ISHARES MSCI TURKEY INVESTBL TUR S
June 07, 2013 - 2:55pm EST by
Lincott
2013 2014
Price: 64.00 EPS $0.00 $0.00
Shares Out. (in M): 1 P/E 0.0x 0.0x
Market Cap (in $M): 850 P/FCF 0.0x 0.0x
Net Debt (in $M): 0 EBIT 0 0
TEV ($): 0 TEV/EBIT 0.0x 0.0x
Borrow Cost: NA

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  • Macro
  • Turkey
  • ETF
 

Description

Short idea: TUR

EXECUTIVE SUMMARY  

  • Turkey’s GDP grew at 9% a year over the past decade, and its stock market was up 60% in 2012. Meanwhile its government debt is only 40% of GDP. Turkey seems like it's healthy and getting healthier. In reality it’s in danger of collapse.
  • With government debt so low, Turkey seems to have spared itself the debt troubles other countries have. But the problem isn’t public debt. It’s the explosive loan growth of 32% a year in the private sector.
  • Credit growth is a wonderful thing when the money goes into productive assets. Turkey’s loans aren’t. They’re funding consumption.
  • Turkey has a Greek-size current account deficit of 9% of GDP. It also has scary-high loan growth that it can’t—or won’t—slow down.
  • To fund the current account deficit, Turkey has in just a few years ramped up short-term external debt to $110 billion or 14% of GDP. Even worse, almost half of this debt is in the most fickle form of short-term financing: interbank borrowing. This money could be yanked from the economy in weeks, not months.
  • For reasons discussed below, we believe there is a strong likelihood this money will be pulled from Turkey’s economy over the next year. As a result, Turkey is in danger not of a correction but a collapse.
  • We recommend minimizing exposure to Turkey’s economy, particularly its banks, and/or shorting the Turkish lira or the Turkish stock market (TUR).

 

 

IMPORTANT TO REMEMBER WHAT KIND OF ECONOMY WE’RE DEALING WITH

 

Turkey is an emerging market economy and while much is made of the growth of these economies, there are still extremely negative aspects to them. For instance, Turkey has a high level of corruption and—more important—a low net worth both on an absolute basis and relative to its GDP. 


Turkey’s GDP is $770 billion. But according to Credit Suisse, Turkey’s net worth in 2011 was only $1.3 trillion—meaning it has little economic surplus of its own to invest. And the net worth of its financial assets in 2011 was only $250 billion. When financial net worth is only a fraction of total net worth, the marginal value of additional financial assets is very high. Conversely losing financial assets is very painful. And that is precisely the future Turkey is facing.

 

One other thing I should mention: Turkey has been hailed as a miracle of the Middle East. But as a June 4 article by Michael Rubin in the WSJ makes clear, there is a significant amount of political risk involved in investing in the country. It jails more journalists than any other country in the world, according to Reporters without Borders. Also Kurds form about 25% of the population, and the tension between them and ethnic Turks at times reaches "civil war" heights.  This is to say nothing of course of the recent protests going on.

 

 

DEBT-FINANCED CONSUMER BUBBLE

 

Since 2007, total loan growth in Turkey has averaged 32% a year and consumer debt has increased 31% a year. Total loans are now 60% of GDP and 180% of Turkey’s financial net worth. Why is this a problem? The money is going towards consumption, not into growing Turkey’s asset base. Turkey isn't using the money to get richer. It's using the money to get poorer. Over the same period, imports of capital goods have only grown 5%. And in 2012, imports of capital goods dropped a staggering 9%.

 

Meanwhile Turkey is run-rating a current account deficit of $70 billion or 9% of GDP. This is reminiscent of Southern European countries pre-crisis and is just not sustainable. Keep in mind the deficit has been going strong since 2011, so at this point the deficit is structural in nature.

 

In 2012, things seemed to get better when the current account deficit dropped to $50 billion, but the reality is imports never came down and the improvement in the deficit was largely a function of Turkey exporting gold to Iran to help it circumvent U.S. sanctions. This wasn’t actual reform, and the U.S. government has since put a stop to the practice.

 

What is so scary about the loan growth and the size of the current account deficit is that there seems to be no way to reduce them. In 2012, GDP growth flat-lined, growing only 2% compared to growth of 9% in 2010 and 2011. Yet at the same time, loans grew at 20% and imports never decreased. So in other words, Turkey’s eyes are officially larger than its stomach.

 

It gets worse. As one commenter David Goldman has pointed out, consumer spending didn’t increase in Q1 2013 and barely increased in 2012. Goldman by the way has great research on Turkey available at Asia Times.com. By my calculation, in 2012 consumer spending increased only 6% or about $9 billion. Contrast that to absolute loan growth of $70 billion. So GDP flat-lines and consumer spending increases only modestly, yet there is massive loan growth. Where did the other $61 billion borrowed go?

