Major emerging market bond fund managers expect the ruling AKP party to maintain its absolute majority in parliament after Sunday’s election in Turkey, thereby ensuring a continuation of responsible economic policymaking, an Emerging Markets straw poll has shown.
The survey - which canvassed key bond fund managers with a combined total of over $10 billion under management - also showed that investors expect the AKP to plump for a compromise presidential candidate acceptable to the secular “deep state” military and business establishment.
Moderates in the party, who have been pushing for such a compromise, are expected to emerge strengthened if the AKP comes out with a majority slightly diminished from the current 365 seats in the 550-seat parliament.
Speaking to Emerging Markets before the latest opinion polls, Nehad Chowdhury, emerging markets economist and strategist for BlueBay Asset Management in London, summarized the optimistic mood.
“Our central scenario is a positive one, with a parliament dominated by the AKP, and a president who will be at least not hostile, and at best supportive but viewed as independent,” said Chowdhury, formerly an official at the Turkish central bank, who now helps to manage around $2.7 billion in long-only EM fixed income assets at BlueBay.
Even before the most recent opinion polls, which showed the AKP increasing its support to more than 40% of the vote, Chowdhury assigned only a 10% probability to a more fragmented parliament forcing an unstable governing coalition.
Blaise Antin, head of research for the $1.9 billion TCW Emerging Market Fixed Income Fund in Los Angeles, put a 70%-75% probability on an absolute AKP majority that fell short of a potentially controversial “super-majority” – the two-thirds hold on parliament that would allow the party to change the constitution.
Antin suggested that the more likely risk was a minor uptick on election day for one of the smaller parties, taking them beyond the 10% threshold required for representation in parliament. A Credit poll sponsored by Credit Suisse, published on July 19, suggested only two other parties (the CHP and MHP) will break the 10% barrier. However, the Genc (Youth) Party of businessman Cem Uzan and the New Party (DP) formed from a merger of two centre-right parties, have hovered just below the 10% threshold in the opinion polls.
At Invesco in New York, Claudia Calich and Eric Lindenbaum who manage at least $1.5 billion in dedicated and crossover EM debt funds, are also positioned for an AKP absolute majority. Yet, they acknowledged the risk of a sell-off if this does not transpire – especially if other parties attempt to squeeze out the AKP with an alternative coalition.
Matt Ryan, fund manager of more than $3 billion in EM fixed income assets at Boston-based MFS Investment Management, agreed, although he too is currently basing his investment decisions on the best-case scenario.
“The CHP and the MHP have both shown more populist tendencies and seem less committed to reform,” Ryan told Emerging Markets. He added that he would be particularly concerned if the GP crossed the 10% line – the Uzan family has clashed with the authorities in the past over efforts to clear up non-performing loans in the Turkish financial sector.
Moreover, beyond the parliamentary vote, uncertainty continues in the form of the AKP’s internal debate over whether to select a compromise presidential candidate. Kieran Curtis, fund manager of around $750 million in two emerging market debt Sicavs for Morley, the fund management arm of UK-based pensions and insurance firm Aviva, believes a smaller AKP majority would strengthen the hand of the moderates.
“There are many party members who recognize that it is easier for them to run the country if they avoid further confrontation with the military. If the lead in parliament is narrower, that will reinforce the point,” Curtis told Emerging Markets.
Above all, noted Antin at TCW, Prime Minister Tayyip Erdogan himself has clearly prioritized the maintenance of relations with the secular elites.
Antin told Emerging Markets: “It seems unlikely that Erdogan would allow a fresh confrontation with the military. He has personally selected a candidate list for parliament that had fewer hard-line Islamists, and more high-profile market-friendly names” – including former Merrill Lynch analyst Mehmet Simsek.
Resilience, not complacency
Not all investors are convinced by the positive scenario. Enzo Puntillo, senior emerging market debt portfolio analyst at Bank Julius Baer in Zurich, is one of the few Turkey sceptics, and cautioned against over-exuberance:
“The markets were very calm when the army effectively vetoed the AKP’s presidential candidate [in April 2007]. But the military has a track record of intervening in domestic politics, so I’m note sure this risk has been sufficiently priced in,” said Puntillo, who co-manages one of the oldest dedicated EM local markets funds, founded in 2000.
Ryan at MFS acknowledged that he was also surprised at the resilience of Turkish assets ahead of the elections, but would not characterize this as complacency. The appreciation of the lira could be partly attributed to seasonal factors – especially strong current account revenues, such as tourism earnings – rather than purely to portfolio inflows, and he argued there is still room for further upside.
“A lot of the local corporates and funds have been waiting on the sidelines, especially in the fixed income markets, so there is a further bid that can support valuations after elections,” said Ryan.
Lindenbaum at Invesco also believes that the technical picture is supportive, especially for lira-denominated bonds, which should be helped further if the current exchange rate strength and decline in inflation allows for interest rate cuts by the end of 2007.
"So far this year, the gains in local debt for foreign investors have come mainly from currency appreciation, but we should get more juice from yield tightening if the central bank brings forward interest rate cuts after the elections," said Lindenbaum.
Chowdhury at BlueBay is also expecting interest rate cuts by year-end 2007, but Morley’s Curtis thinks the central bank may delay any significant easing until early 2008, due to fiscal slippage before the elections.
“To put the budget back on track, the government may need to undertake tax hikes that could feed through to CPI. Governor Yilmaz will also want to avoid a repeat of the lira sell-off in 2006, when they probably made one rate cut too many, so he will be cautious to maintain his credibility,” said Curtis.
Still, he is reassured by the recent move to enhance monetary policy sophistication by giving the central bank its own liquidity instruments, rather than relying on Treasury bill issuance as now. In stark contrast to the sharp sell-off ahead of the polls in 2002, the deepening credibility of Turkey’s economic policymaking institutions has encouraged fund managers to bet on continuity after the elections. And, adds Curtis with a laugh “It is hard to argue with real yields of 10%.”