Turkish Markets Slump as Bets on Return to Orthodoxy Unravel

(Bloomberg) -- Turkey’s markets slid as the nation heads for a runoff election, with stronger-than-expected support for President Recep Tayyip Erdogan wrong footing investors who were betting on a quick end to his unconventional economic policies.

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The benchmark stock index, the BIST-100, closed 6.1% lower after earlier falling as much as 6.7%, triggering a circuit breaker. Turkey’s dollar bonds were the biggest losers in emerging markets and the cost of protecting the debt against default jumped. The lira slid about 0.5% against the dollar, with state lenders intervening to limit losses, according to people familiar with the matter.

Investors closely watching the elections to determine whether to plow money back into the $900 billion economy are losing confidence following Sunday’s first round of voting. A potential post-ballot reversal of Erdogan’s unorthodox policies — which have sparked the worst inflation crisis in decades and led to an outflow of international capital — had recently fueled a rally in Turkey’s bonds and stocks.

Erdogan, who has been in power for two decades, will face Kemal Kilicdaroglu in a second round on May 28 as neither candidate won the 50% of votes needed for victory on Sunday. Erdogan’s strong showing and the majority gathered by his party alliance in parliament suggest he has the momentum to win, according to Hasnain Malik, a strategist at Tellimer in Dubai.

“This is a major disappointment to investors hoping for a win for opposition candidate Kilicdaroglu and the reversion to orthodox economic policy he promised,” Malik said. “The two weeks ahead will be characterized by a high level of uncertainty.”

Read more: Vote Gives $900 Billion Emerging Market a Comeback Shot

Erdogan won 49.5% of the votes on Sunday, while Kilicdaroglu secured just under 45% support with nearly all the ballots counted, Turkey’s High Election Board said on Monday.

Paul Greer, a portfolio manager at Fidelity International in London, said the results “shocked the market and left many participants on the back foot.”

The lira depreciated to 19.6731 per dollar as of 5:22 p.m. in New York. Earlier in the session, state banks intervened to hold the exchange rate at around 19.65 per dollar, according to people familiar with the matter, who asked not to be identified as the information wasn’t public.

The central bank declined to comment on the exchange rate. In a sign of rising demand for the currency from short sellers abroad, the offshore overnight forward implied yield on the lira-US dollar pair surged to above 400%, before trading at 139%.

The Turkish currency has been under pressure since Erdogan ramped up a slew of unorthodox policies starting in 2018, including interest-rate cuts to boost growth even as inflation surged, exchange-rate controls and state intervention.

Stealth interventions in the market by the central bank have totaled nearly $177 billion over the past 16 months, according to an estimate by Bloomberg Economics.

“Backdoor foreign exchange interventions are likely to continue over the next two weeks to keep the lira relatively stable,” said Piotr Matys, a senior currency analyst at In Touch Capital Markets in London.

Analysts at JPMorgan Chase & Co. and HSBC Holdings Plc said before the ballot they expected the lira to depreciate to around 24-25 per dollar. Goldman Sachs Group Inc. strategists said last week that the market is pricing in a “sharp devaluation,” whose timing would be difficult to predict.

Turkey’s dollar bond due in 2047 dropped on Monday, sending yields surging. Five-year credit default swaps jumped 128 basis points to about 634 points, the highest since November.

Policy U-Turn

Kilicdaroglu’s opposition alliance has promised to reverse many of the current administration’s economic policies, bring back an interest-rate policy similar to those in other countries and to appoint an “autonomous” central bank chief. In contrast, Erdogan has chased out three central bank governors since 2019 in pursuit of ever-lower borrowing costs.

Total foreign-investor holdings of Turkish stocks and bonds stood at less than $24 billion on Friday, according to data compiled by Bloomberg. That’s down from about $152 billion a decade ago. A policymaking U-turn has been seen as critical to restoring foreign investors’ confidence.

Government efforts to prop up the lira have depleted central bank reserves and left the currency at “unsustainably high levels,” said Nick Stadtmiller, head of product at Medley Global Advisors in New York.

After covering its short positions in Turkey earlier this year, Columbia Threadneedle Investments reduced its exposure late last week with the market pricing in higher odds of an opposition victory in the first round.

“Market consensus is quickly shifting to an Erdogan victory in the second round and I expect credit spreads to widen into the May 28th vote as recent short-covering flows are reversed and the prospects for economic policy changes recede,” said Gordon Bowers, a London-based analyst at Columbia Threadneedle Investments. “Following last night’s results, we are more pessimistic on Turkish assets.”

Why Turkey’s Erdogan Faces His First-Ever Runoff Vote: QuickTake

--With assistance from Selcuk Gokoluk, Srinivasan Sivabalan and Neil Chatterjee.

(Updates prices throughout)

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