Losing Ground


Economic News

22 Jul 2010
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After a volatile May, Turkish markets welcomed the new month despite growing concerns over the possibility of a further rise in US interest rates and larger than expected increases in domestic inflation.

Politicians and market analysts alike were quick to reassure investors, however, noting that Turkey's long-term fundamentals remain strong and the recent dip had more to do with global rather than local economic troubles. Investors have been pulling hot money out of leading emerging market economies over the past month in a wave of global risk reduction, with Turkish markets taking a particularly bad beating.

Shares traded on the Istanbul Stock Exchange (IMKB) lost an average of 13.10% during May, with the IMKB falling 5748.22 points to 38,132.21, while the dollar surged 18.70% over the month and reached a three-year high of TL1.60 on June 5. The euro was also up markedly against the lira throughout May, rising some 21.53% to top TL2.00 ($1.28), and reaching TL2.05 ($1.32) on June 5.

Foreign investors began to pull their money out of the IMKB after April inflation figures came in above expectations. As many thought Turkey had finally defeated the "inflation monster", it came as a shock when the month-on-month (m-o-m) consumer price index (CPI) rose sharply from 0.27% in March to 1.34% in April. The producer price index (PPI) registered a similar jump m-o-m, leaping from 0.25% in March to 1.94% in April. This trend continued into May, with recently-released May CPI and PPI figures rising m-o-m to 1.88% and 2.77%, respectively. Expectations are strong that June CPI will come in even higher as producers raise prices to compensate for the increasing cost of commodities.

As Morgan Stanley economist Serhan Cevik noted in a report released on June 2, however, these CPI figures may actually be somewhat misleading. While CPI rose to 8.8% year-on-year (y-o-y) in April, "core" CPI - excluding administrative prices, gold, energy and unprocessed foods - actually declined y-o-y to 5.3%, down from 7.7% at the end of 2005.

Regardless, the Turkish Central Bank's Monetary Policy Committee is certainly taking the threat of inflation seriously, holding a meeting on June 7 to address the issue. The bank recently stated that it would take the "necessary steps to bring inflation in line with the target range, and the extent of such an adjustment would, of course, depend on whether the recent bout of volatility in financial markets is temporary." And they put these words into action at the meeting, shocking market analysts with a whopping 1.75% hike in interest rates, pushing them up to 15%. In his announcement of the hike, Central Bank Governor Durmus Yýlmaz explained that the move was necessary to curb inflationary pressure and stressed that price stability remains the bank's principal concern.

Political uncertainty ahead of the selection of a new Turkish president and the impact of rising oil prices also present challenges to the economy in the near term, and may limit international investors' interest in Turkish shares.

Regardless of domestic developments, foreign speculators are less likely to return to Turkey's markets, at least until it becomes clear what will happen to US interest rates at the Federal Reserve's upcoming meeting on June 28-29. Investors are worried that the Fed will push interest rates above 5% as Ben Bernake, the new chairman, tries to establish his inflation-fighting credentials, even at the risk of reining in economic growth at home and abroad. It is this concern that has speculators pulling their investments out of emerging markets.

Though there is a risk of the lira's recent depreciation translating into a return to the time of double-digit inflation, as Cevik noted in his report, "prudent fiscal policies and structural reforms that have strengthened the economy and financial markets make the probability of such an adverse shift very low".

The reforms of the last several years have helped to strengthen Turkey's economy, and particularly its banking and financial institutions, and the central bank's solid commitment to fighting inflation have left most market analysts feeling optimistic about the country's long-term prospects. And they aren't the only ones.

Despite the market's recent ills, foreign lenders have moved to scoop up two more of Turkey's leading banks. According to banking industry insiders, Dubai Investment Group, Italy's Sanpaolo-IMI and France's Banque Populaire are interested in teaming up to buy a stake in Sekerbank. While no price has yet been mentioned, foreign banks have been paying heavy premiums in Turkey recently, as the country represents one of the last untapped markets in Europe. Just last week, Franco-Belgian lender Dexia announced plans to buy 75% of Denizbank in a deal valued at $3.25bn.

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