Turkey: Failed coup unnerves foreign investors

LONDON : Turkey’s bungled military coup has shaken foreign investors and stoked fears about political stability that are expected to weigh on Turkish financial assets in days and weeks to come.

On Friday night, a group of rebel soldiers using tanks, attack helicopters and fighter jets attempted to topple President Tayyip Erdogan, strafing parliament and intelligence headquarters in Ankara while seizing a bridge and surrounding the airport in Istanbul.

Yet the coup, in which at least 265 people were killed, was thwarted as Erdogan rushed back to Istanbul from a Mediterranean holiday and urged people to take to the streets to support his government.

The latest turmoil adds to Turkey’s economic headaches, with investors already concerned that a gaping current account deficit could making the country vulnerable to a run on the lira, and worried about Erdogan’s push to consolidate power, which has seen the departure of some key economic reformers such as Ahmed Davutoglu, the prime minister.

Turkey is largely dependent on imports for its growing energy needs and relies heavily on tourism as well as investment flows to stock and bond markets to help fund its current account deficit, which stood at over $ 32 billion in 2015, or about 4.5 percent of GDP.

“Given the sharp rise in political instability and Turkey’s extremely vulnerable external profile, which is likely to worsen as tourism gets hit further, we think Turkish assets are likely to remain under pressure,” said Salman Ahmed, chief global strategist at Lombard Odier.

Jorge Mariscal, chief investment officer for emerging markets at UBS Wealth Management, said the coup was a reminder of the importance of the country-specific risks in emerging markets:

“If uncertainty persists, it will likely induce capital flight out of Turkey.”

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Erdogan is a polarising figure whose Islamist-rooted ideology lies at odds with the secular principles of modern Turkey espoused by nationalists and others. His AK Party has long had strained relations with the military, which has a history of mounting coups to defend secularism, although it has not seized power directly since 1980.

“I hadn’t expected a military coup, although they have had them in the past,” said a prominent U.S. emerging market debt fund manager, declining to be named.

“I’ve been underweight for a while. And before this latest coup attempt, I felt the situation had gotten out of control in that Erdogan was usurping political power.”

Turkey’s lira tumbled nearly 5 percent against the dollar in late trading on Friday – its steepest one-day fall since the financial crisis in 2008. Since the start of the year, the lira has lost 3.4 percent, sharply underperforming emerging market peers such as South Africa’s rand which has strengthened more than 6 percent, or Russia’s rouble which has added nearly 15 percent against the dollar.

While MSCI’s Turkey index in dollar terms has risen by nearly 18 percent year-to-date, it has also underperformed its peers in South Africa and Russia, which have seen their indexes jump nearly 20 and 25 percent respectively over the same period.

Turkish stocks have not traded since the coup.

Turkey’s government tried to soothe markets’ nerves on Sunday. Deputy Prime Minister Mehmet Simsek said the government was in charge and had decided on “all necessary measures” after consulting with the central bank and treasury. The central bank pledged to provide unlimited liquidity to banks.

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Investors have already grown more wary of assets in Turkey, whose economy which is smarting from slowing exports and weak investment. Some economists have forecast that tourism revenue will drop by a quarter this year, costing around $ 8 billion.

Turkey with its large financing needs has benefited more than some of its peers from the prospect of a Federal Reserve interest rate hike moving further into the future, especially given the recent rapprochement between Russia and Turkey which could bring Russian tourists back into the country.

Yet the coup could bring more pain for Turkish assets.

“It is a disaster for Turkey where the risk premium on the political side must move up sharply after normalising recently as the politics seemed nice and straightforward with an AKP majority and Erdogan following a ‘predictable’ path of power consolidation,” said Emad Mostaque from Eclectic Strategy investment consultancy in London.

Investors expected the cost of insuring exposure to Turkish government debt to rise sharply on Monday. Five-year Turkish credit default swaps (CDS) last traded at 223 basis points on Friday ahead of the coup, having lost more than 40 basis points since the start of the year.

Michael Harris, Turkey Strategist and Head of Research at Renaissance Capital. While the coup had been foiled quickly, this was far from the end for political risk.

“It now leaves the ball totally in President Recep Tayyip Erdogan’s court,” said

Erdogan could opt to reconcile with opposition parties, said Harris, or – more likely – call a snap election to capitalise on the crisis, gain a majority that would allow him to change the constitution and consolidate his power further, which could bring political clarity but heighten the risk of Kurdish separatism and social instability.

On Saturday, French President Francois Hollande said he expected a period of repression in Turkey.

Some 6,000 members of the armed forces and judiciary have been arrested in the wake of the coup.

Given the situation in Turkey, Harris said Russia, Brazil and South Africa all offered better ways to gain exposure to emerging markets.

“Unless Erdogan seeks reconciliation, 2016 Turkey trade is over.”