Turkey

April 26-May 2, 2008


Global Developments:


The past week has been a roller-coaster ride for the oil price which began falling sharply on Tuesday as a strike ended at the Grangemouth refinery in Scotland. Prices continued to decline Wednesday after the news that US crude reserves had risen sharply last week. On Thursday, prices slipped to 111 dollars after a strike ended in key crude producer Nigeria and as the dollar continued to strengthen. The price of oil climbed back towards 114 dollars on Friday on news that Turkish Air Forced had bombed Kurdish rebel hideouts in northern Iraq. Grain prices started sliding down gradually responding to the dollar rally.


The dollar rose to a five-week high against the euro on Thursday as traders took profits on the euro, in part driven by the optimism that the Federal Reserve's cycle of cutting interest rates might be ended. There is also the sentiment within the market that interest rates in the euro zone would have to be lowered at some point as growth is slowing down, particularly in Germany.

The US economy grew by 0.6 per cent in the first quarter of 2008, essentially on account of exports which increased by 5.5 percent over the quarter and the growth in consumption in services. Real consumption expenditure slowed down significantly to one percent and it was the weakest growth in consumption since the second quarter of 2001. Roubini argues that since all other components of aggregate domestic demand were in the negative territory, NBER will end up dating the beginning of the 2008 recession to the first quarter. Today’s overall non-farm employment data which showed labor shedding four months on a row support the EPA’s view that a “domestic recession” describes what went on in the first months of the year well.


The Federal Reserve cut interest rates by a quarter percentage point to 2 per cent on Wednesday and signaled its preference to pause at its next meeting in June. The Fed also cut the discount rate at which it lends directly to banks by a quarter point. With the latest cut, the Fed has brought its key interest rate down from 5.25% in September. EPA shares the view that Fed’s statement was dovish and “the pause” will be short-lived.

The decision by S&P to give Brazil a BBB rating, the lowest on the investment grade rung, reflected the Government’s determination to consistently produce primary budget surpluses, a functioning inflation targeting and a healthy GDP growth of 5 per cent during the global financial crisis. Among the emerging economies, Brazil’s stock market has been the best performer this year (11.2 percent in dollar terms). Brazil also has one of the highest real interest rates attracting large short term capital flows. An overvalued real should, however, be a cause of concern.


Saudi Arabia is about to formalize the launch of a sovereign-wealth fund (SWF) with a capital of about $6 billion, a modest initial investment compared to other SWFs. (Russia's newly-created National Wealth Fund is worth about $US 32 billion). In contrast, SAMA manages external assets of more than $300 billion. The Saudi SWF is being set up as subsidiary of the Public Investment Fund and likely to be organized around Singapore’s GIC model. The decision may indicate that earlier concerns about criticism of Saudi DFI in the recipient countries have been overcome.

The Central Bank of Russia raised all its interest rates by 25 basis points to curb inflation. The Bank raised the floor for its one-day repo rate -its main refinancing tool -- to 6.5 percent from 6.25 percent. It also raised its refinancing rate, which is rarely used in practice and serves as a ceiling for all official interest rates, to 10.5 percent from 10.25 percent. The Central Bank last raised its rates by 25-basis-points in February, but with inflation now running at 14 percent; over 2 percentage points above last year's level, real official interest rates remain deeply negative. Finance Minister Alexei Kudrin raised his forecast for inflation this year to 10 percent from 9.5 percent.

Hungary's Central Bank raised the two-week deposit rate, its benchmark interest rate, by a quarter of a percentage point to 8.25 percent to curb inflationary pressures. Hungarian consumer prices in March rose at annual rate of 6.7 percent, more than twice as fast as the central bank's target.

Iceland’s inflation rate hit a twenty-year high of 11.8 per cent in April in order to stem rapid inflation as a result of the depreciation of the krona that has lost around a third of its value since the beginning of the year. Large current account deficits that Iceland has been running led to a reassessment of risk and further undermined confidence in its financial system. The Central Bank pushed interest rates to 15.5 per cent – the highest in Europe – after an emergency 1.25 percentage point hike in March followed by another 0.5 percentage point rise in April.

