Where is Turkey headed?
Photo by Michael Parulava on Unsplash
The number of English language books written about Turkish leader, Recep Tayyip Erdogan, has grown significantly in recent years.
As recently as 7 years ago, there were almost none to read, but of those that have been published since, we can safely say we have now read them all (if you know of any more, please let us know!). Soner Cagaptay’s trilogy of books, “The Rise of Turkey: The Twenty-First Century's First Muslim Power”, “The New Sultan: Erdogan and the Crisis of Modern Turkey” and “Erdogan's Empire: Turkey and the Politics of the Middle East” provide an excellent background to anyone who wants to understand Turkey’s recent history and context. More recently, “Erdogan Rising: The Battle for the Soul of Turkey” by Hannah Lucinda Smith provides a brilliant account of what drives Turkey’s most important political leader since its founding father, Mustafa Kemal Ataturk, nearly a century ago.
Mr Erdogan is an enigmatic political genius and the primary driver of everything that happens in this extraordinary country. But what often gets lost in the political analysis is the actual country itself. Turkey will be there even after Erdogan is gone, albeit completely reshaped by him. As Mr Cagaptay points out in a recent podcast appearance on Hidden Forces with Demetri Kofinas, most people conflate Erdogan with Turkey and vice versa. As such, there is an obsession with what happens when Erdogan leaves the scene (never mind how he ultimately does so).
Erdogan spent August 26th (the day we penned this piece) summoning the victorious spirit of the Seljuks (the people who ultimately became the Ottomans):
“The Battle of Manzikert was fought between the Byzantine Empire and the Seljuk Empire on 26 August 1071 near Manzikert, theme of Iberia (modern Malazgirt in Muş Province, Turkey). The decisive defeat of the Byzantine army and the capture of the Emperor Romanos IV Diogenes played an important role in undermining Byzantine authority in Anatolia and Armenia and allowed for the gradual Turkification of Anatolia. Many of the Turks, who had been travelling westward during the 11th century, saw the victory at Manzikert as an entrance to Asia Minor.”
It just so happens that Turkey is currently embroiled in a heated standoff with Greece over territorial rights in the Eastern Mediterranean. Erdogan did not forget to mention that the Turks have beaten the Greeks before and will not be afraid to do it again. This is symptomatic of his newfound aggressive military stance, and represents how Erdogan wishes to portray his vision of Turkey – not necessarily to those global powers who are watching (although they do feature in his audience), but mainly to his local voter base.
The Great Showman was on top form. The question is whether Erdogan ends up like the Byzantines or the Seljuks?
Telling it as it is
For the best possible explanation of what Erdogan sees for the future of his beloved country, all you need to do is watch this video, a phenomenal piece of propaganda courtesy of his chief spin master, Fahrettin Altun. It encapsulates all the key components of Erdogan’s ideology, which still, as it stands, is shared by enough of the voting population to keep him in power. It cleverly mixes in the romance of the Ottoman era with a sprinkle of conservative Islamic piousness, topped off with a grand show of Turkey’s own modern domestic military capability. At the heart of it all is none other than Erdogan himself.
Turkey has dramatically shifted course over the past years, partly due to Erdogan’s maturing ideological differences with the West. More specifically, the shift has been catalysed by the 2016 coup attempt, after which Turkey seems to have turned eastwards into the warm bear hug of a certain Mr. Putin. Turkey is the prize and Erdogan knows it. Throughout history, it has been in a tug of war between East and West. This tug of war is best expressed not in the geopolitical battles we see all around (relevant as they are), but rather glaringly within the country: in the extremely divergent hopes, dreams and actual realities of the Turkish population.
The schism fuelled by propaganda videos like that one mentioned above is further augmented by policy, ideology and, indeed, history. Secular Turks who predominantly populate the wealthier coastal cities (where Erdogan’s AKP has recently lost a string of mayoral elections) wish for closer ties to the West, in line with Turkey’s original Kemalist history. In fact, Turkey’s omnipresent founding father was such a fierce proponent of westernising Turkey that one of his first acts in charge, nearly a century ago, was to rewrite the Turkish alphabet using Latin characters rather than the Arabic script popular at the time in an attempt to shift the new nation’s culture westwards. This was a move vehemently opposed by conservative, religious elements within Turkey even back then. Yet the century that followed has proven that this initiative, as well as many others - including the ban of the popular Fez – did what it was meant to do, and for 80 years or so, Turkey’s identity (at least on the surface) became decidedly West-facing. We highly recommend reading A Fez of the Heart by Jeremy Seal for a beautiful overview of Turkey in the 90s and how the fez itself came to symbolise the very battle for the soul of the country.
However, notwithstanding the success of the country’s westward cultural shift, beneath the surface and primarily in the interior hinterland of the country, a massive portion of the population was left behind. It is this more conservative, religious populace that has risen in many ways since Erdogan took over the reins.
Back to the future
Despite economic growth cooling dramatically over the past few years, this segment of Turkish society adores the Neo-Ottoman ideology and still credits Erdogan with elevating them from poverty into the middle class. This support has waned somewhat over the past years, but they have nonetheless continued to deliver Erdogan broad-based support, keeping him in power. The question now is whether Erdogan can get back to delivering continued economic progress and improvements to them. Unfortunately, the situation seems rather grim, further galvanising Erdogan’s efforts to advance his neo-Ottoman ambitions as an appropriate distraction from this unfortunate reality.
