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Stanford economist [John] Taylor’s Rule is often used by analysts to get a sense of how far from “idealized” monetary policy a given central bank sits by taking into account information conveyed by output gaps, inflation, neutral levels for policy rates and the exchange rate; Taylor’s blog post from last fall approximates the level against which corrective actions should theoretically be taken and I like to think of it as how far ‘behind’ or ‘ahead’ of the curve rates currently sit.  While not a predictor of short-term policy action by any means, it can give insight into whether or not the market might be overly anticipatory of impending action.  Turkey, right now, is a perfect case in point.  New central bank (CBT) governor Erdem Basci’s first meeting last month seemingly extended the Bank’s hitherto dovish efforts to use unorthodox, macro-prudential measures rather than aggressive rate hikes to counteract the G20’s third-fastest growth rate in 2010, holding the policy rate (the one-week repo) at 6.25 percent but lifting the reserve requirement ratio [for foreign and local banks] on one-month lira deposits to 16 from 15 percent, and raising the ratio on FX deposits >1yr to 12 from 11 percent.   This against the backdrop of nominal wage growth (+18%), domestic demand (+25%) and credit growth (30-40%) in 2010 however that has aggravated the country’s deteriorating current account (CA) deficit beyond expectations (9.8% of GDP in March versus 8-8.5% projected) and, per last week’s Economist, will likely “pressure” the government following next month’s election (where AK is likely to win a third term of single-party rule) to “tighten fiscal policy and the central bank to raise interest rates”.   That said the CBT remains firm in its conviction that the economy is suffering the effects of over-borrowing rather than overheating per se, a distinction that should make all the difference to policy watchers and bond holders and makes the latter continued buyers of Turkish debt, especially as many market participants change their paradigm away from hawkish, rate hike expectations (at least near-term 2011; ultimately analysts see a rise to 8.00 percent by Q12012).  To that end, per Taylor’s Rule Turkey remains only slightly behind the curve (~200bp) when aggregating its policy and reserve rates, a function largely of lira appreciation as well as just a slight output gap (symptomatic of its 44% employment rate–the OECD’s lowest) which augments the stance that consumer lending growth is best left tackled through non-rate measures.  The former in particular has played a role in holding down inflation so far, though the CBT revised its inflation forecast for end-2011 to 6.9% (from 5.9% versus a 5.5% target) and consensus forecasts calls for 7-7.5% citing higher oil prices and taxes on textiles.


Woe is the EM central banker; as RBI’s Dr. Subir Gokarn pointed out in Wednesday’s FT, for instance, the delicate balance between “keep[ing] inflation in check by containing the potential spillovers from food and energy prices, while minimising deviations from a sustainable growth trend” has rarely been so harrowing.  For the Central Bank of Turkey (CBT), the foundations underpinning 8.4% annualized real growth last year have paradoxically also pressured a rapidly ballooning current account deficit (roughly -48.6bn USD in 2010 versus -14.0bn in 2009) as Q4 private sector credit extension surged (41% y/y) and has remained above 40% in the first two months of 2011–well above the government’s 20-25% y/y guidance and despite reserve requirement increases.  This ‘monetary normalization lite’ underscores the degree to which lira depreciation remains the Bank’s primary tool (rather than rate hikes which invite capital flows, not to mention political scorn in an election year) to reverse the CA deficit bulge, since the alternative would be to raise real rates and encourage portfolio financing (which saw record flows in 2010) of the very deficit officials purportedly seek to address.  The Bank’s policy has also been helped hitherto by falling inflation which slowed to only 4.2% y/y in February, a record low.  Yet against the backdrop of the CA breakout and secular lira fall this magic act cannot last forever.  Barclays notes, for instance, that low inflation last year “was driven largely by base effects (tax increases early in the year)” while projecting that headline as well as core prices would respond sharply going forward–to 8% by July and then “to about 7.5% by end-year, much of it depending on local harvest dependent developments in unprocessed food prices.”  Said occurrence, however, coupled with a CB new governor this month and a further entrenched AKP by summer, may finally create the perfect recipe for bona fide monetary hawks to spread their wings, which in turn would theoretically signal an end to the lira’s nearly four year fall from grace.  Payer swaptions, which pay a fixed rate while receiving floating, seem a sensible way to play this envisioned outcome, especially since the market’s current 125bp hike expectations seem low.

