GDP – Turkish Market News

Q1 2016 GDP Growth: Stronger but Iffy

Turkish economy grew by 4.8% in Q1 2015, above the consensus and our expectations of 4.4%. In seasonally adjusted terms, the economy expanded by 3% q/q. Household consumption expenditures, which generates two thirds of the GDP, continued to improve and posted a growth rate of 6.9% y/y. By this, the contribution of the biggest component of growth to the economy became 4.8%, in other words, it was all about domestic demand again. 120 bps of contribution to the economy by the government was offset by higher exports. With those being said, evidenced by the pre-indicators in Q2, we are very likely to see weaker GDP growth in Turkey going forward as downside risks are getting more visible. One also should highlight that 30% hike in minimum wage might have helped.

We noted the weakness in private sector capital formation time and time again. Despite 8.2% higher capital formation in construction, we saw investment expenditures declining for the private sector owing to the lower machinery and equipment investments.

Turning back to adjusted data, the annualized growth in Q1 2016 was 3%, way lower when compared the linked quarter when the economy expanded 4.8%. The same symptom of an underlying problem appeared there which was insufficient investment demand. Despite the intense criticism over high interest rates by politicians, we believe that the current rates are particularly low and investment-friendly given the inflation outlook. Our concern is the weak investment appetite evidenced by stagnant business confidence data. Interestingly, for the trailing four quarters, government expenditures were 8.5% higher y/y, suggesting that the government has recently devoted to itself to back the economy.

Meanwhile, some argued that the Q1 GDP data added to skepticism about Turkey’s true growth rate with more concerns about data reliability against this backdrop. According to the sub-lines of the household consumption, healthcare, entertainment and “other” items increased by 22.1%, 10.3% and 6.5%, respectively, adding a remarkable 200 bps to annual real GDP growth. However, this did not appear to be supported by the sectoral breakdown data as healthcare and TMT particularly remained weak.

Despite the better than expected data in Q1, we remain cautious on the sustainability of the current growth rates as we believe that consumption will be less buoyant, and more uncertainties on horizon for the economy including deterioration in tourism performance, recovery in energy prices and ongoing geopolitical problems. On the other hand, the high growth will create a better environment for the central bank in policy making.

Iran: Deserves A Closer Look

After seven years of international sanctions, Iran is once again open for business. The end of sanctions is a lifesaver for the economy as billions of dollars’ worth of frozen Iranian assets were released. In addition, years of isolation and a lack of investment have severely affected the economy and specifically natural resources infrastructure which now requires strong injections of fresh capital. At this stage, many investors started to look at Iran to invest in since the country in a kind of way provides a win-win story. While the isolated-for-years country is about to be reintegrated into the global economy, talking about the unnoticed structure of the economy may come in useful.

Firstly, the chart above shows Iran’s GDP composition by sectors. The share of oil and gas has absolutely been lower in the recent years, as services has become more important. The biggest contribution to the services industry has come from transportation & communication and real estate services (10-year compound annual growth rates were 10.6% and 6.5%, respectively). On the industrial side, mining was the business area which posted the highest growth (10Y CAGR was 10.6%).

Enlightening the potential of Iran’s natural resources which may attract capital, Iran is #1 in proven natural gas reserves (1,187 cubic feet and #4 in proven oil reserves (157 billion barrels) and #1 in proven reserves of zinc, #2 in Copper, #9 in Iron Ore and plentiful gold, lead, and many other minerals estimated at representing over 7% of the world’s mineral reserves.

Analyzing the main components of GDP, my key takeaways are the strong household consumption that contributed to the national income even in the recession period, and the low government spending that remained very low in absolute terms, highlighting Iranian fiscal policy is remarkably non-populist and predictable. Investments, however, was highly macro-sensitive and played an important role for the total income. That said, changes in inventories shown in the chart below with unfilled bars also have tipped the balance on growth. In the sanctions era, we have seen the annual inflation rising up to a record level of 45% but fortunately lowered slightly above 10% thereafter. With average deposits rates around 17% Iran simply returns the value to investors, and the central bank is primarily pursing the goal of price stability with keeping the real interest rates high.

