets Corporate Plus Index, EMIL - The ICE BofA High Grade Latin America Emerging Markets Corporate Index, EMHL - ICE BofA High Yield Latin America Emerging Markets Corporate Plus, EMRE - ICE BofA EMEA Emerging Markets Corporate Plus Index, EMIE - ICE BofA High Grade EMEA Emerging Markets Corporate Plus Index, EMHE - ICE BofA High Yield EMEA Emerging Markets Corporate Plus Index,. Index performance is for illustrative purposes only. You cannot invest directly in the index. Indices selected provide best proxy for highlighting performance of emerging market corporate bonds. For illustrative purposes only. 

Yield to Worst

Source: ICE data platform. as of 30th September 2024. EMGB - ICE BofA Emerging Markets External Sovereign Index EMCB - ICE BofA Emerging Markets Corporate Plus Index,  EMIB - ICE BofA High Grade Emerging Markets Corporate Plus Index, EMHB - ICE BofA High Yield Emerging Markets Corporate Plus Index, Q690 - ICE BofA Custom Emerging Markets Short Duration Index, EMRA - ICE BofA Asia Emerging Markets Corporate Plus Index, EMIA - ICE BofA High Grade Asia Emerging Markets Corporate Plus Index, EMHA - ICE BofA High Yield Asia Emerging Markets Corporate Plus Index , EMRL - ICE BofA Latin America Emerging Markets Corporate Plus Index, EMIL - The ICE BofA High Grade Latin America Emerging Markets Corporate Index, EMHL - ICE BofA High Yield Latin America Emerging Markets Corporate Plus, EMRE - ICE BofA EMEA Emerging Markets Corporate Plus Index, EMIE - ICE BofA High Grade EMEA Emerging Markets Corporate Plus Index, EMHE - ICE BofA High Yield EMEA Emerging Markets Corporate Plus Index,. Index performance is for illustrative purposes only. You cannot invest directly in the index. Indices selected provide best proxy for highlighting performance of emerging market corporate bonds. For illustrative purposes only. 

References

1.Economic and Social Commission for Asia and the Pacific, as of December 2023 “Section 1: Demographic indicators”
2.Eurostat, as of 1st January 2024. “EU median age increased by 2.3 years since 2013”
3.S&P Global Ratings, as of May 3rd 2024. Research update: Turkey upgraded to ‘B+’ on economic rebalancing: outlook positive.
4.OECD Economic Department Working Papers no. 819. Łukasz Rawdanowicz - The 2008-09 Crisis in Turkey: Performance, Policy Responses and Challenges for Sustaining the Recovery, as of 13th December 2010.
5.BBC news, as of 29th May 2023. “Turkish election victory for Erdogan leaves nation divided”
6.Currency-Protected (or Currency-Linked) Deposits, known as KKM (Kur Korumalı Mevduat): Individuals and businesses can deposit Turkish Lira in a KKM account with a fixed term, usually between 3 to 12 months. At the end of the term, depositors receive interest based on the Turkish lira deposit rate. However, if the lira depreciates against a chosen foreign currency (often the US dollar or euro) during the deposit term, the depositor is compensated for the difference in the exchange rate.
7.Reuters, as of 20th August 2024. “Turkish central bank holds rates at 50% for fifth month.”
8.Türkiye: Banking Sector Outlook 1Q, 2024. Deniz Ergun, Garanti BBVA Research
9.World Bank Group, as of 1st October 2024. The World Bank in Türkiye, overview.
10. Reuters, as of 2nd September 2024. “Turkey economic growth slows to 2.5% in face of rate hikes”
11. Reuters, as of 3rd October 2024. “Turkey inflation hits new 24-year high of 83% after rate cuts”
12. Anadolu Ajansi, as of 8th August 2024. “Turkish Central Bank keeps inflation forecast constant for 2024”
13. Bloomberg, Turkey Insight: Rising FX reserves suggest safety levels in 2025, as of 25th July 2024
14. duvaR. English, Turkey’s own independent gazette, as of 12th September 2024 “Turkey’s current account surplus at US$566mn in July”
15. Hurriyet Daily News, as of 5th April 2024 “current account deficit will be less than forecast in 2024: Simsek”
16. Trading Economics, as of 31st December 2024. “Turkey current account to GDP - Turkey recorded a Current Account deficit of 4 percent of the country's Gross Domestic Product in 2023.”
17. CEIC, as of 30th July 2024, “Key information about Turkey Unemployment Rate”
18. ICE data platform, as of 30th September 2024. ICE BofA US Emerging Markets Liquid Corporate Plus Index (EMCL)
19. Reuters, as of 20th August 2024. “Turkish central bank holds rates at 50% for fifth month.”
20. JP Morgan, as of 27th September 2024. EM Corporate Weekly Monitor.
21. Reuters, ‘China vows 'necessary spending' to hit economic growth target,’ September 26, 2024
22. International Trade Administration, as of 12th July 2023. Latest available data used.
23. Bloomberg, as of 30th September 2024. “Top copper supplier Chile posts best monthly output of this year”

This material is not intended to be relied upon as a forecast, research, or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed by Muzinich & Co are as of September 2024 and may change without notice.

