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Voting With Their Cash, Investors Lose Faith in Erdogan Economy

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For the first time since he came to power in Turkey 15 years ago, investors aren’t so enthusiastic about the prospect of Recep Tayyip Erdogan winning another election.

Concerned that the political-stability dividend of Erdogan’s rule no longer pays, they’ve been selling Turkish assets in the run-up to an early vote called for June 24, driving the lira to successive lows and yields on long-term government debt to the highest on record. Assurances that Erdogan is ultimately a pragmatist on economic issues have been replaced by fears that his single-minded focus on growth is running the economy into the ground.

“An Erdogan victory would be the worst possible outcome for the market as it would signal likely policy continuity,” said Paul Greer, who manages a $2 billion emerging-market debt fund at Fidelity International in London. “Albeit, this result would be the least surprising for Turkish markets.”

The popular support that Erdogan has commanded over the past 16 years has been a welcome substitute to revolving-door coalition governments that wreaked havoc on the economy in the 1990s, leaving investors conflicted about an optimal outcome at the polls next month. But money mangers from Aberdeen Asset Management Plc. to RAM Capital say this time is different, and an extension of his reign may not be taken well in markets.

Growth First

That’s largely because Erdogan, who remains the favorite in the race, shows no signs of backing down on populist economic policies to backstop break-neck economic growth. The Turkish economy grew faster than China’s last year, even as analysts cautioned that the pace was neither healthy nor sustainable, and urged measures to address growing economic imbalances.

“Turkey arrived at the level it’s at today due to growth-oriented policies," the president’s office said in a statement last Wednesday after Erdogan convened an emergency meeting of policy makers to discuss the lira’s plunge. “In the period ahead, our country will also continue on its way with growth-oriented policies."

New fiscal stimulus measures announced at the end of April are compounding concerns: investors say monetary policy is too loose to anchor the nation’s assets, the economy’s current-account deficit isn’t sustainable, and Erdogan’s distaste for higher interest rates is preventing the central bank from getting a lid on double-digit inflation.

Drifting Away

The anxiety isn’t confined to the economic sphere, either. Turkey has drifted away from its traditional allies in the West. It remains under emergency rule imposed after an attempted coup two years ago, and Erdogan’s increasingly autocratic rule is alienating two of its biggest sources of capital: Germany and the U.S., the latter of which is considering unprecedented sanctions against its NATO ally.

If a victory for Erdogan and his ruling party “means the continuation of the current unsustainable policies, then it is clearly not a good investment case,” said Viktor Szabo, who helps manage $14 billion in emerging-market debt at Aberdeen Asset Management Plc in London. “I’d be looking for a policy change which would accept slower, but more balanced growth, avoiding the boom-bust cycles."

While Szabo adds that a return to the unpredictable politics of previous eras would probably be worse for investors than Erdogan staying around, he says it’s difficult to imagine his government changing tack, leaving the market “stuck between a rock and hard place.”

Changing Course

For some, the best hope is Erdogan and his government will change course. After securing a victory, the ruling AK Party will have little incentive to court voters with spending windfalls or prop up friendly construction companies with government contracts for mega infrastructure projects, that argument goes.

“Investors appear to be hoping that after the elections, the government will roll back efforts to promote growth at the expense of increasing vulnerabilities,” said ABN Amro economist Nora Neuteboom. “We are not convinced that such a normalisation will actually take place."

In an interview with Bloomberg TV on Monday, the Turkish president said he intends to tighten his grip on the economy and the monetary policy if he wins the election. “This may make some uncomfortable. But we have to do it. Because it’s those who rule the state who are accountable to the citizens, ” Erdogan said. His remarks sent the lira to its weakest level ever against the dollar.

Turkey’s corporate sector is starting to buckle under a record $336 billion pile of foreign-currency debt while the lira plunges to record lows, making it more expensive to pay back. The nation’s overstretched banks rely on foreign inflows to keep growth ticking, and a development model based on domestic consumption and real estate looks to be out of steam. A global backdrop of dollar strength and higher U.S. interest rates is meanwhile laying bare the costs of years of growth fueled with borrowed money.

Long Term

“Turkey has been struggling economically for the last 3-4 years, maybe even longer," said Ogeday Topcular, a fund manager at RAM Capital in London. “The political and economic decisions taken by this government have pushed the country towards a worse situation than before."

So what to investors want to see now?

“Central bank independence, press freedom, a better foreign policy approach and relations with countries, a better Middle East strategy, and improved domestic policy," Topcular said, adding that the track record suggests achieving any of that is a long shot.