Awhile back we mentioned that one key indicator to watch in Turkey going forward was its current account deficit (CAD)/GDP ratio, which as the FT noted today in regards to Turkey’s suddenly diverging 5yr-CDS spread with Russia (with whom it had been treading in parity) is largely a function of its reliance on imported energy despite the obvious proximity advantages which shave roughly US$2-4/bbl off the spot rate.  Primarily, Turkey’s CAD should be monitored if for no other reason than the fragility of its foundation: analysts noted last December that “FDI coverage of CAD is less than 14% (12 months rolling), while portfolio flows into local bonds and equity together with rising non-resident lira (TRY) deposits make up over 70%.”  With this in mind the current spike in oil prices is particularly troublesome for Turkey’s economy, especially when coupled with the central bank’s (CBT) apparent curve lagging in the face of inflationary signs (i.e. high production rates and rising capacity utilization levels) that were ignored late last year in favor of rate cuts (75bps in December and January to cool inflows) and reserve requirement hikes to temper loan growth against the backdrop of implied political pressure (to combat currency appreciation) in the face of general elections in June to appease exporters.  Recent data only adds to the fear that the CBT’s rush to normalization cannot be abrupt enough: while February’s headline numbers sit at 4.16% y/y (from 4.90% y/y in January and versus a 5.5% target), the central bank’s preffered I-measure gauge (which excludes all food, energy, alcohol & tobacco and gold) rose to 3.8% y/y from 3.2% previously.  Moreover, per an Absa Capital note from today, not only are the “favourable statistical base effects that have kept the y/y rate of CPI growth low likely to run their course by May this year,” but “the sustained lira weakness (down 11% since November), combined with the surge in oil prices, is likely to start to pass through to inflation,” especially when taken in tandem with unrelenting credit growth: consumer loans rose 3.4% m/m at the end of December (38% y/y), and data as of mid-February saw a 2.6% m/m rise (39% y/y, versus 20-25% targeted).  For investors, however, Turkey’s woes bring opportunity: while Turkey’s benchmark two-year bonds sit at 9.12 per cent (as of Monday), some analysts remain skeptical whether or not local markets are adequately pricing in rate hikes over the coming twelve months.  On the opposite end of the spectrum, Credit Suisse wrote that it believed “a lot of bad news is now priced in as Turkey [now] trades on a 41% discount on our price-to-book versus ROE valuation model, replac[ing] Russia as the most undervalued market within [emerging markets].”

Turkey bulls such as myself have some pretty concrete indicators to watch going forward: while long-term the outlook remains positive–despite the fact that near-term fiscal discipline remains somewhat lax in the face of impending elections in mid-2011–Barclays Capital recently noted that AKK’s popularity (not to mention the increasingly probability of a ratings upgrade from Fitch) should reinforce discipline: “the government has been able to issue debt at nominal interest rates significantly below nominal GDP growth, which is likely to lower the government’s interest bill in the years to come.  If the government manages to move the deficit to 3% by 2012, we estimate the debt ratio falls well below 40%–a safety threshold often used for EM countries,” analysts wrote this month.  So one pertinent measure to track is gross public debt as a percentage of output, which currently sits at 42.5% projected down from 45.5% in 2009.  To this end, it’s importance to note that even if the political will, post-election, to curb spending is lacking the state could be afforded breathing room through continued improvement in its tax revenue/GDP profile, where it was tied with Mexico in last place as of two years ago.

