In addition, we consider whether the different outcomes could enable AKP to push for constitutional change and a shift to an executive presidency.
Three Scenarios: Market seems to be pricing in maintenance of status quo
We highlight three core electoral scenarios: a base case scenario is hard to identify amid elevated uncertainty. In Scenario 1 HDP qualifies for parliament and AKP is able to form a majority single-party government. Most probably in this scenario, the AKP will fall short of the 330 seats needed to call a referendum on amending the constitution. We believe most asset classes are skewed towards pricing in this scenario today. In Scenario 2, HDP fails to qualify and AKP could easily end up with enough seats to call a referendum on the constitutional change, which would likely involve a shift to an executive presidential system. In Scenario 3, HDP gets into parliament and AKP fails to secure enough votes to govern alone. The need for a coalition government is likely to result in increased uncertainty, potentially impacting markets.
Key macro themes beyond elections: growth, corporate leverage, and reforms
Beyond the elections we believe the implementation of structural reforms urgently needs to be accelerated. Trend growth is likely to be constrained by the low savings rate, an overhang of corporate leverage, and labour market rigidities. We sketch out key priorities. Prospects for reforms and the attainment of higher quality growth would seem to have highest chance of success under Scenario 1.
FI/FX Strategy: Elections unlikely to mark a sustained turning point for the TRY
In Scenario 1, assuming AKP secures at least 280 seats, the TRY should have tactical room to outperform peers such as the ZAR or RUB: dollarization momentum could temporarily be reversed and implied volatility could ease modestly, leading to unwinding of FX hedges. We believe FX embeds more risk premium than rates. But medium-term, declining trend growth and reliance on pro-cyclical capital inflows, low real rates and weak exports imply TRY strength will not be sustained. Scenario 2 should catalyse higher risk premium; we think 10y bonds may need to cheapen by 75bps and USD/TRY should clearly underperform 3m forwards at 2.65. Scenario 3 implies further weakness. We don’t see a compelling risk/reward on long TRY positions into the elections.
Equity Strategy: Attractive, but Risky (Neutral in GEMs)
Strong relative gains in Turkish equities in May suggest that the market now partly discounts the risks associated with inflation/rates/Lira and the elections. Given below-average valuations, a cheaper Lira and decent earnings momentum, Scenario 1 might be bullish for equities. However, the elections’ outcome is unclear; at the other extreme – Scenarios 2 or 3 – equities may have considerable downside. We go into the elections Neutral on Turkey within GEMs. We also highlight value in Isbank, Akbank and Halkbank under Scenario 1.
Corporate Credit Strategy: Will the good times last?
Should Scenario 1 be the outcome, we expect a ‘relief rally’ immediately after elections. We favour the old style Tier II subordinated paper as it offers an attractive pick up versus the senior paper with Yapi Kredi, Isbank and Vakifbank our preferred issuers.