Steer clear of toxic Turkey

Not too long ago, Turkey was an emerging-market darling. But now investors are shying away – and for good reason.

15-10-22-Erdogan-634
President Erdogan's increasingly authoritarian rhetoric has alarmed investors

Not too long ago, Turkey was an emerging-market darling. But now the world's 18th-largest economy is going from bad to worse. The currency has slumped by around 20% to a record low against the dollar this year. Foreign investors are leaving in droves. Growing political instability threatens to do further damage to a sputtering economy, and there seems little scope for a turnaround.

The immediate worry is a national election on 1 November, which follows a vote in June that produced no clear winner or coalition government. The second time round doesn't look like being any better. As an RBS note puts it, "the net outcome of many of the possible scenarios points to a prolonged period of political instability". President Recep Tayyip Erdogan's increasingly authoritarian Islamist Justice and Development Party (AKP) remains in charge, but lost ground in June and is reluctant to form a coalition. "The balance of probabilities" points to a repeat of the June impasse, says RBS.

But even if there is a new coalition, don't expect foreign investment to flood back. Turkey has been drawn into the chaos in neighbouring Syria, with almost 100 people killed in a suicide bombing in Ankara earlier this month. Islamic State is suspected of involvement in the attack. Meanwhile, there has been renewed conflict between the authorities and Turkey's Kurdish minority.

Bullying the central bank

Over the years, the AKP has become less market-orientated, neglecting reforms, and more dictatorial and interventionist, a shift that culminated in an attack by Erdogan on the central bank governor when he began raising interest rateslast year. This behaviour, along with"a perceived weakening of the ruleof law makes it hard to attractforeign investors", says The Economist.

A bad time to scare off foreigners

Countries plug their current-account deficit with a mixture of foreign direct investment, foreign investment in stocks and bonds, or foreign bank loans.The latter two types of inflow are considered "hot money" cash that can turn tail quickly and leave the economy. Most of Turkey's external gap is plugged with hot money. As a result, when money leaves, demand is undermined.

Turkey's banks, moreover, have binged on foreign borrowing, and are very dependent on short-term capital inflows to roll over external debt. If foreign funding dries up, "a severe credit crunch" is in the offing, says Capital Economics. Even if it doesn't, foreign-currency debt burdens will rise if the lira falls further, raising the cost of servicing corporate debt. Now that overall economic momentum is slowing, non-performing loans are set to rise and credit growth will slow sharply. All in all, this is a toxic cocktail for investors. As Gaurav Patankar of Boston Co. told Barron's, "I would steer clear for now".

China has long been accused of manipulating its GDP figures, and the latest data did nothing to allay scepticism. The economy grew by 6.9% year-on-year in the third quarter, only a little down on the previous quarter, despite poor data over the summer. It left the government on track to hit its 7% full-year target. An alternative index devised by Chinese Prime Minister Li Keqiang, covering electricity consumption, bank lending and rail cargo all deemed harder to fake than GDP points to growth of 3%-4%.

But the idea that China is slowing is hardly new. What matters is the broad direction of travel, which is more encouraging. Industrial production growth eased to 6% year-on-year, but retail sales grew by 10.9%. "Despite widespread panic about the health ofthe Chinese consumer, she is clearly out spending," says Lex in the Financial Times. "Take a look at any international shopping district."

Stronger services are offsetting a weaker industrial sector, adds The Economist good news, because services now comprise a bigger proportion of GDP than industry. As a result, the jitters over a hard landing look overdone, especially as recent cuts in interest rates have bolstered credit growth, and there is plenty of scope for more fiscal and monetary stimulus.

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