More pressing, present concerns however relate to the country’s large and growing balance of payments deficit.  While Turkey’s current-account deficit (CAD) sits at levels last seen during the 2006-2007 boom (6% of GDP projected, versus 2.3% year-end 2009), Barclays observes, and is a stark commentary not only on rising domestic, credit-fueled (27% y/y real growth in October) growth and low-savings, but also dependence on imported hydrocarbons and raw materials, compared with several years ago “the composition of financing is more precarious as FDI coverage of the deficit has fallen from 60 percent pre-Lehman to roughly 14%, twelve months rolling per Barclays (see graph left):  “The remainder is short term trade credit and residents drawdown of foreign assets. The main capital inflow in the pre-Lehman years was medium and longer-term borrowing (ie, syndicated loans) by banks and non-bank corporates. Today, banking sector’s net borrowing is pretty much flat and corporates remain large net re-payers of debt. In other words, while the corporate sector continues to de-lever, past borrowing from banks is being replaced by portfolio money.”  But while this trend is more EM than Turkey specific per se, analysts project that robust fundamentals underpinned by negative real interest rates to spur spending, as well as an overnight borrowing rate of just 1.75% (to discourage pure carry trades) and hitherto a lack of capital controls seen elsewhere make it more likely than not that short-term inflows will continue unfettered.  That said, the strengthening lira, which is likely to see further appreciation in 2011 as core and headline inflation likely converge and a new CBT governor (in April) mulls the timing of inevitable rate hikes (from 7.00% now) will not do wonders either for exporters or for its CAD deficit, which Barclays projects remaining flat for the next two years.  Short-term portfolio flows must ultimately be replaced by a renewed uptick in FDI though the FT noted last week that “high energy costs, rigid labor laws, high social security premiums and the formidable unregistered economy are all challenges,” not to mention “legal grey areas and bureaucracy.”  Turkey’s EU ascent has always been predicated on its desire for recognition; for now, anyway, the scrutiny faced by prospective FDI should give it as much of the limelight as it desires, for better or for worse.

It’s hard not to be bullish on Turkey given its favorable demographic pyramid, manufacturing prowess and strategic location vis a vis the world’s proven gas and oil reserves–all against the backdrop of projections that over the next seven years its growth will match or exceed that of any other big country except China and India.  That said, as Barclays Capital notes “the comparison with Asian economic performance does not go much beyond recent headline growth” considering the country’s low savings rate and rapidly widening current account deficit.  The most recent data, in fact, points to “export growth slowing with imports continuing to boom”, which The Economist noted last month is “worrying because it suggests that competitiveness is steadily eroding.”  The solution?  In part, increase domestic savings while moving [exports] up-market and continuing to diversify trade away from the EU and towards MENA.  Per the latter issue, “in 1990 only 15% of Turkey’s exports were in medium-or high-tech sectors, according to Fatma Melek, chief economist at Akbank.  Today, the figure is almost 40%. Yet Turkey spends only 0.7% of its GDP on research and development, compared with an OECD average of 2.3%. And with almost a quarter of the workforce in agriculture, overall productivity remains low.”

Saudi-based Savola’s “expansion drive” was temporarily halted after the Middle East’s largest sugar refiner announced that it would not bid for the six sugar beet processing mills being sold by the Turkish government, as previously expected. In October the firm said that, along with farmers’ union Turkey Tarim Kredi and the Nesma Holding Company, it would set up a joint venture in order to increase production at the plants from 300K to 500k tons/year, while “orient[ing] some of the output to foreign markets,” per one Savola executive. Yet there are other options [for expansion] on the table, reiterated its chief executive, Sami Baroum, including “options in Sudan and Egypt.” And according to at least one analyst at Shuaa Capital in October, “expanding outside of the Gulf Arab region is part of Savola’s stated expansion strategy in the food sector, where its sugar business is a major component alongside edible oil.”

The missed opportunity should be an opportune time to beginning ramping into shares of Savola for our mock frontier fund. The firm is an attractive long-term investment on multiple fronts: one, its highly diversified business operations involve the firm not only in the production of edible oil and sugar, but also in retail and real estate. Savola Foods, however, can be considered part of the bedrock of its identity: in addition to being the world’s largest manufacturer of branded cooking oil, its total sugar refining capacity of 2 million tons/year is nearly double that of its closest regional competitor, UAE-based al-Khaleej Sugar Co. That said, at the end of 2008 the company’s retail segment (highlighted by Panda, the largest retail food chain in the Middle East) was the major revenue generator, accounting for 43.8% of the total company’s revenue followed by edible oil and sugar segments with a share of 32.6% and 17.6% respectively. The company is also targeting expansion for this latter segment; per a report issued in mid-October by Global Investment House, a Kuwaiti investment firm, “expansion in the company’s retail segment is based on two types of strategies: (i) acquisition of other retail chains (e.g. Giant and Geant stores); and (ii) adding new hyper and super-Panda stores. This is expected to increase company’s overall retail stores to 110-116 in 2012, out of which 15-20 will be hypermarkets and remainder will be supermarkets.”