To fill an important blink about the Iranian consumption, Iranian people have remarkable increased their spending on education, communication, healthcare and housing. With such a solid consumption track record, these would be areas where investors should be looking for long-term plays in my view. Also note that household indebtness is significantly low in the country which now has room for growth. We therefore will see high business volume growth in the financial services over the next years. A lesser known fact is that tourism potential of Iran, mainly driven by many historically important sites. You may ski in the North or enjoy golden sandy beaches in the South.

After painting a rosy picture about Iran, this is where I should investors about the corporate governance standards in the country. Iran ranked 130^th among 167 countries in the Corruption Perception Index released by Transparency International in which countries listed from least corrupted to the most in an ascending order. Considering that Iran was one of the worst business environments in a business ethics perspective, the government is making progress in fighting pervasive corruption in Iran. Additionally, the complicated legal system is among the risks investors have to keep in mind before entering the market.

The below is a list of top traded stock listed in Tehran Stock Exchange where the total market cap reaches up to $170 billion. However, due to the above-mentioned risks, as ever it is in frontier markets, debt is currently a better investment than equity in Iran.

With the removal of the sanctions, Turkey and Iran not have the opportunity to expand positive aspects of their relationship. Despite the fact that two countries confront each other over Syria, the economic collaboration will ultimately strengthen over the upcoming period. Turkey will have a lot to benefit from Iran’s huge commercial market but also will face fierce competition in some areas including cement industry.

Turkey’s Gubretas (BIST:GUBRF), a fertilizer producer, recently appeared to be the top pick of investors who bet on Iran’s opening gates to the world in Turkish market. Gubretas owns 48.8% of an Iranian company, Razi Petrochemicals, which generates almost half of the total revenue. With domestic catalysts which include the impact of the removal of VAT on fertilizers, Gubretas has a positive outlook. However, risks related to the corporate governance need to be mentioned here again, since I do not believe the stock is not a buy under the current circumstances.

Sluggish Credit Growth: A Cause for Concern?

The evolution of Turkey’s banking system in early 2000s was a lesson to be learned for any emerging countries, even for the developed ones. Following the 1994 crisis, Turkish financial system had come to settle in a fuzzy equilibrium with a large nominal stock of carried by a handful of banks in a lucrative “carry trade”, and a large number of lemon banks involved in tunneling bank deposits to shareholders through connected lending. Unsurprisingly, the industry had to face another crisis at the beginning of the new millennium with sizable impacts on the economy. After that, some important reforms took effect across the industry including BRSA’s (Turkey’s Banking Watchdog) main objective changing from supervision to restructuring and rehabilitation. Thanks to those reforms, things started to take shape in the financial system as well as in the economy. Banks survived through the crisis got healthier and flooded with foreign capital. With stronger financial structures and capital injections, banks in Turkey were more able to support the economy through their effect of easing overall credit conditions.

Given the eased lending environment, the total amount of credit issued by Turkish has been consistently rising. On monthly basis we have observed only three drops since 2005 excluding the financial crisis period between July 2008 and July 2009. First drop of -0.2% was in Jul 2006. After rising consecutively for 23 months, total credit saw its first monthly drop in July 2008 as the global crisis started to hit many economies across the world. Following the crisis period that is full of ups and downs in the credit market, Turkey experienced only two monthly drops in the total amount of issued credit in 63 months, in January 2012 and October 2014. Since 2005, the average monthly change has been 2.1%. Despite the tightening efforts by policymakers in order to cool down the economy, Turkish credit markets seemingly has growing since the end of 2010.

Turkey has performed the greatest expansion of its history amid the lending boom. Both domestic and foreign lenders have contributed to the transformation that made the country a $800 billion economy. As pervasive fears around the external financing rise due to monetary policy tightening in developed economies in the horizon, credit issued by the domestic institutions become more important to the economy. As discussed above, the average loan growth has been 2.1% since 2005. The next chart shows how the household consumption and the private investment perform during above and below average loan growth periods.

One thing is certain that tumbling loan creation brings recession nearer. The slowdown in non-government components of GDP nicely correlates with the lending growth. The most recent drop in the total amount of lent cash might signal that demonstrates a dramatic change in the well-greased Turkish economic machine.