Monday, May 25, 2009

Weekly Hurriyet Column: The curse of the emerging world

Below is the unedited version of my column for this week. You can read the final version at Hurriyet's authors archive. Note that this is about 10% longer than the final version: I really do a good job in writing in my 3500-3700 character limit set for my column. And when I am not, I can cut it down after half an hour of editing, and I am usually satisfied with the end result. However, I felt that I had lost something by cutting, so I am keeping here the longer version for my own records.

In a matter of weeks, my contrarian argument that the IMF agreement was not a done deal has turned out to be the consensus. The hopes of the few optimists were shattered after Central Bank (CBT) President’s admission of a Plan B last week; the very same Durmus Yilmaz had noted that an IMF deal would be a good idea only three weeks before.

I remember first voicing my doubts over the deal chatting with a bond trader over drinks in mid-March, exactly a day before the CBT delivered the expected 1 percent cut. The trader was extremely bullish on Treasuries, given that the CBT would continue with rate cuts and the stand-by would materialize shortly after the local elections at the end of the month.

Fast forward one month, and the bond market was indeed rallying strongly in mid-April. The same trader told me that local banks as well as London-based short term trading desks were driving up Treasuries. After all, now that the government had revised its targets, an IMF deal was imminent. With expectations of another 1 percent cut (the Bank ended up delivering 0.75 percent) and the rosy global environment, no wonder Treasuries rallied.

If anything, the inconsistencies in the revised projections, especially on the fiscal side, should have convinced markets and economists alike that something was amiss. In fact, I was irked enough to question the wisdom of crowds in the immediate aftermath of this strong rally, risking to look like a complete fool.

Each day after that has brought more people to my camp, with Yilmaz’s comments and the plethora of analyst reports popping up in my mailbox right afterwards closing the matter once and for all: The cap had fallen and the baldhead had been spotted, as the age-old Turkish saying goes. However, notwithstanding the bond pullback, Turkish assets held quite well. To understand this interesting phenomenon as well as the government’s IMF strategy, we must rise above Turkey and look at the bigger picture in the emerging world.

In fact, Turkish assets have not been that spectacular when compared to other emerging markets (EM) for the last couple of months: It is the emerging world as a whole that has been performing well. Part of this reflects the continuation of the global green shoots scenario: Never mind that USA’s banking woes have yet to resolve and housing prices, where all the mess began in the first place, have yet to stabilize. In fact, with the previous two hanging in thin air, my only necessary condition for revival that is satisfied is the inventory depletion. Yet despite many major economists thinking along these lines, the optimism continues unabated.

To give markets some credit, one place where there is marked improvement is the credit front. With central banks throwing everything but the kitchen sink, funding costs and counterparty risks have returned to pre-Lehman levels. Similarly, risk aversion, while still high, has fallen remarkably. With markets flushed with liquidity and carry trades once again profitable, hedge funds and the like have once again turned to EM. With all the conditions that drove EM to negative territory in the first quarter reversed and the reemergence of decoupling (what the Economist calls version 2.0), no wonder EM are in vogue, again.

It is probably this emerging market-friendly environment that is causing the government to drag its feet towards the Fund. Never mind that Turkey is, despite the PM’s claims that the crisis would pass tangent or brush past in the worst case scenario, in the bottom tenth percentile in terms of growth performance, not only at last year’s numbers, but also according to the IMF’s 2009 projections. Without a coherent fiscal framework that will put the much-needed fiscal reforms in place and take care of debt sustainability, the crisis may not pass easily, either- despite the PM’s declaration on Friday.

It is really fun to ride the emerging market wave- until a great white spots you and bites right through your board. Once you end up missing a leg or an arm, it is not much use to call for the lifeguard.

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