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Turkey Time 0 comments
Investors should consider foreign denominated debt for the following reasons:
- Instability of US fiscal and monetary policy
- Diversification can reduce overall portfolio risk and volatility
- Investors seeking higher interest rates are looking abroad
- US economy may be entering a stagnant growth period
- Globalization has added a risk/reward profile on sovereign debt.
It appears Turkey is positioned to enjoy economic growth in the future. It is one of the few top twenty economies in the world, measured by GDP output, with a yield in the 7.5% range. The Turkish story reminds of us our our successfully reviews of other economic success stories we have highlighted in the past including our review of Brazilian sovereign debt which has done quite well.Fixed income investors have been hurt with the global financial down turn. Yields are not what they used to be. The US Government is taking a position with there recently announce second round of bond purchases to keep yields artificially low while trying to reignite the economy. It seems as if the US Government is trying to “print” the economy back into action. By making more US Dollars available and keeping interests rates low, investors holding and purchasing fixed income instruments denominated in US Dollars are being hit with the double loss of historically low yields and principal depreciation due to inflation. What are investors to do? We have been finding higher yields with shorter maturities with global bonds.
During the late 1990’s and 2000’s, investors became familiar with the acronym BRIC which represented the emerging markets of Brazil, Russia, India and China. These countries were able to grow there economy robustly during that time frame. In the last two years, economist have coined the acronym CIVET for the next wave of emerging nations that include Columbia, Indonesia, Vietnam, Egypt and Turkey.
Investing in foreign bonds is not for everyone. These bonds are exchanged on global markets and the traders/market makers dictate what amounts they are willing to buy and sell. Currency volatility can cause large swings in principal value. Many of Durig Capital's clients were asking for much smaller allotments in single foreign currency positions and we have found a way with hard work and excellent industry relationships. While working with multiple traders at different institutions, we have filled orders of $10,000 US dollars.
Country Overview
Modern Turkey was established in 1923 and has had different forms of government including authoritarian, military, and its current Democratic Republic. Located on two continents, Turkey’s geographic location is an important as it is an avenue between Europe, the Middle East and inner Eurasia. Turkey literally means “Land of the Turks” as about 70% percent of the 73 million people are ethnic Turks.
Political
Turkey has a governmental structure similar to other Westernized nations with respect to overall structure. The Turkish President is a symbolic position yielding little power. Executive power rests with the Prime Minister who is elected by the members of Parliament which is composed of 550 members and elected by the people.
The military plays an informal role in the government as they see that they are mandated to keep church and state separate. Since the formation of modern day Turkey, the military has been involved in four coup d’etats. As many outsiders think that the military could be a destabilising force, the general population opinion sees them as the most trusted branch of government. Since 1952, Turkey has been part of NATO. The Turkish Military is currently the second largest standing force in NATO with over 400,000 enlistees.
In the early 2000, political and economic instability recked havoc in the financial markets of Turkey. They had six Prime Ministers in as many years. Leadership was fragile without a clear path for the future. Inflation in Turkey was among the highest in the world. Foreign investors were spooked with the lack of stability and inflation. The government owed $23.5 billion to the International Monetary Fund alone. The financial sector in Turkey was on the brink of collapse and the whole economy went into recession.
Elections were held in 2003 which resulted in one party winning two thirds of Parliament’s sets for the first time in over a decade. Soon after, Recep Tayyip Erdoğan was elected Prime Minister and stability returned. Without having to form a coalition with anyone, the AK Party took control and economic, monetary and fiscal policy changed quickly. In 2002 the Turkish Central Bank had $26.5 billion in foreign currency. Just last year they reported they held over $70 billion. This helps illustrate that the reforms may be working.
On another note, Prime Minister Erdoğan engaged in accession negotiation with the European Union in 2005. There are many hurdles that must be met before membership is granted that include human rights, economic and political issues. Membership is not likely in the next decade however Turkey and the European Union continue to be engaged in talks.
Turkey opened accession negotiations with the EU in 2005 but is considered very unlikely to join in the next 10 years, partly because of opposition from countries such as France and Germany. Its refusal to recognise EU member Cyprus, growing support for pro-Islamic parties on the mainland and the treatment of the Kurdish minority in the country all remain potential stumbling blocks. Since 2005, only 11 out of 35 "negotiating chapters" relating to accession talks have been opened for discussion and only one has been "provisionally closed." Talks continue to be ongoing and open as Turkey motions toward membership.
