Turkey faces ‘muddle-through’ economic recovery, East Capital says

Turkey is expected to “muddle through” as it emerges from an economic downturn sparked by a currency crisis last year, according to East Capital, an asset manager that specialises in emerging markets.

Economic growth will be negative this year and will remain relatively weak in 2020 with an expansion of 2 to 2.5 percent, Emre Akçakmak, Anders Borg and Jacob Grapengiesser, portfolio advisors and managers at East Capital, said in a report on Tuesday.

“We think Turkey’s credit and external-financing-driven rapid economic growth model over the past decade will not be repeatable going forward,” they said.

Turkey is seeking to reverse an economic contraction with more government spending, tax cuts and cheap lending from state-run banks following last year’s currency turmoil, which pushed interest rates and inflation to the highest levels in a decade-and-a-half.

East Capital said it was particularly concerned about the country’s budget deficit, which would have totalled well in excess of 4 percent of GDP had it not been for the injection of central bank profits and emergency funds. Lira weakness could persist, it said.

“Despite a golden opportunity presented by the Fed and the global easing cycle, the lira will remain vulnerable, especially if the newly appointed central bank governor impatiently cuts the policy to reignite a credit-driven economic growth,” East Capital said.

Last week, Turkey’s central bank cut its main interest rate by 325 basis points to 16.5 percent. It had reduced the rate by 425 basis points in July. Inflation in Turkey is currently 15 percent, but is expected to slow markedly in September and October, setting the scene for more reductions in interest rates.

In a negative scenario, where fiscal and monetary policy becomes less prudent, the lira could be attacked, eroding the central bank’s net foreign currency reserves, East Capital said.

“A weak lira would then re-fuel inflation and put a strain on the country’s already highly indebted private sector, resulting in a negative self-fulfilling prophecy with a deep impact on economic development,” it said.

A positive scenario for Turkey could occur should there be a change in, or of, leadership, East Capital said. Policymakers would then act quickly to address the pain in the banking sector, caused by an increase in troubled loans, and by reviving foreign direct investment.

“First, the banking sector should be subject to a stress test to address potential capital shortages given the rise in restructured and refinanced loans,” East Capital said. “A possible recapitalisation programme, along with help from windfall gains on recent rate cuts, would then kick-start the economy instead of turning even relatively healthy banks into “zombie banks” in an extended period of uncertainty.”

The asset manager said it was maintaining its cautious stance towards Turkish stocks, with neither a strong rally nor notable decline in the equity market likely.

“We therefore continue to focus primarily on management and balance sheet quality, as opposed to leveraged companies and turnaround stories … We remain invested primarily in a mix of non-banks with foreign currency revenues and with inelastic demand.”