 

One place where it didn’t go but should have was CAPEX. In the first quarter of 2013, capacity utilization came down 1% yoy. Since it’s unlikely manufacturers would pay for CAPEX while cutting down on production, it makes sense to conclude much of the $61 billion in borrowing did not go into growing Turkey’s asset base. As a sanity check, capacity utilization for the manufacture of investment goods declined in 2012. Also as mentioned before, capital goods imports dropped 9% in 2012 yoy.

 

So we’re back to our original question. Where has the borrowed money actually gone?

 

Turkish borrowers may already be capitalizing interest. When we look at the data, we see a disturbing trend. Interest rates have been dropping since 2011 and yet we see delinquencies rising sharply. Loan delinquencies net of recoveries doubled in 2012 and are on pace to increase 80% in 2013. This suggests the worst-case scenario could already be underway.

 

Turkish borrowers are likely already capitalizing interest and depending on refinancing to stay afloat. If that is what’s happening and if it continues, there’s nothing Turkey’s central bank can do to stop the shock to the financial system.

 

 

WHAT CAN TURKEY DO?

 

Turkey doesn’t have the luxury of “extend and pretend.” The fact is its banks have become so dependent on interbank borrowing that Turkey’s hands are tied.

 

If Turkey raises interest rates to stop the growth of loans that can’t be repaid, the debt burden on households and businesses would cause a wave of defaults. How do we know this? Because it’s already happening. Even with historically low interest rates, loan delinquency is accelerating.

 

Now imagine if loan growth slows and refinancing is no longer available? You see a repeat of what happened to sub-prime borrowers in 2008. 

 

So if you can’t deflate a financial bubble, what can you do? Perhaps Turkey could do what the developed world is doing and use monetary easing and lower interest rates to “financially repress” its way out of indebtedness.

 

Well that is to say, it could have. Now it’s too late—because it’s already racked up $110 billion in short-term external debt (14% of GDP and 44% of the country’s financial net worth). S&P has a good write-up on this (http://www.standardandpoors.com/spf/upload/Ratings_EMEA/2012-12-05_LoanGrowthAndLowDomesticSavings.pdf). Any devaluation of the currency would spark capital flight which—due to the rapid rise in interbank borrowing—could take place over days, not weeks. This would end Turkey’s credit bubble--but at a horrible cost.

 

Plus Turkey has recently had major problems with inflation. In 2011-2012, inflation jumped from 6% to 11% in just four months. Now that GDP growth has stalled and loan growth has continued unabated, conditions are set for the return of inflation.

 

Over the past three years, Turkey’s central bank has grown its balance sheet by 25% a year. In fact, back when the central bank was at least paying lip service to slowing loan growth (and dealing with inflation), its balance sheet continued to grow at double digits. In other words, they were loosening monetary policy even while they told everyone it needed to be tightened. Why do you think that is? Something is wrong in the state of Turkey, and I suspect the central bank is well aware of the problem with the bank’s loans. They probably believe inflation is preferable to a sharp rise in defaults.

 

Just over the past year, the balance sheet grew 50% and is now $130 billion. On April 14, the central bank announced it was cutting short-term interest rates by 50 bps. Clearly they’re trying to re-start GDP growth, but they are possibly going to produce inflation in the process. In fact inflation is something which Turkey’s powers-that-be have consistently indicated they’re not concerned about. In 2011, the Minister of the Economy Zafer Caglayan indicated a weak currency was “no concern” because it helps exports. We’ll see about that.

 

Turkey is damned if it does and damned if it doesn’t. And whether it’s inflation or borrower defaults that spooks investors, it will be the sharp reduction in interbank borrowing that likely brings the bubble to the end.

 

 

I do not hold a position of employment, directorship, or consultancy with the issuer.
I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

 

  • Turkey continues cutting interest rates to stimulate the economy and pretty much does nothing to slow credit growth. Inflation becomes a problem like it was in 2011, and foreign interbank lenders pull their capital, thus causing a shock to Turkey’s financial system.
  • Turkey is forced to raise interest rates to stop loan growth, and Turkish businesses and consumers lose the ability to refinance. Defaults, which are already on the rise, increase even more sharply. 
  • Continued political strife draws attention to Turkey's structural problems. 

 

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    Description

    Short idea: TUR

    EXECUTIVE SUMMARY  

     

     

    IMPORTANT TO REMEMBER WHAT KIND OF ECONOMY WE’RE DEALING WITH

     

    Turkey is an emerging market economy and while much is made of the growth of these economies, there are still extremely negative aspects to them. For instance, Turkey has a high level of corruption and—more important—a low net worth both on an absolute basis and relative to its GDP. 


