Political risk hangs over Turkish markets

ANKARA/ISTANBUL – Political risk hangs over Turkish markets after a showdown between the government and the secular elite, but only a coup could spark capital flight with a strong world economy insulating emerging market investors. «In investors’ minds there’s a certain expectation that in all scenarios, with the exception of a coup, the political situation will not lead to a sufficient deterioration in the fundamental backdrop,» said Caio Natividade, emerging markets strategist at Deutsche Bank in London. A robust appetite for risk around the world has aided the swift stabilization of Turkish asset prices at least as much as a move to early general elections on July 22 as a way out of the standoff between Turkey’s Islamist-rooted government and the secular elite, including the powerful army. Turkey’s main share index has recovered about half of the 7.9 percent it lost in the wake of the row on Monday and the lira and government debt have also rebounded. «Turkey is fortunate to have a supportive global investment environment given that political risks have been rising dramatically in the last week,» said Berna Bayazitoglu, emerging markets strategist at Credit Suisse in London. Political turmoil ensued after the secular opposition won an unprecedented court ruling that annulled the first round of the presidential vote. This is likely to stop Foreign Minister Abdullah Gul, a former Islamist, from becoming head of state. The military, as the guarantor of Turkey’s strict separation of religion and state, added to the uncertainty with a veiled threat that it watched the election with «great concern.» Such statements carry weight as the military has intervened four times in the last 50 years, though early parliamentary polls are expected to ratchet down tensions. Foreign investors are important in Turkey. They hold about 70 percent of the freely tradable stocks on the Istanbul Stock Exchange and have been heavy buyers of high-yielding government debt, spurring a rebound in the lira. Foreign direct investment reached a record $20.1 billion last year. The MSCI Turkey stock index is up 15.22 percent year-to-date versus an 8.1 percent increase in the overall MSCI emerging markets stock index and a 7.9 percent gain for the MSCI World Index. Barring a sudden deterioration in Turkey’s political situation, foreign investors already there are unlikely to dash for the exits – even if attracting new investors could prove a little tougher in the weeks ahead of the elections. «Unless we see a really significant deterioration in the political and economic environment, I think between now and the elections the situation could stabilize. I would not expect foreigners to rush in large numbers before we have clarity,» said Angelika Millendorfer, fund manager for emerging markets at Raiffeisen Capital Management in Vienna. Fundamentals mixed Fundamentals in Turkey are mixed and there are some early signs foreigners are slowing the pace of investment. On the positive side, Turkey’s Foreign Investor Association sees 2007 FDI above the 2006 record $20.1 billion. Average economic growth is expected to be 7 percent annually from 2007 through 2013, Finance Minister Kemal Unakitan said on April 25. Gross national product (GNP) averaged 7.3 percent between 2003 and 2006. It hit 6 percent last year. «The worst thing that may happen to us would be a loss of (democratic) continuity, which may bring a 50 percent devaluation… a heavy intervention of the military or something like that,» said Gianluigi Arduini, managing director of Kraft Foods Turkey. «But anything that is within the continuity of a democratic process, like another government or the same government with a coalition etc, it would be perfectly within our scenarios.» Lira-denominated government debt held by foreigners is down 7.8 percent from late February, but up 39.6 percent since March 31, 2006, according to the latest central bank data. From the trough of July 2006, lira-debt holdings are up 87 percent. Foreign stock ownership is down from 68.81 percent on April 20 to 66.95 percent on May 2, according to Oyak Securities. Meanwhile, one of the largest current account deficits in emerging markets is a constant reminder to investors that any shift in global sentiment leaves Turkey vulnerable, political crisis or not.