Financial markets in Istanbul took a breather last week after a seven-week-long rally in which the benchmark BIST-100 equity index rose 20 percent. The rally was spurred in part by a sustained collapse of crude oil prices in which Brent Crude prices fell 41 percent since July of this year. This makes this bear market the worst in the history of crude, with the exception of the 2008 economic crisis. The one difference between the 2008 crisis and this one is that this appears to be a crisis of over-supply, whereas the previous crisis was born out of a demand-shock.
Much has been written about the reasons behind the drop in oil prices including Saudi Arabia and its OPEC partners' intent to bring crude oil prices down to levels where shale gas production becomes unfeasible. In order for this strategy to work, the group needs to ramp up production and more importantly, it needs to hold it there until shale gas producers go bankrupt. Is this a sustainable model for countries that so desperately depend on oil exports to finance their governments? I personally don't think so. While I do see a drop in Brent crude oil to under $40 per barrel in the near future, perhaps by the Spring of 2015, I'm not convinced OPEC has the resolve necessary to hold prices there for months or even a year. Should my suspicions be confirmed, shale gas producers will start up where they left off, and this entire reverse "super-spike" will have been for naught.
Turkey's finance minister Mehmet Şimşek recently commented that a $10 drop in crude oil prices translates into an improvement of near $5 billion in the current account deficit. In this case, the current account deficit has already improved by over $22 billion as crude fell from over $110 in July to $66 on Tuesday. This also will translate into an improvement in inflation by 1.76 percent currently, and should crude continue to fall to $40 as I predict, inflation will drop by 3 percent according to Şimşek's guidance and the current account deficit will improve by over $35 billion. Such a massive drop will also spur growth of over 2.1 percent, ceteris paribus. However, luckily for Turkey, all else will not remain equal as reforms in democratic institutions and infrastructure investments begin to yield immediate results such as efficiency in public transportation and manufacturing. In other words, the drop in oil's benefit to the Turkish economy is not as simplistic and linear as Finance Minister Şimşek has described it, but will yield greater advantages to Turkey as the decline increases.
This is perhaps the greatest reason for the rally in Turkish equities and debt markets recently, despite continued armed conflicts along the Syrian border and across the Black Sea in the Ukraine. Foreign investors have taken note of the drop in oil and placed their chips in countries who look to benefit the most from the drop, namely Turkey.They have done so, despite a recent report signaling a slowing in Turkish manufacturing, brushed off as a temporary lull.
The Central Registry Agency's (MKK) foreign participation in the Turkish equity markets index continued to climb in the last week as more foreign investors actually did move into Turkish stocks, bringing the participation rate to over 64.19 percent, up over 30 basis points in the last week alone.
The BIST-100 index was in a tight trading pattern hovering around 84,900 points at midday Tuesday. The equity index is down 0.06 percent for the week as investors placed bets on whether or not crude oil would rebound from this unprecedented drop.
Bond markets also saw some profit-taking in the last week as the two-year short-end benchmark issue traded at a yield of 7.86 percent, up over 60 basis points in the last week. The long-end 10-year issue also saw its yield increase to 8 percent late Tuesday, up over 30 basis points on the week. Both issues had rallied nearly 200 basis points since mid-September on premature assumptions of tightening by the U.S. Federal Reserve, assumptions which were later refuted by the Fed.
The Turkish lira also saw profit-taking last week with the lira trading down three basis points to TL 2.26 per U.S. Dollar, whereas it had traded at TL 2.23 against the greenback a week ago. Insurance against economic and political instability measured by credit-default swaps also were more expensive, trading at 1.66 percent late Tuesday, up 10 basis points in the last week. Turkish corporate debt continues to be cheaper than some of its European neighbors, including Portugal which would cost another 20 basis points to insure.
Look for the continued slide in oil prices to immediately help Turkey's bottom line, while also improving its hand politically against wealthy neighbors who may be more inclined to work with Turkey on projects previously thought of as less-attractive during the $100+ per barrel crude oil era.