"Turkey is not a second-class democracy.”
-Turkish Foreign Minister to Secretary of State John Kerry
To say Turkish equity markets have been volatile over the last two weeks would be an understatement. In fact, on June 3rd the main Turkish equity index was down more than 10% as emphasized in the chart below. While Turkey was largely immune to the so called Arab Spring, the current series of protests that have been grabbing media headlines around the world appear to be a Turkish version of sorts, at least at first blush.
Stepping back, the Turkish economy has been the fastest-growing economy in Europe since the early 2000s. In 2002, current Prime Minister Recep Tayyip Erdogan won his first general election and since then the XU100 index is up almost 9x, which can be seen on the graphs presented. Turkey is now the 15th largest world economy on purchasing parity basis. The key components of the highly diverse Turkish economy include: agriculture which is 30% of employment (Turkey is food independent), the fourth largest ship building sector in the world, the 10th largest producer of minerals, and a very active tourism industry (with 11 of the top hotels in the world located there).
Turkey has also been much less affected by the financial crisis of 2008/2009 than many of its European peers. In fact, Turkish GDP grew 9.2% in 2010 and 8.5% in 2011 (long term growth rates are highlighted in the chart below), which were some of the highest growth rates in the industrialized world. The derivative impact of this economic growth is that the country level fiscal situation level is very healthy. In fact, Turkey has met the 60% debt-to-EBITDA criteria of the Maastricht Treaty every year since 2004. As a result of the healthy economy, the Turkish Lira has been stable over the past few years with inflation under control.
Much of the economic success over the past decade can be attributed to Prime Minister Erdogan, who has been in power for most of that period. Erdogan inherited an economy that was deep in recession in 2002 and with the help of Finance Minister Ali Babacan, Erdogan implemented a series of reforms. One key reform included dramatically reducing government regulations, which subsequently altered the path and outlook for the Turkish economy. Perhaps most telling on this front is the fact that inflation was at 35% when Erdogan gained power and CPI is now running sub-5%.
Given the economic backdrop and improving economic situation of the average Turk over the last decade, the protests against the government are somewhat counterintuitive. Regardless, they are occurring with increasing scale. The map and timeline below highlights this fact showing the spread of protests across Turkey. To date, these protests have led to 3 fatalities and 5,000 injuries.
The protests in Turkey, though similar to the protests against local governments that erupted in the Arab Spring revolutions seen in northern Africa with Tunisia, Egypt, and Libya, also hold some specific differences. The unrest shown against Erdogan and his government is different because in the Arab Spring countries the protests were directed to the dictatorships that ascended to power, rather than democratically voted into office. On the other hand Erdogan has won every important democratic election. As well, the Arab Spring was initially catalyzed by the poor economic situation of the broad populace.
To be fair, the AKP and Erdogan have lost some of their popular appeal and are being accused of infringing on personal freedoms in Turkey. Recently the government implemented a restriction on alcohol sales and has also been allegedly imposing conservative Islamic views in legislation. The protesters have stood up, and have fought against police brutality and restrictions on labor unions.
There are a few options to what will happen next in Turkey. A scenario similar to the Arab Spring does not seem plausible, where protests fueled by the dissatisfaction of government led to complete regime changes in Tunisia, Egypt, and Libya. It is unlikely because the Erdogan has had such a positive impact on Turkey’s economy and the violence in the Turkish protests are not to scale of the Arab Spring. In essence, there is no military or armed support to the protests.
Another option is for the protesters to eventually give in with no major changes being enacted or seen in the government. Erdogan has been visiting cities to gain more supporters so that he and the AK party will again win the popular vote in the Presidential elections in 2014.
Ultimately, we do not think these protests will trump the strong track record of Erdogan and will eventually pass, although he may have to acquiesce on the civil liberties front. The biggest tell to us on this front is a chart of credit default swaps on Turkish government debt. While they are elevated, they are still largely in normal territory and are not signaling imminent economic or fiscal stress, which would come from a broad popular uprising akin to what occurred across the Middle East during the Arab Spring.
We aren’t ready to advise buying Turkish equities just yet, but our Hedgeyes are watching and waiting.
Daryl G. Jones
Director of Research