Addendum to The Day After the Referendum

There have been quite a few developments since I wrote my take on the market implications of Sunday's referendum last week, which I will try to summarize here.

First, mimicking the polarization in the country, the polls have bifurcated, as my friends at Istanbul Analytics/GlobalSource coin it: About half of the polls are expecting a narrow "yes" or "no", with the rest predicting an easy "yes" victory. KONDA, the company I do monthly consulting work for, is in the second camp. In fact, their prediction of 57% "yes" votes puts them at the head of that pack. Even PM Erdogan said recently that a 50% +1 vote would enough- that's a far cry from the confident speeches he was giving merely a week ago. Note that with so many undecideds (KONDA is leading that pack with 17% as well), anything is still possible.

In line with these recent polls, foreign economists seem to have finally woken up; the most recent research reports no longer see a "yes" victory as in the bag, as I had noted in my column. Now, most seem to expect a "yes" triumph in the 50-55% range.

Consequently, my perception of the market-neutral, i.e. priced-in territory has somewhat shifted down. I now think that a "yes" win of more than 55% would be market-positive. To my knowledge, only the KONDA poll results fit in that category comfortably.

But as I have argued on Monday, market reaction would be asymmetric, with the negative reaction to a "no" victory being greater than the positive reaction of a "comfortable yes" result. This is not only because the former would be a bigger surprise, but also because Turkish assets are already quite expensive. For example, unless the Central Bank hints of another easing cycle at this week's MPC meeting, the benchmark does not have much more room to go (down) and there is already a case for a weaker lira going forward.

But in effect, a lot will depend on emerging market sentiment Monday morning which will be magnified for Turkish assets as a result of the referendum results. The same can be true in the short-run.

Second, if you are thinking all will be quiet on the Turkish front even with a comfortable "yes" victory Monday morning, you should think again. Even a "narrow yes" would mean political and economic uncertainty going forward, with the opposition questioning AKP's legitimacy, and a wide-margin "yes" win could lead AKP to early elections in the hope of securing another four years. Therefore, we could see Turkish assets diverging from general emerging market sentiment in the long-run, not because of the referendum results per se, but because of the AKP's and the opposition's reaction to them.

Third, and directly following the previous point, whatever the result of the referendum, the fiscal genie is finally out of the lamp for sure: At an interview Tuesday night, PM Erdogan, explaining why he had opposed the fiscal rule, likened it to the IMF inside us, reminding me Turkish football manager Mustafa Denizli's famous phrase, the Irish inside us- yes I managed to squeeze in some football again:)

Coming back to serious matters, the PM also noted that even when some ministers (could he be talking about the Economy tzar Babacan and Finance Minister Simsek?), have a different opinion, the PM says the final word and that's it! No wonder Babacan declared he would not talk about the fiscal rule for a while a couple of weeks ago...

While I commend the PM for his honesty, his comments are a harbinger of what is to come in terms of the fiscal stance. You should see the most recent referendum bribes, such as the wage increase to government employees twice the expected rate of inflation, tax and social security restructurings and interest rate reductions by state bank Halkbank, reminiscent of the horror days before the 2001 crisis, where such duty losses were common, under this lens.

In fact, as if on cue, the IMF voiced my fiscal worries in the Staff Report for the Article IV, which was released right after the PM's interview. Here's Reuters' take of it, courtesy of IMF's own daily press email briefing:

IMF:Turkey should pass fiscal reform without delay


Turkey should urgently pass fiscal reforms intended to govern spending and reduce the budget deficit and debt-to-GDP ratio, the IMF said in a report today, otherwise the government risks weakening its fiscal credibility. Turkey has postponed the "fiscal rule" legislation, which investors had expected to be introduced in time for the 2011 budget, and rating agencies have warned it may result in deficit reduction plans being diluted.


The Fund's comments had little impact on Turkish financial markets which were closing early today for a 2-1/2 day public holiday. The IMF said in its Article IV Consultation report on Turkey that the fiscal rule, postponed by the government last month until after the 2011 election, would introduce needed enhancements to transparency and public financial management. "Staff consider that the fiscal rule is considerably superior to the 2009 medium-term plan and urge passage of the draft rule without further delay," the IMF report said. "Failure to pass the rule quickly may forfeit the window of opportunity that could close ahead of the approaching election cycle, and risk weakening the credibility of the authorities' commitment to fiscal discipline," it said. (Reuters)

Fourth, as a Turkey economist whose opinion I highly value was pointing to my attention on Monday, there is a really important byproduct of the referendum that is being ignored by even the most experienced Turkish politics commentators: The referendum will be the litmus test of how much real control Kurdish party BDP and their brothers-in-arms (literally) PKK have on the Kurds of Turkey. According to KONDA polls, they do not. As I mentioned in earlier columns, Kurds are more likely to vote "yes" than any other self-described ethnic group, even after after controlling for party affiliation and view of the package.

 

Last but not the least, some shameless advertising is in order: I will be interpreting the referendum results as well as their political, economics and markets implications for Forbes.com Monday morning- it should be up on their site Tuesday the latest. It will also be up at Roubini Global Economics shortly after.