After meeting with government officials, multilateral institutions and private sector representatives in Istanbul, David Austerweill, Deputy Portfolio Manager from VanEck, shared his strategy notes on possible post-election scenarios.
One of the most striking points in Austerweill’s notes was that the dollar rate was above 30 TL as the level they would expect to enter Turkish assets. Here are the striking points from the notes of the VanEck analyst:
What happens to the dollar if Kılıçdaroğlu wins the election in the first round?
The election results are directly related to how the exchange rate will be adjusted. If Kılıçdaroğlu wins the presidency in the first round, the central bank will likely not be able to enforce the currency controls that were recently created, as the private sector expects the opposition to lift currency controls, and will also stop selling US dollars to defend a given rate. It will take two weeks before the opposition can fill the central bank administration with its own men. In this temporary power vacuum, the exchange rate could quickly depreciate with a price action similar to that of December 2021. The main difference is that once the Turkish lira is revalued, both local depositors and foreign investors will start converting the US dollar to lira, as the new government will immediately adopt orthodox monetary policy, including a massive series of rate hikes, to attract foreign capital to the lira.
If Kılıçdaroğlu wins the election in the second round, what will be the dollar-TL rate?
If Kılıçdaroğlu wins the presidency in the runoff, the adjustment will become much riskier, as both local depositors and foreign investors will have to wait at least two more weeks before learning the results, and it will be more costly to establish a policy anchor.
The greater the initial devaluation, the greater the burden on the government of paying FX-indexed deposits and phasing out the program.
What if Erdogan wins the parliament and the election goes to the second round?
Even though Erdogan doesn’t have a good enough rate of votes to win in the first round, there is still a clear path for him to win the presidency. If Erdogan’s alliance wins a majority in the parliamentary elections and a runoff for the presidency is held, Erdogan could argue that it is too risky for Turkey to have a divided government and that voters should give up on Kılıçdaroğlu.
In this scenario, the Erdogan government will most likely try to continue on the current policy path with a more gradual approach to easing exchange rate pressures, increasing the likelihood of a patchy adjustment in late 2023 or early 2024.
NO INVESTMENT SIGNAL WHEN THE DOLLAR IS BELOW 30 TL
Due to the overvaluation of the TL exchange rate, there is currently no opportunity to invest in local Turkish assets. If the opposition wins, we will closely monitor the devaluation and look for TL 30+ levels to create long positions in inflation-linked local bonds. The opposition will fail Erdogan’s ultra-easy monetary policy experiment by raising interest rates significantly, but we doubt they will raise interest rates enough to create meaningfully positive real interest rates because they don’t want to do too much damage to the economy and the banking sector. There is an additional catalyst for inflation-linked bonds if the Turkish government’s statistics agency shows inflation higher under an opposition government, as there are concerns that the Erdogan government is manipulating inflation data to make it look lower than it actually is.
On the way to the election, we see the highest value in long-term, low-dollar Turkish government bonds. In our investment process, these bonds deserve a high allocation given Turkey’s fundamentals.
CDS CAN DECREASE 150 BASE POINTS
In addition, if the opposition wins, spreads could narrow by 150 basis points (bps) or more, as foreign investors hold a low weight in Turkish loans and the government will need to add positions as it carries out significantly positive reforms.
In the scenario where Erdogan wins and policy continuity is ensured, these bonds should also outperform due to their relatively low prices of US$70.
In this scenario, we will evaluate whether it makes sense to continue holding the position depending on the government’s future policy stance.
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