It has been hard not to make money in emerging markets during the first quarter of 2017. The JP Morgan Emerging Market Currency Index enjoyed its best return in five years (+4.2%). Emerging markets equities outperformed their developed market peers handily, with the MSCI EM index up 12.5% in dollar terms. Local currency bonds rose 6.5%.
Turkey missed out on the party. The Turkish lira (TRL) was the worst performing significant EM currency (-3.3%) and it has fallen by more 25% in dollar terms since an attempted coup last July. The stock market has edged up, recovering most of the losses of 2016, but it is still a laggard among EM peers.
The macro picture is poor. Inflation surged to 11% in March, the worst reading since 2008. Growth in 2016 was 2.9% year-on-year, compared to 6.1% in 2015. The tourism sector has been hit hard by the coup and its aftermath, as well as sporadic acts of terrorism. Turkey runs persistent current account and budget deficits and its banks have external liabilities of $180 billion (up from $60 billion in 2008).
CBC* data shows that the overall probability of default has been relentlessly grinding higher since coverage began in 2015.
By contrast, both Moody’s and S&P only downgraded Turkey following the aborted coup. Fitch waited to late January this year. The downgrading from investment grade to junk is a significant credit event as the main index tracked by bond investors, JP Morgan EMBI Diversified, is separated into investment grade and high yield sub-indices. Turkey carried a 7.2% weighting in the investment grade index.
On Easter Sunday (16 April) Turks vote in a constitutional referendum called by the governing AK party, which has maintained its grip on power since 2002. The polling is close, but the outcome will do little to alter Turkey’s credit fundamentals. If the “yes” camp win, foreign investors may be put off by what looks like a power grab by an increasingly autocratic and unpredictable president, Recep Tayyip Erdogan. If there is a “no” vote it could sow the seeds of further political instability.
*CBC = Credit Benchmark Consensus; a 21-category scale which is explicitly linked to probability of default estimates sourced from major banks. A CBC of bbb+ is broadly comparable with BBB+ from S&P and Fitch or Baa1 from Moody’s.
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