Thoughts from a Renaissance man Economics & Strategy 4 February 2020 Charles Robertson +44 (207) 005-7835 [email protected] Mobile +44 7747 118 756 @RenCapMan Vikram Lopez +44 (207) 005-7974 [email protected] Thoughts from a Renaissance man Turkey upside growth surprise in 2020/2021 A cheap currency can help lift exports while interest rate cuts lift domestic demand, providing an opportunity for Turkish growth to reach 5% in 2020/2021. There’s a lot tailwinds for Turkish macro in 2020 A combination of factors are supporting Global Head of Equity Strategy Daniel Salter’s Overweight on Turkey this year. Externally, low interest rates from the European Central Bank and the Federal Reserve are once again a good reason to look at a country that over three centuries has often imported capital to support growth. The balanced current account (C/A) is a rarity in Turkey’s history and means a rapid pick-up in growth should not worry investors in 2020 (and 2021 if our forecasts are right). The TRY is the second cheapest in emerging markets after Argentina and should limit C/A widening in 2020, helping with trade and also by encouraging tourism receipts. We also expect Turkey to benefit from rising labour costs in Central Europe. The customs union with the EU guarantees trade access to the EU. The gross minimum wage is about 70-95% of Central European levels. The manufacturing base has a long track record. We expect FDI to continue flowing to Turkey. Meanwhile falling local interest rates mean that domestically financed investment can pick up too, while we expect European banks to continue rolling over (and perhaps expand) lending to Turkey. The banks and corporates in Turkey showed again in 2018, as they did in 2008, that however volatile the economic environment, they are reliable partners for Europe’s lenders to interact with. In the very short term, Turkey also gets a lift from the China-induced weakness in the oil price. We think the undervalued TRY can limit C/A deterioration Taken together, we continue to see a decent chance of Turkey achieving the 5% GDP growth in 2020 that the government is targeting, in excess of the consensus target of 2.8%. This is premised on household consumption rising by 2.4% (consensus expects 3.4%, which we believe is possible), government consumption rising by 4.9% (consensus assumes 2.5%), investment rising 6% (consensus sees just 2% growth), and the C/A slipping from a $1bn surplus in 2019 to a $5bn deficit in 2020 (consensus expects $11bn). We also expect a 5-6% growth rate in 2021. The penalty may be paid for via stubborn inflation and nominal TRY depreciation Last year, we suggested Turkey had a choice of either export- and investment-led growth, or more bank lending supporting consumption but at the expense of the C/A. The authorities appear to favour both at the same time – boosting exports by keeping the currency on the very competitive side of fair value – and lifting investment and consumption via interest rate cuts. This means that reducing inflation has to come second to the growth target, and we assume only a modest fall in headline CPI from 12.0% in January to 9.9% by December 2020. To keep the currency competitive will therefore require some modest nominal depreciation and we forecast TRY5.95/$ in 2019 to TRY6.3/$ in 2020 and TRY7.0/$ in 2021. Portfolio positioning is light Investor positioning in Turkey appears to be light. In 2019, there were net outflows on the debt market and modest $0.4bn of inflows into equities. As recently as 2017 portfolio inflows were $24bn. We suspect 2020 inflows will be closer to 2019 than 2017. © 2020 Renaissance Securities (Cyprus) Limited. All rights reserved. Regulated by the Cyprus Securities and Exchange Commission (Licence No: KEPEY 053/04). Hyperlinks to important information accessible at www.rencap.com: Disclosures and Privacy Policy, Terms & Conditions, Disclaimer. Figure Figure inwage$1,000minimum 2023.promise theto to raise 2019 the PiSwageshigher. won Poland’s pressure workforce to going is decision due in is in factory 202 new ahead ait with anotherifgoes Turkey location, ratherthan competitors that below of isthat a wage minimum One ofadvantages is Turkey’s Note: Turkey's working age population is still growing by 0.5% a yeara growing0.5% Turkey'sisstill by Note: workingagepopulation Figure workforce. declining countries a frontier with emerging or developed, rising those with workforce) countries amany with of (one cause, Turkey compare underlyingtheTo we highlight regional averageoranof Wages canNote: gross, databe 1,000 1,200 1,400 1,600 1,800 2,000 -2.0 -1.5 -1.0 -0.5 200 400 600 800 0.0 0.5 1.0 0 2 1 : Januar dollars, in wages Minimum : Turkey keep will agepopulation working Turkey’s Ireland 1,838 Netherlands 1,816 France