Monday, September 6, 2010

Weekly Hurriyet Column: The day after the referendum

Below is the unedited version of my column for this week. You can read the final version at the Daily News website, but since I have been editing my columns myself on the Daily News website since March, you won't see much of a difference between the two. The title is again a movie reference.

As for the column, I have an detailed addendum, but since it is quite long, I will post it separately. I plan to do that in the next couple of days. Besides, I want to wait until Turkish markets close on Wednesday to see how the mood is to update my views on a possible market reaction.
Anyway, on to the column:
With less than a week to go, Turkish political analysts are fixated on the referendum, but for economists, Sept. 13 is at least as important as Sept. 12.

I have been flooded with questions from like-minded readers in the last few days, who are wondering whether a “no” in the referendum would adversely affect Turkish assets. The answer to this question, at least in the short run, depends on what is being priced in, and it is impossible to be 100 percent certain on that. We can only make some assumptions and guesstimates.

Let's start with the obvious. A "no" victory is definitely not priced in. Almost all the polls are pointing to a "yes" win, although the ayes and nayes are very close in some. Moreover, most of the analyst reports I have received recently see a "yes" victory as in the bag.

Hot money flows confirm the confidence in Turkish assets. Although weekly Central Bank data show some sell-off in bonds and equities by foreigners in the last week of August, monthly inflows actually increased in the former and managed to stay the same in the latter. Even when normalized with data from EPFR Global, a company that tracks fund flows, inflows into Turkish assets look healthy.

All this means that the short-term adverse impact of a "no" win on markets would be rather bad, especially because a “no” victory would question not only the legitimacy of the market-friendly AKP government, but also the sustainability of the single-party rule, a rarity in Turkish politics. Do not count a black Monday in Turkish assets out in this scenario.

A similar argument could be made for a narrow "yes" triumph, especially if voter turnout is low, giving the opposition the chance to question the legitimacy of the AKP. By the same token, a very strong "yes” win would affect markets positively in the short term. I would define market-neutral, i.e. priced-in, territory in the 54 to 58 percent range.

In any case, the relative expensiveness of Turkish assets means that there is limited upwards potential even in the case of a strong “yes” victory. The recent flattening of the yield curve would, however, mean that its long end could be hit the most in case of a market-unfriendly outcome. And regardless of your view on the outcome of the referendum, the low implied volatilities in euro and dollar options, near pre-Lehman levels, means that it is easy to hedge referendum risk in the foreign currency market.

But more interesting is the long-term consequences of the referendum, as it will be business as usual in Turkish assets after a couple of days. And that depends on the reaction function of the AKP. In layman's terms, in case of a narrow "yes" or "no" victory, will the AKP throw off fiscal prudence (what is left of it) completely aside and open the coffers for all-out pork barrel spending?

Here, I beg to differ from the mainstream opinion, as I think that the AKP will go on a pre-election spending binge even in a strong “yes” victory. The longer-term consequences of such a policy would be disastrous, not only for the country's fiscal stance but also for inflation and monetary policy, as the new government is sure to lean on taxes and administered good price hikes. Such knockoff measures are the most common temporary patches to the budget in Turkey.

Whatever happens on Sept. 12, markets will correct after the initial reaction in the first couple of days. Some people will make money at the expense of others; c’est la vie, as the French say. Given there is not too much political noise in the aftermath of the referendum, quite an assumption in itself, markets will revert back to normal soon.

But messing up the country’s fiscal stance will leave longer-lasting scars.

*Emre Deliveli is a freelance consultant and columnist for Hurriyet Daily News & Economic Review and Forbes as well as a contributor to Roubini Global Economics. Read his economics blog at

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