MUFG: Knife-edge elections in Turkey with polar opposite policy agendas

May 15, 2023

Turkey held its most pivotal presidential and parliamentary elections in over two decades on 14 May, with early results signalling incumbent Recep Tayyip Erdogan’s AKP-led Republic Alliance running ahead of the opposition Nation Alliance, led by Kemal Kilicdaroglu, but without enough votes to avoid a second round on 28 May.

Against a volatile macro backdrop, the two blocs’ policy views cannot be more diametrically opposed. The opposition wants a restoration of Turkey’s former parliamentary system with mostly a symbolic and nonpartisan role for the presidency.

In contrast, the current heterodox policymaking under the incumbent government – that has proven to be ineffective in both containing inflation and narrowing the current account deficit – is set to continue. Yet despite the stark differences in policy agendas, we believe that from a monetary policy perspective, the Central Bank of Turkey (CBRT) will tighten its one-week repo rate precipitously, from today’s 8.5% to 32% between now and year-end, irrespective of the election outcome.

Given the build-up of severe fragilities, our conviction for higher interest rates holds (i) either through the return towards rules-based monetary policymaking to re-anchor inflation expectations (led by the opposition), or (ii) through reluctant rate hikes to avoid acute financial stability risks given the rapid depletion of liquid FX reserves due to the expensive FX-protected deposit scheme (led by the incumbent administration).

FX views

The USD has staged a modest rebound over the past week that has resulted in a more challenging external environment for EM currencies. The worst performing EMEA currency over the past week was once again the ZAR as it extended the period of marked underperformance at the start of this year, heightened by fears that geopolitical tensions between South Africa and the US could escalate significantly.

The other main event for EMEA FX this week is the fallout from the elections in Turkey. The initial reaction in the FX market has been relatively modest (-0.3% vs. USD). It is a continuation of more controlled TRY weakness ahead of the elections that has resulted in a slower pace of TRY depreciation this year (-5% vs. USD YTD).

Trading views

There are certainly significant macro worries like the dour reading coming from US Michigan survey or data from China where reopening bets keep getting hurt. Furthermore, we are getting dislocations in certain pockets of EM – not least ZAR which made fresh record lows last week.

However, once again vol fails to register any notably movement and the carry favourites of LatAm continue their strength. While we view these pockets of dislocation may translate into a more larger, broader EM rally, it is too hard to be positioned for this at this stage.

As such we are spending more time looking at individual RV stories where there are still quite a few. Asia continues to be the region that should underperform. The low yield plus the lack of data beats coming from China make it hard for us to be anything but bearish in this region.

Week in review

The National Bank of Poland (NBP) left its policy rate unchanged at 6.75%, in line with our (and consensus) expectations, with a broadly dovish bias. Inflation in Egypt slowed from 32.6% y/y in March to 30.5% y/y in April, predominantly due to favourable base effects and a decline in food price inflation.

The National Bank of Romania (NBR) kept its policy rate unchanged at 7.00%, in line with our (and consensus) expectations, with the MPC highlighting the expectation that inflation will likely drop to single-digits by Q3 2023.

Finally, flash estimates suggest Saudi GDP fell by 1.3% q/q in seasonally adjusted terms in Q1 2023 – first contraction since Q1 2021 – driven primarily by the oil sector, which contracted by 4.9% q/q, as the Kingdom implemented OPEC+ mandated production cuts to shore up prices.

Week ahead

This week we will have Egypt’s rate decision (MUFG and consensus is on hold for the deposit rate at 18.75%) and also we will have flash Q1 2023 GDP readings across the CEE region which we expect to show that growth has passed the trough in line with our Nowcast modelling estimates. Beyond EM, we are keeping an eye on US data, including the April retail sales print on 16 May.

Forecasts at a glance

Whilst EMs continue to grapple with much the same themes at the turn of the year, we view the outlook as a tale of two halves in 2023. A fading boost from reopenings, a global manufacturing cycle downturn and tighter financial conditions are lumpy headwinds that will weigh on EM prospects in the first half of 2023. However, China’s zero COVID policy exit, the eventual end of rate hikes and a US dollar peak, all offer significant tailwinds to the EM complex in the second half of 2023.

Core indicators

According to IIF data, EM securities attracted USD9.8bn (USD2.1bn in equity and USD7.7bn in debt) in April 2023. EM local bond valuations have showed notable resilience this year, as slow growth and broad dollar weakness are driving returns. Carry is a fundamental factor for EM local debt this year, with the potential to better protect creditors from volatile dynamics in local currencies and interest rates.