UK 1,775 assuch China Germany rates exchange2020 4February on $inbased wage Minimum 1,758 Belgium France 2020 February US 1,242 1,708 Poland or Romania. For this reason we still Romania. we this or reason For Poland Finland Spain 1,166 Slovenia 1,045 Czech Republic (15 age Working Greece 841 Mauritius Portugal 823 678 Chile orsectoral wages Poland competitive with Hungarywith competitive not is probably Romania 2023 by $1,000to rise PiS promsing Poland's wages European upCentral driving are Shrinking . Over the coming decade, theOver Lithuania 674 Feb 4at available) latest 2020 (or y Netherlands rightondata Estonia 648 - Spain change% 2020 annual population 64) Slovakia 644 workforces increasing as increasing Czechia 638 Thailand Croatia 606 Austria 541 - Hungary (unskill) reliable) so (not wagesnet or grossof mix bemayside hand Italy Romania 517 Latvia 477 Armenia Central Serbia 381 DM Singapore Bulgaria 346 Europe’s shrinks Europe’s Japan Hungaryabove $536was Turkey March In EM Turkey (Gross) 492 Central Estonia Lebanon (2018) 446 ruary - Eurostat and many other sources via Renaissance Capital, note Capital, Renaissancevia sourcesother many and Eurostat Jordan (2018) 377 choose expect VW to Portugal FM 2018, China (Shenzhen) 354 rates exchange 2020 Europe’s shrinking Europe’s - Serbia Capital Renaissance via projections UN 25, Morocco* 295 Central Slovenia Beyond Colombia 289 279 a on election Greece Argentina Brazil 245 province as cheap as now Russians European European Georgia SA* 250 0 the – 193 Germany Indonesia* the cheapest Russia 191 Hungary Ukraine 190 Moldova China (Heil.) 189 Chinese Bangl (govt) 182 labourergeneral= (gl) workers = textile (txlt) wagesminof mix = avg* = Green EM= Blue Romania Georgia (Tbilisi) 175 Hong Kong Vietnam* 161 FM Yellow Green Blue Red Russia Azerbaijan 147 man a Renaissance from Thoughts Mexico 145 = Developed markets = Developed $100 aroundIndia Ukraine markets Emerging= 143 = Frontier markets Frontier= Tunisia = Beyond Frontier Beyond= 127 Croatia Egypt - Pakistan 114 200 Poland 112 Kazakhstan Renaissan Source: Eurostat, Googlesearches Source:Eurostat, Korea Kenya* (gl) 109 103 2020 4 February Belarus Ivory Coast Banglad. (txtl) 94 Taiwan Zambia 93 ce Capital ce Lebanon Iran (parallel) 79 Source:UN Nigeria (NGN30k) 83 Lithuania Ghana* 53 2 Ethiopia (txtl) 22 Renaissance Capital 4 February 2020 Thoughts from a Renaissance man Not only is Turkey’s working age population still growing, but it also has room to increase labour force participation by drawing more women into the workforce. Turkey is at least a decade ahead of North Africa in this regard, and over 10-20 years, we assume it will approach European and Asian levels of labour force participation. The combination of a rising workforce and rising participation should help keep wages competitive. Figure 3: Turkey has room to increase labour force participation by 10-15 ppts Unemployment rate (2018, IMF) vs Labour Force Participation Rate (2018, ILO estimate) - via Renaissance Capital 30 South Africa 25 Nigeria 20 Greece Problem Jordan Armenia corner if population Tunisia is shrinking 15 Spain Wage inflation Iran Serbia or Low Female Brazil Immigration Participation Rate Egypt Turkey or Italy Croatia 10 Morocco Colombia Higher pension Argentina France Unemployment rate (2018, IMF) (2018,rate Unemployment Ukraine age Chile Portugal Peru Pakistan Mauritius Ireland Lithuania Philippines Indonesia Slovenia Estonia 5 Romania Russia Sri Lanka Korea US UKKazakh. Mex China Germany Switz. Hungary HK Czechia Malaysia Singp. Vietnam Poland Japan Thailand Belarus 0 40 45 50 55 60 65 70 75 80 85 LFPR, ILO estimate, 2018 Note: Turkey has room to increase labour force participation by 10-15 ppts Source: ILO, Bloomberg On growth, our work on demographics1 shows that Turkey should grow by 4.7% annually over 2020-2025, before slowing to 3.8% for 2025-2030. Turkey’s growth since 1960 has been nearly exactly in line with our demographic model, but it could outperform if it brings in more women, raises its investment rate and improves the business climate. Meanwhile, the TRY remains cheap based on our REER model. 1 See Thoughts from a Renaissance Man: Let’s talk about Sex (and money), 14 November 2019 3 Renaissance Capital 4 February 2020 Thoughts from a Renaissance man Figure 4: Our REER FX model shows that Turkey's currency is about 20% cheap to its long-term average FX rate FX rate Standard Yvonne's Current Date of LT avg IMF 2019E IMF 2020E RenCap 1Y local implied if REER falls deviations avg REER FX rate REER divided by C/A C/A 20YE currency by LT to previous away from 9/19 vs $ low current rate (% GDP) (% GDP) forecast yields avg REER lows historic average estimate Czech Republic 22.8 28.2 43.7 Jan-95 1.24 -0.1 -0.2 1 2.0 China 7.00