What’s the Turkey story here?

What do I think of Turkey’s economic outlook here?

The media today was awash with stories of potential rating upgrades for Turkey which appears to have stemmed from comments attributed to Moodys on Bloomberg highlighting what they would want to see for their B3 rating to be upgraded. They did not really imply here that a rating upgrade was imminent but just stated the obvious that they would want to see a return to a more rules based economic policy and greater transparency as the kind of triggers for future ratings actions.

The Turkish media ran with the story, suggesting that upgrades were in the offing. Mehmet simsek pushed the line a bit also today with his various tweets highlighting that his focus was delivering good policy which could indeed improve the credit profile and rating of Turkey. Nothing wrong with that, and Simsek is certainly talking his book there - he has an interest both in buoying market confidence, to stabilise markets and make his policy adjustment that much easier but also I think in promising light at the end of the tunnel, via rating upgrades as a reward for good policy. I think he thinks that will build support within Turkey for the return to rational or orthodox policy which he and his team are trying to roll out. It’s a no brainer from Simsek’s point of view.

But should we expect Moodys or the other two rating agencies to move to upgrade any time soon?

I think herein it is unlikely before local elections next March. I think it’s still a bit fresh after the parliamentwry elections, and the new team are only a few months, or weeks in some cases, into the job. And I think there are a lot of tough decisions still lying ahead, plus the “Agbal Factor” - concern therein that Erdogan just cannot resist his desire to mess in economic policy and will want a return to the pro growth, low interest rate policies which have won him so many elections in the past. Perhaps he just cannot help himself, and I think Moodys et al will be nervous therein. In any event, macro data is set to deteriorate in the near term, with Simsek, Erkan et al suggesting that inflation will increase in the near term and indeed end the year at only (or as much) as 58%. It’s just hard to upgrade Turkey with a still massive current account deficit, large post election fiscal deficit and inflation heading higher. Sure we have had some positive policy and HR moves, and on the geopolitical front we are seeing positive noises around improved Turkey - US and EU relations, but I think the rating agencies will want to bed them in. That said, if, as I expect, Simsek and his team remain in place thru to local elections and well beyond, then I think we see ratings upgrades next year, and Moodys likely will be front in line there with its very lowly B3 rating, one notch below S&P and Fitch.

And what about the Agbal factor?

It’s fair I think to ask why it is different this time with Simsek, and why I don’t think that he will suffer the same fate as Naci Agbal, in being fired from office just months after taking office and having instigated rate hikes.

Why do I think it is different this time around, and hence why I am I ultimately more optimistic about the outlook now?

First, I don’t think the move against Naci Agbal was just about his move hiking policy rates. Rather, I think he may have touched nerve points around the issue of FX intervention and why at the time leading up to his appointment the CBRT had wasted as much as $128bn in a failed defence of the lira.

Second, I think the current Simsek situation is quite different to that which faced Agbal. In particular, back in late 2020, when Agbal was appointed he was pretty isolated and was not really given full scope to hire a team. His political backing, or cover, was limited. Perhaps at the time there was not a full understanding of the scale of the challenge facing the CBRT, and Agbal was a stop gap, aimed to buy time.

This time around I think there is real understanding in the corridors of the presidential palace that Turkey faces a systemic crisis, after the election if the unorthodox policy mix was carried on with. I don’t think that sense of real crisis was there in 2020-21, yet. And given the scale of the economic challenges now faced I think Simsek has won a much stronger mandate, and that has been seen in the hires he has been able to make, including Hafize Gaye Erkan at the central bank, and more recently three really impressive, competent deputy governors, from the orthodox school of thinking. This time around if Erdogan wants to fire Simsek, he would have to roll out a much more far reaching clearout than occurred with Agbal in March 2021. I think if Erdogan now tried such a clearout it would certainly set in motion the systemic crisis that he hired Simsek to avoid. It would make that crisis inevitable. And would Erdogan want to fight local elections with the Turkish economy facing systemic crisis, with the currency and banks collapsing, and the country likely at the brink of default. I don’t think so.