At an election in June 2015, when it became clear that Turkey was headed for a hung parliament, the fear of political deadlock associated with multi-party rule sent markets into a tailspin. Foreign investors pulled $2.6 billion out of the bond market and volatility reined until Erdogan renewed the vote and AK Party won back its majority.

“The market has always seen an AK victory as positive, but that mainly seems to be because it reduces uncertainty, not because it promises better economic prospects,” said William Jackson, a senior emerging markets economist at Capital Economics in London. “Investors have become more downbeat on the economy’s longer-term prospects due to increasingly unpredictable policy making and the lack of reforms."

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    Eurozone economy's slowdown may be longer than expected

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    LONDON — A much-anticipated economic pick-up across the 19-country eurozone does not appear to be materializing yet, if one closely-watched survey is anything to go by.

    Financial information firm IHS Markit said Wednesday that its purchasing managers’ index for the eurozone — a broad gauge of business activity — fell in May to an 18-month low of 54.1 points from 55.1 the previous month.

    Though any reading above 50 still points to growth, the drop reinforces the argument that a first-quarter slowdown may not have been merely a soft patch. The survey found new order growth slowing and hiring easing, while companies are less optimistic about the future. However, it also indicated that businesses across the bloc were hindered by an unusually high number of public holidays.

    “The May PMI brought yet another set of disappointing survey results, though once again a note of caution is required when interpreting the findings,” said Chris Williamson, chief business economist at HIS Markit.

    Whatever the cause, the survey suggests that second-quarter growth won’t beat the first quarter’s 0.4 per cent. That was down on the 0.7 per cent seen during the previous three quarters, which had helped the region expand by a decade-high rate of 2.5 per cent during 2017.

    Most economists had thought the first-quarter slowdown was a blip, due to some bad weather and even an outbreak of flu in Germany.

    Wednesday’s survey suggests the slowdown may be more protracted and could be due to the euro, which raised the cost of eurozone exports.

    “At this point we are still comfortable with our recent downward revision of the 2018 GDP growth outlook to 2.2 per cent, but downside risks are mounting,” said Moritz Degler, an economist at Oxford Economics.

    The euro was down a further 0.5 per cent at $1.1723 and near 2018 lows as the weakness in the economic data is likely to raise questions over when the European Central Bank will end its bond-buying stimulus program. That in turn will affect how soon it joins its peers, notably the U.S. Federal Reserve, in raising its benchmark interest rate, currently at 0 per cent.

    The ECB has indicated it could ease off stimulus further once inflation gets back to its goal of just below 2 per cent but so far inflation has remained stubbornly low — in the year to April, consumer prices were up a mere 1.2 per cent.

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    Erdogan Is Threatening Israel With Sanctions – While Turkish Economy Tanks

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    The Turkish economy is going through a very tough time, and many of the reasons stem from the behavior of its leader, President Recep Tayyip Erdogan.

    He has been president since 2014, following 11 years as prime minister. This makes him one of the longest-serving elected leaders of any major country. Russian President Vladimir Putin, for example, surpasses him by just three years.

    To be clear, Turkey’s economy has grown rapidly since the end of the global financial crisis a decade ago. Its annual growth rate ranged from 4.8 to 11 percent, before slowing to 3.2 percent in 2016, then rebounding to 7 percent in 2017. It has benefited from a surge of construction fueled by generous credit.

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    Nevertheless, this relative boom is being threatened by the policies of the president, who is seeking to centralize power. This distances Turkey’s system of government from democracy, and its economy from the free market.

    Erdogan exploited the failed coup of July 2016 to declare a state of emergency. Last month, the Turkish parliament extended the state of emergency, and Erdogan called snap elections that will take place on June 24 – some 18 months earlier than planned. Given his emergency powers, his control of the media and state institutions, and his rising popularity among conservative voters, he is expected to breeze through this election, which no one expects to be fair.

    Even so, his desire for centralization is rattling both local and foreign investors. The Turkish lira fell 14 percent between March 14 and May 21, and it has fallen by 52 percent since Erdogan was inaugurated as president in August 2014. Moreover, inflation has soared during Erdogan’s presidency: From about 7 percent when he took office to 13 percent at the end of 2017 (though it moderated slightly, to 10.9 percent, last month).

    Traders working at their desks on the floor of the Borsa Istanbul, May 22, 2018.OZAN KOSE/AFP

    Turkish bonds are also collapsing. According to Bloomberg, yields on 10-year, lira-denominated government bonds are higher than yields on bonds issued by the governments of Nigeria, Pakistan and Lebanon. Turkish bonds have fallen more sharply than those of any other of the world’s 27 emerging economies.

