Turkey: Crossroads of change
Turkey has undergone a tremendous growth cycle transforming it from basketcase to poster boy. Baldwin Berges comments on the reasons and the potential consequences
Sometimes, emerging markets move in mysterious ways. Back in the 1990s very few investors would have entertained the idea of Turkey becoming one of today's favourites, but the past decade has seen it achieve a remarkable transformation. Its capital markets have been a very rewarding place to be. Today investors are asking whether this performance can and will be sustained.
Turkey has gone through a tremendous growth cycle, with total GDP going from less than $200bn (€150bn) - in 2001 to around $800bn today - half that of India. The economy grew an annual 10.3% during Q2 2010, matching China as the fastest growing economy in the G20. The IMF predicts annual growth of 7.8%, more than double the pace of most other emerging markets.
This achievement has not only changed Turkey, but also the way the world deals with it. It attracts increasing levels of international capital flows. International rating agencies agree: in October Moody's raised Turkey's Ba2 foreign currency credit ratings to "positive" from "stable", citing its "unexpectedly robust" economy. Ba2 is two notches below the coveted investment grade, and matches Standard and Poors' BB. Fitch rates Turkey a single notch below investment grade at BB+.
Despite the onset of the recent global financial crisis, the Turkish economy has dealt relatively well with external influences. A number of factors have helped Turkey to excel and are likely to enable the country to develop even further:
• Trading partners: Turkey has made the best of its central location linking some of the most exciting emerging countries in Central Asia, Africa and the Middle East. Across these markets ranging from Iran to Ethiopia, local companies are building up strong relationships with Turkey and are helping Turkey to sustain its growth cycle. During a recent trip to Africa, it became even clearer to us that the strength of today's Turkey is not only its connections with the developed world but also its relationship with the emerging markets.
• Political stability: The current government is not loved by all but it has given Turkey a stable base to work from and has proven ability to stimulate foreign direct investment.
• Education: Turkey ranks around the global average in terms of access to education: net primary enrolment is at 94%, gross secondary enrolment at 82%, and gross tertiary enrolment at 37%. This has resulted in a current literacy rate of around 85%. The educational standard is already above that of many emerging markets and one should seek for that to rise further.
• Improving institutions: Turkey has witnessed a remarkable transformation of its institutions. Big improvements have been achieved across the board, ranging from a stronger central bank to an easier framework for establishing a business. The net result has been better corporate governance. In 2000, Turkey ranked amongst the most corrupt countries (close to Argentina and China in Transparency International's Corruption Perceptions index). Today it ranks 56th, a level similar to that of South Africa or the Czech Republic and higher than Brazil or Italy. Its former neighbour in the index, Argentina, ranks as the 105th most corrupt country in the world.
• Financial stability: One of the biggest achievements of Turkey has been its ability to tame its high inflation, which averaged 50%-plus through the 1980s and 90s. The right policies have resulted in a lower and stable the rate around the current level of 11%.
• Developed Infrastructure: Increasing links to tourism have actually helped local companies. Despite the fact that the country ranks 61st in terms of overall economic competitiveness, it ranks 48th based on the quality of roads and 24th in terms of air travel connectivity.
• Robust consumer base: Turkey's economy is very much dependent on local demand, so almost all sectors benefit from the growing population - roughly 78 million people with a median age of 28 years. There is still a prospect for continued population growth dynamics: what we could call a ‘marriage economy'.
The macro case is solid - but an increasing number of investors are starting to feel the vertigo. The Turkish capital markets have achieved all-time highs recently and it is important to analyze what is next. In this context is it important to look at both valuations and catalysts.
Current average forward P/E multiples are at around 12-times, with financials as low as 7.4 times even though they avoided much of the troubles that rocked the financial industry. Even though P/E ratios used to be at levels of 6-8 times for many years, it should not be forgotten that this was when the inflation rate was around 50%. The Turkish market shouldn't be regarded as expensive in today's lower inflationary environment, especially compared to China and India, which are trading at P/Es of around 30- and 20-times, respectively.
Turkey is becoming a market which none of the large multinationals can afford to ignore. This will further increase the number of M&A transactions. The recent BBVA transaction to buy into Garanti is yet another good example.
Turkey's debt is trading at a lower spread than Greece's - which may sound absurd, but the reality is that Turkey is more financially sound. Its debt-to-GDP stands at 46% while Greece's is 113%.
Can the above growth be sustained? The bond market's momentum remains robust. Bond yields have contracted over the past year and investors can expect 4.2% for medium term hard currency government paper, down from 7.8% in 2008. The latest current account figures show net portfolio holdings of bonds gained by the equivalent of $10.2bn during the first half of 2010, compared with withdrawals of $870mn in 2009. The government and corporate sector are issuing new debt to lock in the low yields. So far this year there have been 10 issues from Turkish corporate borrowers, with AK Bank raising $1bn and Yapi Kredit $750m. There are now 16 market makers in the Turkish bond markets, up from nine in 2009. The CDS market is also well-developed. The cost of credit default protection has dropped 20% this year.
The Turkish government faces a series of difficult decisions in intervening in its currency. During the past year, the lira has already appreciated against the euro by 8% and even more versus the US dollar. The impact has been benign as Turkey benefited from the cheaper costs of its imports, but its exporters have started to feel the pressure now. The principal trading partners and export markets for Turkey are the countries in the euro-zone, towards which Turkey is now losing competitiveness.
Its increasing trade with the Middle East, Central Asia and Africa is however helping it to balance the currency impact. Many of the countries around the Caspian basin share a similar cultural and linguistic base with Turkey, and expansion into these areas only seems natural. Its relationship with Iran is also important. Turkey's desire for wider regional influence could be matched with Iran's desire to further integrate into the world's economy. Currently, two-way trade between both nations stands at around $10bn. Both countries have pledged to double this in the near future. Needless to say this relationship makes sense as it creates an economic bloc of around 150m people.
In conclusion, we believe that Turkey still offers an attractive investment case with a growing and sustainable economic base. Valuations remain compelling for investors a number of catalysts will keep the positive momentum. Moreover, Turkey's regional economic integration with Africa, the Middle East and central Asia offers investors a way to benefit from a wider play on convergence of frontier markets.
Baldwin Berges is a managing director at Silk Invest