Third, and related to both points above, I think we are seeing political change in Turkey post election, with the focus of Erdogan moving onto the succession, and a revamp/refresh of the cabinet and the economic policy team to reflect the best succession option for the Erdogan family. And at this point it is appearing as the Bayraktar line, which are rational, logical, meritocratic and have delivered in the technology sphere for Turkey and Erdogan in the last election. Not saying they delivered the victory completely because there Erdogan’s supreme political acumen - his great campaigning ability, his ability to read  the mood of enough of the nation to win an election, and to constantly run rings around the opposition, was critical. But, a big theme in the election was Turkey’s increasingly technological prowess, with drones, an unmanned fighter jet, a first helicopter carrier, a new electric car, et al. And the Bayraktar brand were central to all that - look at Technofest. Technology won votes in the election, and the Bayraktar name is a winning brand there. And, if Erdogan does decide not to run in the next national vote, the likely next best candidate with the best chance of winning is Selcuk Bayraktar who is married to Erdogan’s daughter, Sumeyye. As a stand alone candidate he is popular, but with the AKP backing he would be the candidate in the driving seat (albeit not of the unmanned fighter jet). I think therein you can read the cabinet changes we saw this time around - the ousting of potential rivals in Soylu and Akar as clearing the way for a succession to the Bayraktars.

And I think what we saw with the appointment of Simsek, Erkan et al is some delegation in the economy sphere by Erdogan to a younger generation whom he trusts, and have proven themselves to be technically competent. This younger crew around the Bayraktars are rational in economic outlook, and are affecting a positive change in terms of a change in economic policy settings. So unlike Agbal, who was politically isolated, I think Simsek, Erkan, et al have critical political backing from within the family. I would say this is still not cast iron, and there are still some of the less orthodox advisers around Erdogan - worrying a bit that Kavcioglu was moved from the CBRT to the BRSA. But there is now hope.

I think in recent weeks we have seen in their policy actions and their interaction with the market, investors and Gulf backers, that Simsek, Erkan, et al are extremely competent, have a plan to exit Turkey from a potential systemic crisis, and there is now light at the end of the tunnel.

Fourth, the plan noted above can work but it needs financing. Failing resort to the IMF, which Erdogan is loathed to do, the only source of financing in sufficient scale, is the Gulf. And as we have seen only a few weeks ago with the $51bn UAE deal for Turkey, the rich Gulf states are willing to back Turkey. But importantly, the sea change in Gulf bailouts for economically distressed states from Bahrain to Pakistan, Tunisia and now Turkey, is that Gulf states will provide financing, but they want it back, as it’s an investment which they want returned with interest. And the Gulf policy makers are not stupid, they understand that to ensure a good return on investment requires a solid macro backdrop which itself demands sound and orthodox policies. So I imagine when Simsek, Erkan et al are touring the Gulf to request financial support, they have a pitch book which details and ticks the boxes in terms of prudent fiscal policy, orthodox monetary policy, a flexible and competitive exchange rate, structural reform and perhaps also improved trading relations with key partners - the latter which might explain the push to inject some life again into Turkey’s EU accession bid which at the least might see reward in terms of a new Customs Union agreement.

Simsek and Erkan are not operating in a political vacuum, and they understand the political reality that Erdogan is focused on winning local elections next March. They have constraints in terms of how far they think they can risk monetary policy tightening this side of local elections. But they are pitching that while the boss might baulk at moving to positive real rates anytime soon, they can achieve the same in terms of actual slowing of domestic demand vis fiscal and macro prudential policies, that they can get away with smaller hikes in headline rates. I would argue that more upfront policy rate hikes will likely mean less over the longer term. I think that’s the best way to turn inflationary expectations lower sooner. But I guess in Erkan’s less ambitious end year inflation forecast of 58%, she accepted that less near term ambition in policy rate hikes has a price of higher inflation. But the message is that after local elections the heavy lifting will come in then reining in inflation. In the meantime, it’s about buoying confidence with an upbeat reform story, or the promise of one, and the hope of ratings upgrades to come it part of that.

Can it all work?

As I noted, yes there is now a route out of systemic crisis. Systemic crisis is no longer inevitable even likely, but the current suboptimal path for policy rate normalisation (which should be much higher, much sooner) will pay the price in terms of higher, more sustained inflation, for longer which will ultimately subtract from longer term growth and stall recovery. That’s the price of the focus now, or distraction of local elections.