After a year of relentless currency crisis, a credit freeze and slide into recession, some global investors are betting Turkey has weathered the worst of its biggest financial and economic shock since its 2001 banking collapse - by accident or design. While Turkey faces numerous unresolved political and economic challenges, the more extreme fears of a sovereign funding squeeze that threatened national bankruptcy and international bailout, or even a return to its dark past of hyperinflation, appear to have eased.
Some luck in timing has been critical to the rethink as the world's central banks have prepared for yet another round of monetary stimulus over recent weeks and prompted a dramatic easing of global financial conditions. Bursting back onto international capital markets with a $2.25 billion bond sale on Tuesday that was more than twice oversubscribed, Turkey confirmed it had little trouble to entice investors back to a country whose woes had caused tremors that ripped through emerging markets around the globe last year.
Investors seem ready to take an upbeat view, despite continued tensions with Washington over a Russian defence system which Turkey has bought and which could prompt US sanctions, a pile of bad debt left behind by a sharp economic slowdown that has yet to be tackled and an urgent need for structural reforms. "Turkey is beyond the worst," said Magdalena Polan, global emerging markets economist at Legal & General Investment Management. "The political outlook is more stable as it's quite a long time before the next election. That means the government can focus, if it chooses to, on proper economic reforms."
This week's bond issue coincided with falling Turkish borrowing costs, as yields on the 2030 sovereign dollar bond dipped to 7% - levels last seen in the run-up to local elections on March 31 that saw Turkey curb offshore lira trading, sending shudders through its international investor base. Market watchers point to other factors they say also bear the hallmarks of a turnaround.
Inflation has been steadily slowing, with the latest numbers delivering the best reading in almost a year. Turkey has historically been haunted by strong price pressures, and it only really got on top of hyperinflation 15 years ago. "The long-awaited base effects have kicked in, which could provide impetus for inflation to continue declining in the coming months," said Carla Slim at Standard Chartered Bank.
Being a large energy importer, Turkey remains vulnerable to a sudden rise in crude prices. But with oil prices hovering around $60 per barrel - nearly $15 below their 2019 peak - and little upside in sight, that pressure seems to have waned. Turkey's current account deficit has been fairly narrow after a sharp adjustment in the wake of last year's currency crisis that sent the lira tumbling around 30%, making it less reliant on foreign flows to plug the gaps. The current account is closely watched by investors as the broadest measure of trade and investment.
In April, the current account deficit stood at $1.33 billion - a far cry from the nearly $8 billion it had ballooned to by end-2017. Economists expect the gap to shrink further in the months ahead thanks to higher exports and tourism. In a sign of nascent investor confidence, Turkish bonds and stocks sucked in $256 million in the week to June 21, the largest inflow since early February, according to Deutsche Bank.
Along with Russia, Turkey's bonds were the best performers in emerging market fixed income in the second quarter. Citi's emerging market fixed income survey published this week found fund managers expected Ukraine and Turkey to be the top value plays in the third quarter. Still, year-to-date Turkish assets have suffered outflows of $1.65 billion - the worst performance since 2015, said Deutsche.
Adding to the upbeat mood was a stabilisation in foreign currency buffers, whose rapid depletion in spring had unnerved markets. The central bank's net international reserves dipped to $28.3 billion as of June 21, but still reflected a trend of relative stability in recent weeks. Domestic investor behaviour - a key measure of market confidence in many emerging market crises - also seems to point towards a halt in deterioration. The rapid rise in dollarisation of FX holdings by local institutions and individuals looks to have taken a breather after hitting record highs in June.
Markets have been buoyed by hopes of a more stable political backdrop after Turkey's opposition wrested control of Istanbul, Turkey's biggest city, from President Tayyip Erdogan's AK Party in a re-run mayoral election last month. Societe Generale's Phoenix Kalen said Turkey had reached an "inflection point towards a more positive dynamic" following the vote, with economic rebalancing well underway.
Turkey will not vote again until presidential and parliamentary elections in 2023, providing a long runway for possible reforms many investors are crying out for, such as ensuring monetary policy independence and steps to support the banking sector. "In the positive scenario this will lead to a rethink of economic policies by the government," said Polan.
"In the more realistic scenario there will be a mix of those scenarios, so some progress on reforms and some progress on responding to concerns of the wider population on jobs, debt and interest rates." Bolstered by a spending spree before the local polls, Turkey pulled out of recession earlier this year, but that recovery could prove short-lived. Some predict gross domestic product to have contracted again in the second quarter following April's weak industrial output and retail data. Turning point or not, the recent rally might be capped by any imposition of US sanctions if Turkey takes delivery of the Russian S-400 system, possibly as soon as next week.
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