    Turkey’s GDP is $770 billion. But according to Credit Suisse, Turkey’s net worth in 2011 was only $1.3 trillion—meaning it has little economic surplus of its own to invest. And the net worth of its financial assets in 2011 was only $250 billion. When financial net worth is only a fraction of total net worth, the marginal value of additional financial assets is very high. Conversely losing financial assets is very painful. And that is precisely the future Turkey is facing.

     

    One other thing I should mention: Turkey has been hailed as a miracle of the Middle East. But as a June 4 article by Michael Rubin in the WSJ makes clear, there is a significant amount of political risk involved in investing in the country. It jails more journalists than any other country in the world, according to Reporters without Borders. Also Kurds form about 25% of the population, and the tension between them and ethnic Turks at times reaches "civil war" heights.  This is to say nothing of course of the recent protests going on.

     

     

    DEBT-FINANCED CONSUMER BUBBLE

     

    Since 2007, total loan growth in Turkey has averaged 32% a year and consumer debt has increased 31% a year. Total loans are now 60% of GDP and 180% of Turkey’s financial net worth. Why is this a problem? The money is going towards consumption, not into growing Turkey’s asset base. Turkey isn't using the money to get richer. It's using the money to get poorer. Over the same period, imports of capital goods have only grown 5%. And in 2012, imports of capital goods dropped a staggering 9%.

     

    Meanwhile Turkey is run-rating a current account deficit of $70 billion or 9% of GDP. This is reminiscent of Southern European countries pre-crisis and is just not sustainable. Keep in mind the deficit has been going strong since 2011, so at this point the deficit is structural in nature.

     

    In 2012, things seemed to get better when the current account deficit dropped to $50 billion, but the reality is imports never came down and the improvement in the deficit was largely a function of Turkey exporting gold to Iran to help it circumvent U.S. sanctions. This wasn’t actual reform, and the U.S. government has since put a stop to the practice.

     

    What is so scary about the loan growth and the size of the current account deficit is that there seems to be no way to reduce them. In 2012, GDP growth flat-lined, growing only 2% compared to growth of 9% in 2010 and 2011. Yet at the same time, loans grew at 20% and imports never decreased. So in other words, Turkey’s eyes are officially larger than its stomach.

     

    It gets worse. As one commenter David Goldman has pointed out, consumer spending didn’t increase in Q1 2013 and barely increased in 2012. Goldman by the way has great research on Turkey available at Asia Times.com. By my calculation, in 2012 consumer spending increased only 6% or about $9 billion. Contrast that to absolute loan growth of $70 billion. So GDP flat-lines and consumer spending increases only modestly, yet there is massive loan growth. Where did the other $61 billion borrowed go?

     

    One place where it didn’t go but should have was CAPEX. In the first quarter of 2013, capacity utilization came down 1% yoy. Since it’s unlikely manufacturers would pay for CAPEX while cutting down on production, it makes sense to conclude much of the $61 billion in borrowing did not go into growing Turkey’s asset base. As a sanity check, capacity utilization for the manufacture of investment goods declined in 2012. Also as mentioned before, capital goods imports dropped 9% in 2012 yoy.

     

    So we’re back to our original question. Where has the borrowed money actually gone?

     

    Turkish borrowers may already be capitalizing interest. When we look at the data, we see a disturbing trend. Interest rates have been dropping since 2011 and yet we see delinquencies rising sharply. Loan delinquencies net of recoveries doubled in 2012 and are on pace to increase 80% in 2013. This suggests the worst-case scenario could already be underway.

     

    Turkish borrowers are likely already capitalizing interest and depending on refinancing to stay afloat. If that is what’s happening and if it continues, there’s nothing Turkey’s central bank can do to stop the shock to the financial system.

     

     

    WHAT CAN TURKEY DO?

     

    Turkey doesn’t have the luxury of “extend and pretend.” The fact is its banks have become so dependent on interbank borrowing that Turkey’s hands are tied.

     

    If Turkey raises interest rates to stop the growth of loans that can’t be repaid, the debt burden on households and businesses would cause a wave of defaults. How do we know this? Because it’s already happening. Even with historically low interest rates, loan delinquency is accelerating.

     

    Now imagine if loan growth slows and refinancing is no longer available? You see a repeat of what happened to sub-prime borrowers in 2008. 

     

    So if you can’t deflate a financial bubble, what can you do? Perhaps Turkey could do what the developed world is doing and use monetary easing and lower interest rates to “financially repress” its way out of indebtedness.

     

    Well that is to say, it could have. Now it’s too late—because it’s already racked up $110 billion in short-term external debt (14% of GDP and 44% of the country’s financial net worth). S&P has a good write-up on this (http://www.standardandpoors.com/spf/upload/Ratings_EMEA/2012-12-05_LoanGrowthAndLowDomesticSavings.pdf). Any devaluation of the currency would spark capital flight which—due to the rapid rise in interbank borrowing—could take place over days, not weeks. This would end Turkey’s credit bubble--but at a horrible cost.