Turkey faces a litany of problems, but there isn’t much point rehashing them. That said, there are a couple of key structural issues one should keep in firm focus, given many of the decisions being made today may ultimate prove difficult, if not impossible, to reverse in the years to come – regardless of whether Erdogan remains at the helm.
Most critically, international relations have changed spectacularly, with Russia and China taking advantage of Erdogan’s new tilt eastwards. Recently, ties with China have become deeper and deeper, as Turkey’s inability to secure a funding lifeline from the West amid continued FX weakness and very high foreign currency indebtedness of local corporates has seen China riding to the rescue.
Of course, as we all have come to understand in recent years, China has its own set of priorities, chief of which is embedding Turkey into its Belt and Road Initiative, cementing China’s role as a global superpower. As a recent article in The Diplomat highlighted:
“China and Turkey have a yuan-lira swap deal dating back to 2012. The first time Beijing transferred funds to Ankara under the terms of this deal was during an election month in 2019. This June, Turkey again made use of the swap deal to pay for a batch of Chinese imports. Erdogan, who — despite repeated attempts in 2020 — has failed to secure any swap deals with Western central banks, hopes that China will join his closest ally Qatar to offer greater capital injections through investment and swap deals to help bail out Turkey’s flailing economy.”
“Gao Tian, the China-Germany Railway project manager, argues that projects like these foreshadow how Turkey will be the very center of the BRI rail and infrastructure project connecting East and West. The vision involves developing Turkey from a simple transit hub for LNG, freight goods, and other products into an active, global hub of international trade, the “Middle Corridor” of China’s Silk Road Economic Belt.”
Amidst its increasingly untenable efforts to defend the value of the lira (FX reserves reported at the end of June 2020 were US$47.27bn, almost half of what they were in Nov 2019), the government’s narrative around the currency has shifted dramatically. It now paternalistically remarks that a weaker lira is good for the country as it improves competitiveness and brings foreign tourists to the country.
Less is unfortunately not more
The problem here is that Turkey has an incredibly sophisticated economy and is an emerging technology centre. An example of this is the domestic defence industry, led by state-controlled defence firm, Aselsan. Turkey’s recent military activities in Syria and Libya are facilitated to a large degree by products and technology developed domestically as part of a monumental focus, over the past decade, on building a domestic defence supply chain.
Such a comprehensive and complex system, built through decades of effort and development, is not one to be tinkered with lightly. While allowing the currency to collapse further would certainly make the country attractive to foreign tourists and improve Turkey’s appeal as a low cost manufacturing centre, this would come at the further expense of the Turkish people as the cost of living would soar once more, not to mention the impairments to trade, supply and costs which will surely come about as a result of an increasingly debased currency.
International markets will be the ultimate arbiter of what unfolds, and the recent announcement by MSCI that Turkey may be considered for a downgrade from Emerging to Frontier status is symbolic of the decline over the past few years and the desperation that many “White Turks” feel.
The end of the tunnel
However, not all is lost from an investment perspective. Turkey has a vibrant stock market and ironically, as the foreigners depart in droves, it means the influence of local investors rises. The plethora of individual traders and so-called punters means that there is always an opportunity somewhere. The most interesting driver of all is in fact the composition of the domestic investment basket. Traditionally, local pension funds and institutions have always allocated the vast majority (around 90%) of capital to the bond market, given the rich yields on offer from the bonds of many blue-chip enterprises on offer in a hitherto high interest rate environment.
There is only one way for this allocation to shift over time and that is increasingly into equities. And as foreigners vacate the markets, especially with a possible downgrade to MSCI Frontier markets (even though it may still be early to make that call just yet), it leaves space for locals to step in and be the marginal maker of the prices of Turkish traded equities. A downgrade would also result in the near disappearance of passive flows and result in “proper” price discovery.
The destruction of central bank independence and the resultant interest rate policy is doubtlessly negative, and with the central bank recently embarking on its own quantitative easing program, the result is not difficult to imagine: the inevitable balancing term in this equation is a currency that weakens even further.
For the markets, this isn’t necessarily bad. We have seen many times what happens to local stock markets when currencies plunge. After a short-term sentiment-driven hit, the rally is usually vicious and rapid as local investors look to hedge against inflation. Turkey has many Lira-hedge stocks with solid and well-run underlying businesses to choose from. Unfortunately, these returns are limited to being denominated in local currency, as a depreciating lira would, in this scenario, obliterate dollar returns.
Mind the gap
From our perspective, Turkey is a wonderful country, with the gift of geography placing it smack bang in the middle of all the action between East and West. It is a tourist’s dream, with great natural beauty as well as a deep and mesmerising history. It has a young, highly skilled labour force and a well-run corporate sector. And it has wonderful people, many of whom are our close friends, colleagues and partners.
As a foreign investor into Turkey’s equity markets, the opportunities right now are very specific, and one needs to be nimble. We have absolutely no idea what exactly will unfold next. What we do know is that there will come a time, whenever that may be, where the potential of this great country will once again begin to be realised and its structural tailwinds will resume. When this happens, Turkey could prove to be one of the great investment opportunities of our careers, in both private and public markets.
We are waiting patiently. We can’t wait to travel to Turkey again and we’re watching for the day when these opportunities present themselves.