According to the Turkish Daily News, Şişecam, Turkey’s largest glassmaker, had $2.5 billion of sales in 2007, as reported by Teoman Yenigün, head of the company’s glass-packaging department. The Istanbul-based company is planning to boost sales by 20 percent to $3 billion this year, said Yenigün. Şişecam will increase output to 3.5 million tons in 2008 from 3 million tons last year and more than double investments to $1 billion.

And last month featured even more promising news from the glassmaking giant, when it opened the doors of its $ 380 million valued glass complex Thracia Glass Bulgaria. The complex, first stone of which was symbolically laid by Turkish Prime Minister Recep Tayyip Erdogan in 2004, consists of glass packaging unit, glass warehouse unit, processed glass plant and mirror glass facilities. The complex will be manned by 1500 employees. It is the first stage of a massive investment project with one more glass packaging factory, automotive glass unit, coated glass production line and laminated glass facilities to be completed by 2010. The new $ 415 million complex will provide employment for another 1700 people.

Turkish Prime Minister Recep Tayyip Erdogan, Minister of Industry and Trade of Turkey Zafer Caglayan, Bulgarian Minister of Economics and Energy Peter Dimitrov, President of Turkish Exporters Association Oguz Satici, President of Şişecam Group Gulsum Azeri and many more highly esteemed guests took part in the inauguration ceremony at the Bulgarian city of Targovhiste. The total worth of the two-staged project will amount to nearly $ 1 billion, the greatest amount invested by Turkey elsewhere up till now.

“Thracia Glass Bulgaria is the most sizable foreign direct investment in Bulgaria as yet”, stated Ahmet Kirman, the Board President of Şişecam Group.

Expanding production in Bulgaria serves a long stated main goal of Şişecam’s, namely to expand into Eastern European markets, even though said factories will admittedly have limited capacity. “This investment [in Bulgaria] is very important for us as the automobile industry is continuously growing. It is also connected to our strategy for expansion of our production that has high added value. Besides automobile industry glass, we will also manufacture products with high emission-holding properties, which, in turn, save energy,” Azeri said. Şişecam’s Turkish plans currently cover 75% of the demand for glass by the car industry in Turkey.

There was a time, however, when the Bulgarian investment looked doubtful. After announcing the success of its first investment in the then-new Turgovishte glass complex worth $220 million, in May 2007, Şişecam management was troubled by Bulgaria’s labour laws. Their main beef was with the perceived contradiction between the Labor Code and Collective Labor Disputes Settlement Act, which Şişecam worried would allow unions to organize unregulated strike actions. According to the company, these regulations neglected the collective labor contract arrangement, which has been in effect since May 1, 2006 and regulated the relationship between the two parties.

Turkish glass making has a storied history that frontier market investors should be familiar with. My interest in this industry was piqued, per usual, by Jim Leitner of Falcon Fund Management, whom I consider to be one of the world’s preeminent “frontier” market investors.

The history of Turkish glass making began with the Seljuks in the 11th century. Following the conquest, Istanbul became the center of Ottoman Turkish glass manufacture. A glass factory, established on the Asiatic shore of Bosphorus in 1795, produced the famous opaque twistware known as cesmibulbul. In 1934, 11 years after the establishment of young Republic of Turkey, the glass industry featured in the first Industrial Plan, which envisaged first a factory producing 3.000 tons of bottles and tumblers per year, was followed by a flat glass factory with a capacity of 2.000 tons. Turkiye Is Bankasi was entrusted with the task of founding these factories. Finally, in 1936 Turkish Glass Company “Şişecam ” was founded.

Today, Şişecam is considered Turkey’s leading glass company, using the latest technology to manufacture a wide range of glass products, including flat glass, automobile glass, fibre glass ando glass tableware. Total production is now one million tons per year, of which a high percentage is exported to 104 countries around the world under the “Şişecam” brand, which has international reputation.


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