Morgan Stanley announced its dollar and stock market forecasts for Türkiye!

According to President Erdogan’s long-held view, high interest rates increase inflation. Therefore, we do not expect a reversal in interest rate policy after the elections. However, recent pressures on official reserves, large external financing needs and high inflation indicate that policy change will be required to contain risks to macroeconomic stability.

Whether this will be implemented by adjusting the current policy set or by a partial return to traditional (orthodox) policies in the President’s new five-year term, we will see from now on.

The first approach, in our opinion, is more likely in the short term. Appointment as Minister of Finance and potential changes in central bank management will be important signals that we expect to receive further guidance on the economic policies expected to be implemented after the elections.

Policy implications: In the absence of traditional monetary tightening, we think that external rebalancing after the elections may be more likely with the depreciation of the exchange rate. And other instruments will have to withstand tightening financial conditions through regulation. Policy officials are expected to adjust their strategies for permitting transactions in Turkish lira and reserve management of the CBRT, alternative tools:

1) The exchange rate (TL) depreciates faster;

2) Deposit and loan interest rates rise;

3) Limit the supply of credit; And

4) Tighten regulatory control measures over foreign exchange transactions of domestic individuals.

Returns to KKM hidden foreign exchange request

The new liraization targets set by the Central Bank for banks aim to encourage retail foreign currency deposits to a monthly conversion of 10 percent. Accordingly, banks offer higher deposit interest rates in conversions to KKM (Currency Protected Deposit), which is purchased by the Central Bank.

The Central Bank may see a partial recovery in its reserves in the short term by reducing indirect foreign exchange sales, ie allowing the TL to depreciate more rapidly, but conversions to KKM indicate a hidden demand for foreign currency in the future.

Risks and advantages

The slowdown in domestic demand from the 3rd quarter of 2023, a smaller energy import bill and a strong tourism season, are the factors that will reduce the current account deficit (Morgan Stanley’s estimate of 40 billion dollars for 2023, a cumulative deficit of approximately 10 billion dollars between June and December) .

A weaker currency and tighter financial conditions may reduce the short-term risks associated with loss of reserves, but may bring high and sustained inflation and weak growth performance in the second half of 2023 and beyond. Turkey’s high external financing needs, if there is no change in a macro policy framework that prioritizes disinflation and adopts market-friendly policies, will keep macro risks alive and increase sensitivity to global shocks (commodity prices, Fed) and the availability of foreign exchange inflows from regional partners.

Dollar rate may be 28 TL towards the end of the road

The worsening of the Central Bank’s net foreign exchange reserve position suggests that a faster exchange rate adjustment than our previous expectation may be required for Erdogan’s victory scenario. The market came to the same conclusion and a faster adjustment was pre-priced. In our pre-election scenario note, we stated that the dollar/TL could reach the level of 26 by the end of the year. However, if there is no change in the interest policy, especially in terms of interest rates, there is a risk of reaching a USD/TRY level closer to 28 TL towards the end of the year.

Stock strategy: Exporters and companies with a high foreign exchange position

MSCI Turkey has lost 22% of its value since the beginning of the year and showed high volatility. It’s down 13% in USD since the first round. Valuations still have a large discount from historical levels and the estimated cost of equity (24.6%) is high relative to historical values ​​and other EEMEA markets.

However, foreign positioning, which has been on a downward trend in recent years, is likely to remain low as risks to TL increase. The slowdown in domestic demand may be an additional hurdle for stocks focused on the domestic market. Additional banking sector regulations for banks may affect their lending activities. On the other hand, in anticipation of high inflation in the local currency, the equity market is expected to maintain its inflation-balancing attractiveness for local investors, but it will not perform as well as 2022 because KKMs have become more attractive. In this scenario, we expect exporters and companies with foreign exchange income to perform relatively better in the Borsa Istanbul market.

Bonds and bills strategy: Erdogan’s victory pre-priced

The middle part of Turkey’s 5-year CDS (credit default swap) and cash curve (2033) has widened by 171 basis points and 164 basis points, respectively, since the first round of voting. This indicates that the runoff results are fully priced in advance. We resist the temptation to trade average returns, as investors’ concerns about informal policy direction could mean that spreads could trade in this range in the near term. Bond yields could break this range if local investors increase their domestic borrowing, but the 64% share of local investors suggests that local demand may not be as strong in the future as they are close to 66% peaks. This is in line with our pre-election scenario note where we foresee a sideways movement in spreads and a trend towards broadening. For now, we consider it appropriate to remain neutral on the loan.