Monday, February 23, 2009

Weekly Hurriyet Column: The value of political connections, a la Turca

Below is the unedited version of my column for this week. You can read the final version at Hurriyet's authors archive. Judging by user response, this has been by far my most popular post to date, although most of the responses were AKP-sympathizers not too happy with my tone with the party. To give the more civil critiques some credit, they are right that it is not very scientific not to disclose the name of the companies perceived close to AKP. But I get a lot of disutility from getting sued, even when I am sure to win, as I figured out a couple of years ago, when some old pals wanted to turn me into pay, pal:)

As for my references to Suharto and Adolf, I know they are not very gentlemanly, but the last two months have proven me right, especially with the country turned into East Germany as depicted in Lives of Others.

The Treasury’s record tax levy against the Dogan Media Group (DMG) managed to bypass even the Central Bank’s 1.5% rate cut as the shocker of last week. It is true that given the past surprises, the real surprise would have been if the Bank had cut the policy rate in line with expectations, but the Treasury still deserves some credit for stealing the show.

It was only natural that the stock prices of DMG and other media companies of the Dogan Group dove on the news. After all, even though DMG is likely to fight the levy in a lengthy legal battle, there is a possibility of a huge cost item entering DMG’s balance sheet, which needs to be priced in, not only for DMG but also for other Dogan companies in the media sector. However, the sharp falls (more than 10% for each Dogan company and nearing 20% for DMG over the course of three days) are much more than simple accounting can account for. More interestingly, the mere fact that Petrol Ofisi, a non-media company in the Dogan group, also had a fall in excess of 10% hints that something deeper and more sinister might be going on.

That something may be the value of political connections. The notion that firms with political ties might be affected from the fate of their party would be a no-brainer to almost any Turk. But actually measuring political connections is no easy task. The trick is to find unexpected political events that have no obvious financial bearing on the firm so that any abnormal return (the difference between the expected and actual return) could solely be attributed to the political event and thus to the value of the political tie. The Dogan levy unfortunately does not pass this litmus test, but Turkey has seen its share of political events in the past two years, providing fertile testing ground.

In an exercise borne out of curiosity a few months ago, I tried to measure the value of political connections by following up on the fate of companies perceived to be close to AKP by the finance community (from a small survey I conducted) during the major political events since 2007: The e-warning at the end of April 2007, Tarhan Erdem’s July 19 survey showing AKP further ahead than thought, the AKP elections victory, the filing of charges with the Constitutional Court against AKP in March 2008 and the Court’s decision at the end of July. In AKP-positive events, the average cumulative abnormal return (CAR) turned out to be around 3%, with the effect almost doubling in AKP-negative events.

While the results above show the value of political connections, they do not demonstrate the destruction in value of being labeled by the AKP. Therefore, urged by the events of last week, I repeated the same exercise for Dogan companies. There does appear to be an AKP effect in the reverse direction, but only for the Constitutional court events, and much smaller in magnitude- less than 1% CAR. But then again, the hatchet has just been unburied, so we might have to wait for the next political shock.

I should say that this small exercise is by no means original: The first academic paper to demonstrate such effects showed that firms close to Indonesia’s Suharto were affected disproportionately by changes in the dictator’s health. Another looked at the Nazi seizure of power after the Reichstag fire, snap election and constitutional change by March 1933, when the Nazis decided to get off the democracy tram (no pun intended), and found that stock prices of firms that had tied their fortunes to the Nazis in the process surged.

It is comforting to know that AKP finds itself in such good company.

Monday, February 16, 2009

Weekly Hurriyet Column: The curious case of government bonds

Below is the unedited version of my column for this week. You can read the final version at Hurriyet's authors archive. In retrospect, I might look like a fool after the huge Treasury rally after I wrote this column. But on second look, there isn't a much of a rally left once you leave out global effects (common to other EM) as well as factor in CBT cuts. In the same vein, with the global rally having slowed down at the end of April and the CBT having room for at most another 75bp cut, I find expectations of another 150bp fall in Treasuries somewhat out of whack...

Last week, the economics agenda was rather lively. While the policymaking community was doing its best to lighten up the mood with humorous words and deeds, it was also possible to detect some important signals pertaining to government bonds, most of which got almost lost in all the clatter.

