Turkey: An Exception in the Middle East

Includes: GUR, TKF, TUR
by: Zhong Jin

Recent violence and regime changes in the Middle Eastern and North African countries drastically increased uncertainties and raised risk premiums of emerging market assets. Especially for those countries, mounting political risks not only hindered economic activities, but also scared investors away from those economies. Prices of assets in countries in Middle East and North Africa, measured by the S&P Pan Arab Composite index, fell by 6.41% YTD.

When the unrest spreads across Middle East and North Africa and seems to be unstoppable, there are exceptions, which are countries largely in a different category from the troubled areas. One of those exceptions now in Middle East is Turkey, a strategically important country, has a lot of religious and demographical similarities to countries who are struggling with the political turmoil.

Along with other stock markets, Istanbul stock market index (XU100) so far has dropped by more than 6% since the peak in January 2011. However, at the fundamental level, Turkey is different because its political transition has been relatively smooth and is near its completion. The Turkey’s current government apparently enjoys popular support. Thus, the political unrest in other Middle Eastern and North African countries is likely to spare Turkey.

One of major reasons behind the recent unrest in the Middle East is surging inflation. It appears that inflation is less of an immediate threat to Turkey since its annual inflation rate has declined five months in a row to 4.9% in January 2011 from 9.24% in September 2010, led by dropping food and alcohol inflation rates. Economic growth has returned to Turkey. The real GDP growth in the 3rd quarter 2010 was 5.5%. The International Monetary Fund forecasts GDP to increase 5% in 2011 in Turkey. Domestic demand and private consumption played important roles in Turkey’s economy since more than 70% of GDP comes from private consumption.

One of the biggest risk factors in Turkey’s economy now is the rising trade deficit. The trade deficit in 2010 was about $71.5 billion, accounting for 3.5% of annual GDP.The biggest contributors to the trade deficit include energy (crude oil, natural gas, and coal), chemicals, petroleum products, and machinery. Together these items accounted for about 87% of Turkey’s 2010 trade deficit. Turkey’s industries with the biggest trade surplus include food products, textiles, and clothing, which are mostly labor intensive industries. This growing trade deficit has been largely funded by capital inflow. In 2010, the net financial account inflow was at the historical high of USD $44.26 billion, with a record USD $16.26 billion of net portfolio investment and a low amount of foreign direct investment: USD $7.12 billion.

In November 2010, Turkey’s unemployment rate trended down at 11%.The seasonally adjusted capacity utilization rate of manufacturing industry in February 2011 was 76.1, slightly down from January. To boost economic growth, the central bank of Turkey has taken multiple steps. Starting from November 2011, the policy rate has been cut to 6.25% from 7%. At the same time, the required reserve ratios for Turkish lira have been raised several times. This policy mix is aimed to set a low borrowing cost and limit the amount of credit available at the same time. As one result of such policies, USD/TRY had increased from the two year low of about 1.4 to about 1.6 now, which is a 14% depreciation against USD for Turkey lira. During the same period, other major emerging currencies mostly appreciated against USD.

Uncertainties in that part of the world is driving the oil price through the roof. For Turkey, it means larger trade deficits and potentially returning pressure on inflation. Under the current monetary policy mix implemented by the central bank, Turkey lira is likely to continue depreciating against USD and in turn devalue against other major emerging currencies. In medium term, Turkey’s export industries, including textile and apparel, are likely to benefit from the cheap lira and the political stability that is rare in Middle East. Equities of companies in these industries look cheap as the whole market is falling due to the ongoing crisis in the region.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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