Economy
The Turkish economy has developed greatly since the 1980’s. Actions taken have included privatizing corporations, adapting a flexible exchange rate, increasing exports while relaxing import regulation, deregulating financial markets and lowering the levels of corruption. These steps have assisted in Turkey being recognized by the US Department of Commerce as one of the top ten promising economies of the global emerging countries. Although there is still room to improve, these are very positive signals for a nation considered as emerging.
Turkey’s GDP, as measured in Purchasing Power Parody, is the 16th largest in the world just behind Canada and slightly larger than Australia which have done well since our review. The Turkish economy produced an estimated $1 trillion US Dollars in 2009. Since 2002, GDP has grown at an average rate of 4.5%. The government is currently estimating that it will continue to grow at a rate of 6.8%, 4.5%, 5%, and 5.5% for 2010 through 2013. For comparative purposes, the US Central Bank revised it’s growth projection downward to under 3% per year until 2013 for the US economy.
There are three financial trends that are occurring in Turkey that each on their own would be good but all trending illustrate the strength of the economic growth.
With a favorable age demographic, 92% of the population under the age of 60, the young large work force is ideal for continued economic growth. The government expects the population figures to grow to 77 million by 2015. Since 2002, unemployment figures have hoovered between 10% and 11%. Over the last two years, Unemployment has inched up to 13%. The recent rise may be attributed to the global financial crisis, however if these unemployment rates could be reduced, growth prospects may be even better than current outlooks. Having a young growing working class is important to economic growth theories.
One ratio we like to assess when looking at foreign government debt is the general government debt to GDP ratio. Below one will find these numbers as reported by the Turkish Undersecretariat of Treasury. Since 2004, this ratio has trended downward----a good sign. It is important to note that it did increase in 2009 due to the global financial crisis. It is expected to remain constant for 2010. Current levels are still well below the 2004 reported ratio even after global credit lending froze and are currently better than many of the “Big Boys” in the European Union.
Turkish General Government Debt/GDP
*denotes pundits estimates
In the recent news, Western European nations such as Greece and more recently Ireland have needed foreign assistance to stay solvent. Ireland recently asked the IMF and European Union for an estimated $110 million dollar loan. These loans are needed due to the Irish government backing of the fragile banking system. The Turkish banking sector, on the other hand, seems to be in a healthy state due partially to the deregulation that has been occurring since 2002. Without going into to much detail regarding private banking debt, Turkey seems have superior capital coverage similar to the Brazilian financial markets. From an outsiders perspective, it seems like fate of the Irish and Turkish banking systems are not the same.
The three independent rating agencies, Standard & Poor’s, Moody’s and Fitch, have each upgraded Turkey’s debt since 2005 and have established positive to stable outlooks. They currently have BB+,Ba2 and BB+ ratings from these three institutions. Although these ratings are below the industry standard of investment grade, we like to see the positive outlook and the recent historical upgradings. In the last few years, few sovereign debt issuers have been upgraded while many have been downgraded.
One of the criteria we review is the Heritage Foundations World Economic Freedom Rankings as we did with our review of Hungary. Turkey has a world rank of 67 meaning they score higher than the median global score. Although the ranking is not as high as Hungary’s, more importantly we focus on looking for countries with improving levels of freedom. Since last year alone, the score has move up from 61.6 to 63.8. Turkey has a very strong upward trend since reforms were put in place.
Conclusion
The currency and political issues could and most likely will, affect future returns. American government debt is experiencing massive growth with little apparent control while Turkish policies have been able to reduce their debt load in recent years. If you have followed our methodology over the weeks, it is easy to understand why we like issuers, corporate or government, with smaller amounts of debt and brighter prospects. As numerous academic studies have illustrated, diversifying ones portfolio will help reduce systematic risk. This is just another way for the investor to diversify away from a portfolio over weighted in holdings denominated in US Dollars. While being able to reduce the overall risk, a yield in the range of 7.5% for two years is phenomenal. Turkeys dynamic economic growth, geopolitical position between Westernized nations and Arab nations and their fiscal and monetary policy management gives the Lira a bright outlook compared to Washington's policy of weakening the US dollar in order to repay amassed US debt.
Disclosure: Durig Capital is currently recommending Turkish Government debt to it's clients.
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