Turkish Statistical Institute’s (TURKSTAT) industrial production data blunder was highly entertaining and managed, albeit unintentionally, to turn the attention away from the dismal figures, which have ascertained that the economy almost came to a halt in 2008, to the dismal Institute. That a 40% growth in textiles could go undetected would itself warrant a separate column, but having spent some time at TURKSTAT thanks to various World Bank projects, I somehow wasn’t surprised at all. Quoting Forrest Gump, stupid is as stupid does, and that's all I have to say about that.

Equally entertaining were Economics Minister Mehmet Simsek’s remarks that if the government had acted early on the crisis and secured an IMF deal, the recession would have been deeper. Never mind the contradiction with another claim made moments earlier that inflation and interest rates were falling thanks to the government’s measures, I find it hard to choose which part of the statement is more virtual: The implication that the government is acting now or that an IMF deal would have fuelled the recession.

While the former is simply out of sync with reality, the latter is based on the idea that the Fund would have called for tighter fiscal policy instead of the loosening necessary to get the economy out of recession. In fact, the January budget figures of last week have been justified in some circles on exactly these grounds. To me, the figures reek of election spending rather than a boost to the economy. Moreover, even in developed countries, where textbook expansionary policy works best, the effectiveness of fiscal stimulus is uncertain. In Turkey, where there is arguably much less scope for fiscal policy, it is remarkable that expansionary policy is taken as a panacea without question by many.

The demand and supply picture for bonds

Election spending or not, the rise in expenditures, along with the decrease in tax revenues on the back of a slowing economy, is causing a rapid deterioration in the budget. If not reversed, this trend is likely to lead to an increase in the debt rollover ratio, putting upward pressure on bond rates and crowding out private lending. In this sense, although the Treasury does not face a heavy financing burden for the next couple of months, the fiscal outlook does not paint a supportive supply picture for bonds.

Turning to the demand side, while I plan to wait until all the fourth quarter balance sheets are released before a complete assessment of the banking sector, early releases show that banks have indeed been banking on rate cuts, with gains from the bond rally making up for the contraction in interest margins and the stall in loans. However, the latest figures also reveal an upward trend in non-performing loans (NPLs). If NPLs are to surge to twice the 2008 figure of 3.5% by mid-year, as forecasted by some analysts, simple scenario analysis reveals that banks’ appetite for bonds could be severely hampered. Therefore, the demand for bonds does not look that rosy, either.

Lately, I am seeing a lot of bond-optimists, dancing to the tune of Central Bank and fiscal policy. However, neither bond fundamentals, which I outlined in previous columns, nor a supply-demand framework justifies such confidence. The question is not when the music will stop, but who will be left standing when it does.

Monday, February 9, 2009

Weekly Hurriyet Column: Deceived by the Winter Sun

Below is the unedited version of my column for this week. You can read the final version at Hurriyet's authors archive. In retrospect, I noticed that I have chosen a title very similar to the previous week's. What a bore I am:)....More interestingly, two and a half months after this column, I stand behind my necessary conditions for a US recovery- unfortunately, the US economy has not really gained much ground in the past 70-odd days on these.

One of the first things you learn living in New England is not to get deceived by the bright winter sunshine, as it usually goes in hand with temperatures in the negative Fahrenheit territory.

Optimism abroad

Lately, there are increasing signs abroad that the worst of the crisis has passed, to such an extent that even the dismal US non-farm payrolls data was largely ignored. While stimulus packages around the world are providing the moral motivation, the uptick in several purchasing manager indices is leading hopes that the global economy has bottomed out. In a similarly Pollyannaish manner, the recent rise in the Baltic Dry Index, an assessment of the price of moving major raw materials by sea, is being interpreted as a sign that trade credit is finally stirring.

Although I will not attempt a global economic treatise here, I find it hard to believe that the US will start recovering before inventories are being worked down, household savings rise or house prices stabilize and banks get rid of their toxic assets one way (a government insurance scheme) or another (a bad bank solution). Unfortunately, none of these three necessary conditions is close to being satisfied yet.

Optimism at home

While I hit bull’s eye with my inflation forecast last week, this is one prediction I would have preferred to be dead wrong in. It is true that the 0.29% monthly rise, although above expectations, was the best January figure ever, but despite the unanimous laying of the guilt solely on food inflation, I am worryingly seeing early signs of an exchange rate passthrough. Similarly, while the muted producer inflation and decline in manufacturing prices hint to limited cost-led pressures, it seems that –as noted by the Central Bank- the fall in oil prices has equalized foreign currency movements. Inflation is likely to be a tug-of-war between domestic demand-dependent service goods and tradeables in the coming months.

