To view a PDF of the full report, click here.
If international investors are uneasy about the geopolitical situation in Turkey, they did not show it when the government launched a large dollar benchmark bond issue in early March. By Philip Moore
Priced at a coupon of 4.875 percent, which equated to 316 basis points above US Treasuries, the 10-year $1.5 billion issue generated total demand of close to $4.5 billion, allowing the bonds to be distributed across a well-diversified range of investors. Just over a third of the bonds were placed with investors in the US, with 22 percent sold in the UK and 20 percent in Turkey.
“The Turkish debt management office has always been very savvy about timing its issuance in the international capital market,” says Anders Faergemann, Senior Sovereign Portfolio Manager at Pinebridge Investments in London. “It is good at identifying times when investors have plenty of cash on the side-lines and when sentiment towards Turkey is improving.”
For Turkey, maintaining consistent and competitively-priced access to the international capital market is essential, given its need to plug the gap created by its current account deficit. Turkey’s persistent current account deficits have been a product of its low savings rate of about 15 percent of GDP, twinned with its historical trade imbalance, driven chiefly by imported energy. Some economists have argued that the deficit is a healthy indication of buoyant consumer spending in a country where 50 percent of the population is under the age of 29. That may be. But the deficit has also fuelled the build-up of an external debt pile which Fitch describes as “very large” compared to the country’s peers at 38.4 percent of GDP at the end of 2015.
Given that about a third of this debt is denominated in US dollars, Turkey’s vulnerability has been exacerbated by the weakness of the Turkish lire and the threat of rising US interest rates. “Although we have started to see an improvement in the current account deficit, the government has built up a large stock of foreign currency liabilities, which is where my main concern lies with Turkey as a credit going forward,” says Faergemann at Pinebridge.
The good news, according to Turkish government statistics, is that the current account deficit continued its downward trajectory last year, falling from 5.8 percent of GDP in 2014 to 4.4 percent in 2015. The government expects this decline to continue, reaching 3.9 percent in 2016, 3.7 percent in 2017 and 3.5 percent in 2018.
The less-positive news for Turkey is that the recent trend in the current account deficit has been driven almost entirely by the collapse in the oil price, which on the surface is a blessing for an economy which is dependent on imported energy. As the IMF comments in its most recent update, “The smaller current account deficit is welcome, but external imbalances persist. Much of the improvement can be traced to lower oil prices, and the non-energy balance has barely changed.”
Depressed oil prices are not universally good news for Turkey, as a recent analysis published by Standard & Poor’s (S&P) explains: “What low energy prices give in terms of a lower import bill, they at least partly take away via declines in exports (including tourism exports) to key commodity-producing trade partners, and lower capital inflows via the financial account.” S&P points out that tourism contributes about 12 percent of Turkish GDP, and that Russia is the second largest source of visitor arrivals (behind Germany). With Russian tourism hit by a combination of sanctions, the weak ruble and deteriorating relations between Moscow and Ankara, declining visitor numbers could generate a drag on Turkey’s growth and balance of payments.
Inflation, which has traditionally been another point of vulnerability for the Turkish economy, continues to be a concern for economists and investors. The inflation rate for February 2016 of 8.8 percent was a very far cry from the annual average of more than 70 percent posted between 1995 and 2001. But it remains well above the central bank’s target of 5 percent, with the sharp fall in the Turkish lira and the introduction of populist measures such as last year’s 30 percent hike in the minimum wage both putting upward pressure on the CPI.
Nevertheless, in spite of elevated geopolitical risks, the growth outlook for Turkey remains upbeat, with continued expansion of the economy underpinned by robust consumer demand. The government’s medium-term plan sees the economy expanding by 4.5 percent in 2016 and by 5 percent in both 2017 and 2018, with unemployment declining over the same period from 10.2 percent to 9.6 percent.
This encouraging outlook may provide some respite for the Turkish equity market, which was among the worst-performing within the beleaguered emerging market universe last year, falling 14.1 percent in local currency terms but by 31.2 percent in dollars. “Turkey is one of the cheapest emerging markets, trading on a P/E ratio of about nine times 2016 earnings, compared with around 12 for emerging markets as a whole,” says Emre Akcakmak, portfolio manager at East Capital in Stockholm. “At these levels, we see some very attractive pockets of value within the Turkish equity market, given the resilience of the economy, which has continued to perform well in spite of political uncertainty, regional instability and concerns about US monetary policy.”
Investors say that the underdeveloped banking sector, in particular, still has attractive growth prospects. According to Akbank, of Turkey’s population of 78m some 48m remain either unbanked or semi-banked. Total loans equate to just 71 percent of GDP, with the ratio of household and mortgage debt to GDP 22 percent and 7 percent respectively. To put these numbers into some international perspective, even after the accelerated deleveraging since the financial crisis, household debt was still about 80 percent of GDP in the US in late 2015.
Little wonder, against this backdrop, that Akbank sees considerable potential for growth in retail banking, projecting compound annual growth rates (CAGR) in 2016-2018 of between 14 percent and 16 percent in loans and deposits for the Turkish banking system as a whole. Akbank itself is forecasting that it will outgrow the industry, with its loans and deposits each advancing at a CAGR of 16 percent to 18 percent over the same period. In line with this expansion, Akbank estimates that the share of retail banking will rise from 42 percent of the bank’s revenues in 2015 to 45 percent in 2016.
Among Turkey’s other leading banks, Halkbank is also optimistic about its prospects for continued growth in the domestic banking market. It plans to open 40 new branches in 2016, and is projecting increases in assets and loans in 2016, much of which will be driven by its strength in the market for lending to SMEs, which Halkbank describes as the “backbone” of the Turkish economy.
Equity investors say that the strong growth outlook for the Turkish financial services sector is not reflected in the valuations of the leading banks. “Banks have been facing a number of regulatory and economic headwinds recently, which have widened the discount at which Turkish banks are trading, both to their emerging market peers and to domestic non-bank sectors,” says Akcakmak at East Capital. “We think some of these headwinds may turn into tailwinds this year, with Turkish banks expected to post earnings growth of 15 percent to 20 percent and return on equity (ROE) ratios projected to improve from 11 percent-12 percent to 13 percent-14 percent over the short term.” With banks trading on undemanding multiples of about 6.7 times 2016 earnings, and on price/book value ratios of 0.8, Akcakmak sees compelling value in the Turkish banking sector.