S&P lowered its outlook on the long-term sovereign credit ratings on the Republic of Kazakhstan to negative from stable. 'The outlook revision reflects the increasing risk that deteriorating bank asset quality in combination with funding challenges will weaken the country's fiscal and external balance sheets, and impair policy flexibility and growth prospects,' said S&P. &P also affirmed the country's 'BBB-' long-term foreign currency, the 'BBB' long-term local currency, and the 'kzAAA' national scale ratings. S&P said Kazakh banks' scheduled principal repayments on external debt amount to $14 billion this year, much of which may not be rolled over because of higher borrowing costs and counter-party difficulties, which will likely force a contraction in outstanding domestic credit. This will result in economic growth falling sharply in 2008 to below 4 percent, putting pressure on banks' asset quality. In a separate release, however, S&P affirmed its counterparty credit ratings on 12 Kazakh banks, saying that although asset quality continues to deteriorate, it feels the problems are manageable, due to the loss absorption capacity of the banks and state support.

The EU signed a Stabilization and Association Agreement (SAA) with Serbia. An SAA, involving a tradeoff in reforms by a state in exchange for trade and aid, is normally regarded as a first step for the membership negotiations. The signing which offer came 12 days before a general election brought mixed reactions. In Belgrade, Serbia's Prime Minister Vojislav Kostunica declared that signing the deal was illegal and said it "cannot be interpreted as Serbia's signature for the independence of Kosovo." EU officials insisted the EU-Serbia agreement does not apply to the territory of Kosovo, which declared itself independent from Serbia in February.

FT reports that the demand for camels soars in India as the prices of tractors and oil go up. According to FT, a sturdy male with a life expectancy of 60-80 years now fetches up to Rs40,000 ($973), compared to Rs5,000-Rs10,000 three years ago. This compares with $4000 for an entry-level tractor.

And the torch is yet to make its Everest ascent.


Political Developments:

Turkish labor unions called off the final leg of their May Day march to Istanbul's Taksim Square facing a show of excessive force by security forces that used pepper spray and water cannons to control demonstrators. Security forces also shut down public transportation in much of the city. While no casualties were recorded, there were several reports of police beating and resulting injuries. The prevalent view is that Thursday’s show of force flew in the face of the Government which advocates a platform for democratic freedoms and considers itself a victim of “prohibitions”. Arzuhan Yalcindag, chairperson of the executive board of the Turkish Industrialists' and Businessmen's Association (TUSIAD) said that "We watched the security forces' disproportional use of force and the incidents with sorrow and concern. This was a bad test for the 130-year-old tradition of Turkish democracy." There were conflicting responses from the Government. While the Minister of Labor tried to put the blame on the local authorities saying that “the civilian authorities need to explain why they acted with such brutally against the demonstrators in the beginning”, Prime Minister Erdogan put all the blame squarely on the trade unions and said that “The government performed its duty; the undesirable incidents that took place yesterday during the May Day march in Istanbul are a result of the imposition by the trade unions,”

Turkish warplanes launched intensive bombing raids on Kurdish rebel targets in the Qandil mountain region overnight, the Turkish General Staff said on Friday. Turkish forces have stepped up strikes against Kurdistan Workers Party (PKK) targets in northern Iraq in recent weeks in addition to operations against them in Turkey. The United States said that it supports Turkey's air strikes against targets of the Kurdistan Workers' Party (PKK) in northern Iraq. These are ongoing operations against the PKK, a terrorist organization. The United States, Iraq and Turkey are all committed to dealing with this problem," U.S. National Security Council spokesman Gordon Johndroe said.

A Turkish delegation, led by Erdogan's chief policy advisor Ahmet Davutoglu met Iraqi President Jalal Talabani and the Kurdish administration PM Nechirvan Barzani. "The two delegations met and they discussed mutual relations between the two sides and studied the problems and anxiety which have colored relations between them in the past," a statement from Talabani's office said. "This is the first time a meeting has taken place between the Turkish government and the Kurdistan government," Falah Mustafa, foreign policy chief in the Kurdish regional government, told Reuters.

Turkey's parliament voted to soften Article 301 of the penal code, which makes “insulting Turkishness” a crime. The European Union has been calling on Turkey to amend Article 301, which has been the basis for charges against Turkish writers and journalists including Hrant Dink, Elif Safak and Orhan Pamuk. Council of Europe Secretary General Terry Davis, however, said in a written statement that “an analysis of the new wording indicates some progress in this respect, it does not alleviate all concerns about excessive restrictions of the freedom of expression, as guaranteed by Article 10 of the European Convention on Human Rights,"

The Constitutional Court forwarded the brief filed by the ruling Justice and Development Party as a preliminary step on in the closure case to the Office of the Chief Prosecutor who is expected state his opinion on defense brief within a month. In the meanwhile, Prime Minister Erdogan who has been meeting with the groups of AKP deputies to discuss strategy seems to have moved away from a hasty constitutional amendment on the closure of political parties.