    Turkey’s trade deficit has been steadily widening as well, as has its current account deficit (which includes both the balance of trade and the balance of capital transfers). And all of these will weigh on its economy over time.

    The fall of the lira and the high inflation rate are two of Erdogan’s biggest weak points – and the reason is his vigorous crackdown on monetary policy. Erdogan previously claimed that the central bank’s high interest rates are the reason for high inflation, and he repeated this claim in an interview in mid-May that rattled the markets.

    Rumor has it that the governor of Turkey’s central bank plans to resign, and market players joke that after the June election, Erdogan himself will take over as the bank’s governor.

    Meanwhile, Erdogan is investing in grandiose infrastructure projects such as bridges, dams and roads, which contribute both to growth and employment, and to his own glorification.

    The Turkish government’s threats to sever trade ties with Israel appear to be disconnected from the Turkish economy. Erdogan cites Israel’s treatment of the Palestinians as the reason for his proposed boycott, and his rhetoric is reminiscent of those Iranian leaders who, beyond the talking, also finance terrorist activity against Israel.

    During recent demonstrations against the Tehran regime, Iranians protested that their government invests money and energy in the Palestinian issue and in promoting anti-Israel terror, instead of improving its citizens’ day-to-day economic situation.

    But for now, the Turks’ situation in general, and their economic situation in particular, is much better than that of the Iranians. So, the chances of demonstrators demanding that the government forget Israel and focus on the Turkish economy seem slim.

    Turkey and Israel have a fairly close trading relationship. In 2016, Turkey’s exports to Israel totaled $2.96 billion, out of total exports of $142.5 billion. In other words, 2.1 percent of Turkey’s total exports go to Israel.

    But Turkey has a trade deficit with most of its trading partners, and Israel is exceptional in this regard: Turkey exports more to Israel than it imports from it. Last year, the gap stood at $1.9 billion. In theory, therefore, halting trade with Israel would expand Turkey’s trade deficit by $1.9 billion.

    Erdogan appears to want to entrench his rule and amend the Turkish constitution before the country’s financial woes infect the broader economy and cause it to collapse. His anti-Israel rhetoric won’t hurt him in the election.

    He has also been campaigning beyond Turkey’s borders, using his familiar rhetoric of intimidation. On Sunday, he spoke to 15,000 Turkish migrant workers from throughout Europe in Sarajevo. He told them the European Union is sabotaging Turkey and that European democracy has failed.

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    Euro-Area Economy Awaits Rebound Suppressed by Temporary Factors

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    The euro-area economic rebound expected this quarter remains out of reach for now.

    After bad weather, strikes and a flu epidemic weighed on growth at the start of the year, manufacturing and services suffered another setback in May, when an unusual number of public holidays damped orders. In a sign that investors are getting impatient with the 19-nation economy, the single currency fell to the lowest level since November.

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    For European Central Bank officials preparing to set out the future path for monetary policy, the report may mean delaying a decision to scale back unprecedented support until they can better judge the region’s economic health. So far, Governing Council members have expressed confidence that the growth and inflation outlook hasn’t been fundamentally derailed.

    In May, new order growth in the private sector weakened, hiring and backlogs of work showed slower rates of increase and companies became less optimistic about the outlook, according to IHS Markit. Its composite Purchasing Managers’ Index fell to an 18-month low of 54.1, weaker than economists had forecast.

    View Challenged

    This will “challenge the view that the economy is experiencing only a temporary soft spot,” said Anders Svendsen, an economist at Nordea Markets in Copenhagen. “The numbers do strengthen our view that the June meeting will come too early, and the ECB will wait until the July meeting before making the next important decisions on the future of its monetary policy.”

    The euro was down 0.4 percent at 11:05 a.m. Frankfurt time, trading at $1.1727.

    “Some of the fog will hopefully lift with the June PMI data,” said Chris Williamson, chief business economist at IHS Markit.

    Preliminary figures will be published on June 22, a week after the ECB holds its next policy meeting. Officials have indicated in the past that they saw scope to wait until July to decide on their bond-buying program. Asset purchases are currently set to expire in September, although they could be extended if warranted.

    Williamson said that activity in euro-area manufacturing and services signals the economy is currently expanding at a quarterly pace of just over 0.4 percent. That would match first-quarter growth but it’s below the rates seen in 2017.

    “It’s also becoming increasingly evident that underlying growth momentum has slowed,” Williamson said. “More expensive oil and rising wages are meanwhile continuing to push companies’ costs higher, but weak final demand means firms are struggling to pass these higher costs onto customers.”

    — With assistance by Mark Evans, and Harumi Ichikura

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