The recent rise in consumer confidence has been another confidence-booster. However, part of the increase is reflecting a correction from the sharp falls earlier. Moreover, a quick statistical analysis reveals that asset prices (especially USDTRY and the ISE index) and political shocks go a long way in explaining consumer confidence. Therefore, while it is definitely a positive development, the rise in the fragile consumer confidence should not lead to rejoicing yet.

As both inflation and consumer confidence seem to hinge on it, it is natural to dig deeper into the exchange rate. The lira has held remarkably well in the past few weeks despite the rout in many emerging markets, even though the government, with the delayed IMF deal, the Davos incident and another round of Ergenekon, was doing its best to have the currency move in tandem with peers. Given that Turkey has led the pack in the reduction in emerging market-dedicated funds’ net exposure, locals seem to be behind the currency’s relative strength, as foreign currency deposits have declined by around USD 4bn this year. This is all fine, unless locals decide to wait out for further lira weakness, so the current situation is definitely not rock-solid.

Another interesting development is the recent uptick in parts of consumer credit, which may also be due to restructuring of credit card debt. Any short-term movements in commercial credit should similarly be taken with a grain of salt, especially as there is no change in the fundamentals restraining loan supply and demand. In this respect, the 117% debt-rollover in the past week’s auctions should be a reminder of the risk of crowding out.

The recent data seem to have led many to a winter jog. They might end up catching a bad cold.

Monday, February 2, 2009

Weekly Hurriyet column: Winter Heat

Below is the unedited version of my column for this week. You can read the final version at Hurriyet's authors archive.

The short month of February is carrying a heavy bag, with a significant part of the action coming early in the month.

Of inflation and Treasuries

With the Central Bank’s front-loaded monetary easing, inflation has returned to the spotlight. The lower-than-expected December turnout as well as the Bank’s disinflationary assessment in the latest Inflation Report seem to have created a positive mood with respect to inflation, with the CNBC expectations survey for January coming at 0.13%. However, my own assessment, which takes into account jumps in inflation sentiment as well, points to an outturn of around 0.3%. Istanbul Chamber of Commerce’s inflation figures will offer rough guidance, as a monthly fall in Istanbul prices of at least 0.6% would be consistent with market expectations. In any case, a modest deviation in either direction is unlikely to move markets much.

While the ongoing positive inflation sentiment is bond-friendly, one of the factors likely to limit a bond rally even in the case of an inflation realization well below expectations is the Treasury’s domestic borrowing program. With nearly TRY 23bn due, February is the month with the heaviest redemptions, and with more than two thirds of that due on Wednesday, the Treasury auctions in the first two days of the week will be watched closely. Just cross your fingers that there won’t be any nasty surprises on the inflation and international fronts.

Closing the 2008 books

The second week of February will bring in the last statistics of 2008: December industrial production, current account and terms of trade. All three will show us how much the economy has slowed down last year before the growth figures for the last quarter are released next month. With the external indicators, I will also be looking for external financing woes and the extent the uncertain environment is leading to postponed investment decisions & durables consumption as well as the size of the damage in Turkey’s external markets and its export competitiveness.

Banking on rate cuts

Another major event of the month will be the release of the bank balance sheets for the last quarter of 2008. While aggregate statistics show the banking system’s response to the slowdown in terms of declining credit and liquidity management, the balance sheets will allow us to see individual differences. In this respect, I will be looking for signs of a flight to quality, which was one of the defining characteristics of the 2001 crisis. While there is not much evidence of this phenomenon so far, I would advise buckling up for some nasty surprises on that front.

Impossible Missions Force

A wait-and-see event this month will be the neverending story with the Fund. While the media has reported the negotiations being deadlocked on extra fiscal measures, but I beg to disagree with the source of disagreement. The reference to the medium-term structural fiscal reform agenda in the short IMF statement last Monday hints that the discords may be more fundamental and forward-looking.

From a practical point of view, however, markets don’t care on such academic questions. In the short-run, an IMF agreement with enough credit to cover Turkey’s external financing gap has already been priced in. Moreover, at this stage, I do not think that it will matter a lot if the agreement is postponed until after the local elections, as long as the PM does not disclose that he is done with the IMF, like he is done with Davos.

With such a heavy agenda, it will be an important feat to leave February behind without any significant road accidents.