     

    Plus Turkey has recently had major problems with inflation. In 2011-2012, inflation jumped from 6% to 11% in just four months. Now that GDP growth has stalled and loan growth has continued unabated, conditions are set for the return of inflation.

     

    Over the past three years, Turkey’s central bank has grown its balance sheet by 25% a year. In fact, back when the central bank was at least paying lip service to slowing loan growth (and dealing with inflation), its balance sheet continued to grow at double digits. In other words, they were loosening monetary policy even while they told everyone it needed to be tightened. Why do you think that is? Something is wrong in the state of Turkey, and I suspect the central bank is well aware of the problem with the bank’s loans. They probably believe inflation is preferable to a sharp rise in defaults.

     

    Just over the past year, the balance sheet grew 50% and is now $130 billion. On April 14, the central bank announced it was cutting short-term interest rates by 50 bps. Clearly they’re trying to re-start GDP growth, but they are possibly going to produce inflation in the process. In fact inflation is something which Turkey’s powers-that-be have consistently indicated they’re not concerned about. In 2011, the Minister of the Economy Zafer Caglayan indicated a weak currency was “no concern” because it helps exports. We’ll see about that.

     

    Turkey is damned if it does and damned if it doesn’t. And whether it’s inflation or borrower defaults that spooks investors, it will be the sharp reduction in interbank borrowing that likely brings the bubble to the end.

     

     

    I do not hold a position of employment, directorship, or consultancy with the issuer.
    I and/or others I advise hold a material investment in the issuer's securities.

    Catalyst

     

     

    Messages


    SubjectToo much too soon, or just as planned?
    Entry08/28/2013 06:29 AM
    Membertyler939
    Turkey obvioulsy being hit as are all EM, but how much is idiosyncratic?  Also, any upside from U.S. action?  Would you short into any EM bounce, or are things moving as scheduled?

    SubjectRE: RE: Too much too soon, or just as planned?
    Entry08/28/2013 02:36 PM
    Membertyler939
    I have one more question.  What are the chances that it invites other countries with geopolitical interests to make a bunch of large foreign direct investments, creating a bunch of jobs, higher stock prices and buys themselves some time?

    SubjectRE: RE: RE: Too much too soon, or just as planned?
    Entry08/28/2013 11:02 PM
    Membertyler939
    Never mind.  Looking at the amount of debt, my scenario seems unrealistic.

    SubjectRE: RE: RE: Author Exit Recommendation
    Entry01/25/2014 09:29 AM
    Memberstraw1023
    Lincott,
     
    We have followed the situation and agreed with your initial analysis and have held onto short. We think there is still more down side, but obviously lots of geo-political players have an interest in Turkish stability. But overall, we think that the fundamentals underlying the down moves in many of the EMs will continue. There are no quick fixes to the mis-allocation of economic resources, even if on-balance the growth was worth the mis-allocation.
     
     
     
     
     
     

    SubjectWow
    Entry01/28/2014 06:56 PM
    Membertyler939
    Watching from the sidelines, but wondering if your original exit theists was correct.  Will Gulf states or other actors support Turkey in the interest of stabilizing the "system" now that it has raised interest rates to the extent it has?  Would it have done what it did to this extent with out some assurances?

    SubjectRE: RE: Wow
    Entry01/29/2014 02:32 AM
    Membertyler939
    I am just wondering if this is some part of a coordinated plan to save the EMs.  This is way beyond my expertise but interesting to talk about (at least to me).

    SubjectThis could get really ugly
    Entry02/25/2014 03:19 PM
    MemberLincott
    The entire point of raising interest rates so drastically was to stop inflation and stabilize the currency. This is something they need considering the country is financed in the most fragile way possible. It has short-term external debt equal to 15% of GDP, and a huge amount of that is in interbank borrowing from foreign institutions which could be pulled in a matter of weeks.The banks would then in short order be insolvent.
     
    And yet...they're still pumping money into the financial system like coal into a bottomless furnace. Banks grew their loan books by a staggering 35% in the last year. The current account deficit is now back in 10% of GDP territory. The money supply grew by 24%, and that's not just due to private credit growth. The central bank is in on it growing the monetary base at double digits. Also strangely the central bank doubled its loans to the private banks.
     
    Why on earth would the central bank do that when you've just raised interest rates to slow credit growth?
     
    I think I know why. Past due consumer loans grew 16% last year. Past-due commercial installment loans grew 30%. And that was before they massively raised interest rates. 
     
    What if they're continuing to grow credit at banana republic levels not because they're stupid but because they have to? If they don't grow credit and allow people to refi and capitalize interest, this could get really ugly.

    Macro is hard. I don't know if things will turn out the way they seem like they will, but this is just shocking to watch.





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