Economic Developments:

Stock prices floundered throughout the week and closed with profit taking sales on Friday. The ISE-100 failed to push above 43700 and lost 0.4 percent of its value for the week. Lira appreciated 1.9 percent against the dollar and 2.7 percent against the euro. Bond prices reached a 12-month peak, closing at 19.4 percent.

The headline inflation accelerated to 1.68 percent, and the producer price index (PPI) rose 4.5 percent in April 2008. On a year-on-year basis, they correspond to a 9.7 percent increase in CPI, and 14.6 percent in PPI. Year-to-date headline inflation was 4.8 percent compared with the Central Bank’s target rate of 4 percent for the year. What is more telling is the 2.3 percent jump in the core inflation in April (8.7 percent y-o-y annual rate) while the recent price increases were attributed to higher food and energy prices by the authorities.

The Governor of the Central Bank, in presenting the quarterly inflation report said that the inflation target is unattainable and, due to expected increases in food prices, the CPI increase is now forecast to be to 9.3 percent. As for the formal inflation target, Mr. Yilmaz indicated the Monetary Policy Board has not yet decided to raise it from its current 4 percent level. He also argued that there would have been no point in changing the official target in mid-year. The Central Bank had already missed its inflation targets in the previous two years. In an interview with the Financial Times earlier this year, Yilmaz acknowledged that missing these targets created a "a huge credibility problem for the central bank". Unfortunately, he also seems to be unable to draw lessons from earlier mistakes and insists on running a homemade monetary policy. The expectation is that the Central Bank will raise overnight rate by at least 50 bp later this month,

The IMF Board is expected to approve the release of last two tranches totaling $3.7 billion at its meeting on May 9. These funds would help reduce the Treasury’s borrowing requirements which include rolling over YTL 6.2 billion ($ 4.9 billion) in May and ease the pressure on interest rates.

The Government plans to cut its primary surplus target under a medium-term economic plan to be announced this weekend. (EPA will comment on the program later once it becomes available) The 2008 target for the primary surplus was set at 5.5 percent of GDP, compared with 6.5 percent in the earlier years under the stand-by agreements. A factor to remember here is the recent upward revision of the national accounts data; a smaller share of GDP would still mean a larger absolute primary surplus compared to earlier years. For instance, primary surplus of 4.9 percent of GDP based on the new series would correspond to 6.5 percent of GDP based on the old national accounts series. While the Finance Minister Kemal Unakitan reassured markets that spending increases would not mean a lax fiscal discipline, there are serious concerns about the Government’s ability to keep a tight lid on expenditures going into the local elections in March 2009. It is not clear, however, how much discussion with the IMF has taken place and whether or not the Fund will sign off on it.

The Telecom IPO is oversubscribed by both the institutional and individual investors, supporting the view that the deal is grossly under priced. Priced at the range of YTL 3.9-4.7 per share, IPO is expected to generate $1.8 billion to $2.2 billion for the budget, bringing the market valuation of the company to about $ 13 billion. At a share price of 4.7, the P/E ratio would come to 6.6, about 30 percent below the comparable ISE listings. Final book-building for the stake in is scheduled for May 7-9 with a green shoe option of 2.5 percent of total shares. A 55% stake was privatized in 2005 to Lebanese-owned Saudi Oger for $6.55bn and is now held by a Dubai-based vehicle, Oger Telekom. Saudi Telecommunications, the state-controlled Saudi Arabian fixed-line operator, took a 35% stake in Oger Telekom for a reported $2.6bn in January. It has 19 million fixed-line and 6.5 million ADSL subscribers. The latter accounts for about a quarter of the company's income.


What to expect next week:

While the sentiment in the US is the continued rebound of the dollar and upward moves in the market indices, barring major surprises in the series of earning reports expected next week and scheduled speeches by Bernanke and other Fed governors, EAP expects that the Turkish market will increasingly become decoupled, as it did last week, and focused on domestic political news.