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Index descriptions

EMGB - ICE BofA Emerging Markets External Sovereign Index tracks the performance of US dollar and euro denominated emerging markets sovereign debt publicly issued in the major domestic and eurobond markets.  Qualifying securities must have risk exposure to countries other than members of the FX-G10, all Western European countries and territories of the US and Western European countries.

EMCB - ICE BofA Emerging Markets Corporate Plus Index tracks the performance of the US dollar and euro denominated emerging markets non-sovereign debt publicly issued in the major domestic and eurobond markets. Qualifying issuers must have risk exposure to countries other than members of the FX G10, all Western European countries, and territories of the US and Western European countries.

EMIB - ICE BofA High Grade Emerging Markets Corporate Plus Index is a subset of the ICE BofA ML Emerging Markets Corporate Plus Index (EMCB) including all securities rated AAA through BBB3, inclusive.

EMHB - ICE BofA High Yield Emerging Markets Corporate Plus Index is a subset of the ICE BofA ML Emerging Markets Corporate Plus Index (EMCB) including all securities rated BB1 or lower.

Q690 - ICE BofA Custom Emerging Markets Short Duration Index tracks the performance of short-term US dollar and euro denominated emerging markets non-sovereign debt publicly issued in the major domestic and eurobond markets.

EMRA - ICE BofA Asia Emerging Markets Corporate Plus Index is the subset of the ICE BofAML Emerging Markets Corporate Plus Index, which includes only securities issued by countries associated with the region of Asia, excluding Kazakhstan, Kyrgyzstan, Tajikistan, Turkmenistan, and Uzbekistan.

EMHA – The ICE BofA High Yield Asia Emerging Markets Corporate Plus Index is a subset of ICE BofA Emerging Markets Corporate Plus Index including all securities rated BB1 and lower with a country of risk within the Asia region.

EMIA -  The ICE BofA High Grade Asia Emerging Markets Corporate Plus Index is a subset of ICE BofA Emerging Markets Corporate Plus Index including all securities rated BBB3 and higher with a country of risk within the Asia region.

EMRL - ICE BofA Latin America Emerging Markets Corporate Plus Index is a subset of The ICE BofA Emerging Markets Corporate Plus Index including all securities issued by countries associated with the geographical region of Latin America.

EMIL - The ICE BofA High Grade Latin America Emerging Markets Corporate Index is a subset of ICE BofA Emerging Markets Corporate Plus Index including all securities rated BBB3 and higher with a country of risk within the Latin America region.

EMHL - ICE BofA High Yield Latin America Emerging Markets Corporate Plus is a subset of ICE BofA Emerging Markets Corporate Plus Index including all securities rated sub-investment grade based on the average of Moody's, S&P and Fitch, and with a country of risk associated with the geographical region of Latin America.

EMRE - ICE BofA EMEA Emerging Markets Corporate Plus Index is a subset of The ICE BofA Emerging Markets Corporate Plus Index including all securities issued by countries associated with the geographical region of Europe, the Middle East and Africa including Kazakhstan, Kyrgyzstan, Tajikistan, Turkmenistan and Uzbekistan.

EMIE - ICE BofA High Grade EMEA Emerging Markets Corporate Plus Index is a subset of ICE BofA Emerging Markets Corporate Plus Index including all securities rated BBB3 and higher with a country of risk within the Europe, Middle East and Africa regions.

EMHE - ICE BofA High Yield EMEA Emerging Markets Corporate Plus Index is a subset of ICE BofA Emerging Markets Corporate Plus Index including all securities rated BBB3 and higher with a country of risk within the Europe, Middle East and Africa regions.

The MSCI EM Index is a free-float weighted equity index that captures large and mid cap representation across emerging market countries. The index covers approximately 85% of the free float-adjusted market capitalisation in each country.

LDMP - ICE BofA Local Debt Markets Plus Index is designed to track the performance of emerging markets sovereign debt publicly issued and denominated in the issuer's own currency.

J0A0 - The ICE BofA ML US Cash Pay High Yield Index tracks the performance of US dollar denominated below investment grade corporate debt, currently in a coupon paying period that is publicly issued in the US domestic market.

C0A0 - The ICE BofA ML US Corporate Index tracks the performance of US dollar denominated investment grade corporate debt publicly issued in the US domestic market.

HE00 - The ICE BofA ML Euro High Yield Index tracks the performance of EUR dominated below investment grade corporate debt publicly issued in the euro domestic or eurobond markets.

ER00 – The ICE BofA ML Euro Corporate Index tracks the performance of EUR denominated investment grade corporate debt publicly issued in the eurobond or Euro member domestic markets.

CLCURFGB Index – Global Copper Refined Total Production - Yearly. This sector contains the copper production data for Chile, release by COCHILCO.

Important information

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