Turkey Outlook Upgraded at S&P

S&P upgraded Turkey’s outlook from negative to stable with a maintain a credit rating of BB which is two notches below the investment grade, citing government policy gradually refocusing on measures to reduce external vulnerabilities. Here we list key takeaways from the report:

  • Accepting that it would have a minimal impact, mandatory enrollment of employees aged under 45 in the Private Pension System is considered as an indicator of positive intent.
  • Attempts to cut the bill for imported energy are important to the credit rating agency regarding the external balances.
  • S&P believes that the government’s reform agenda also targets improving educational standards, increasing labor market flexibility and female participation in the workforce, and reducing the size of Turkey’s sizable informal economy, however, the implementation of this ambitious program of reforms competes to some extent with the president’s intention to bring about constitutional change with the end goal of achieving an executive presidency
  • S&P has lowered its estimate of Turkey’s gross external financing requirement for 2016-2019 to close to 170% of current account receipts plus usable reserves, from close to 185%, largely due to the lengthening average maturity of Turkish external debt (which we believe is very important).
  • S&P views Turkey’s banking system as generally well capitalized and supervised, noting the size of state-owned banks being relatively large and foreign currency funding represent risks (if their hedges do not hold, due to counterparty risk, or because of the second-round effects of the large open foreign exchange position in the corporate sector on banks’ asset quality).
  • S&P could lower its ratings if Turkey’s fiscal performance and debt metrics deteriorate beyond expectations, or if political uncertainty contributed to further weakening in the investment environment or tightening global policy rates intensified balance-of-payment pressures.
  • S&P could raise its ratings if sustained rebalancing of the source of economic growth led to much lower external borrowing needs.

The following shows the changes in S&P Global’s estimates on Turkey for the 2016-2019 period.


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.

Turkey - Components of Real GDP

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.

Turkey - SA GDP Growth and Domestic Demand

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%).

Iran - GDP - Composition By SectorEnlightening 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.

Iran - GDP - by ExpendituresTo 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 130th 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.

Iram - Top Stocks by Market CapWith 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.