Neighbours geographically, economically the contrast between Greece and Turkey could not be starker.
They are small markets in the context of global emerging market equity investing, but over the past decade, the travails of their two economies have created significant headlines. Greece endured the painful effects of a sovereign debt crisis which saw it come close to leaving the eurozone. Meanwhile Turkey, one of the original “fragile five”, has been on a deteriorating economic trajectory for over five years.
Today Greece is a story of economic recovery underpinned by long-term structural reform, while Turkey faces urgent economic adjustment to avert a deeper crisis.
Some longer-term perspective
It has been a tough 15 years for the Greek economy, hit by the global financial crisis, the subsequent sovereign debt crisis, and fiscal retrenchment. GDP posted six years of consecutive declines from 2008-2013, falling by over a third from peak to trough, and the debt-to-GDP ratio jumped from around 100% to 180% during this period. Greece received three rounds of bailout loans between 2010 and 2015, with support from the International Monetary Fund, Eurogroup and European Central Bank, as well as some debt relief.
Under the terms of its bailout agreements, Greece was required to impose a deeper economic adjustment programme in exchange for financial assistance. The objective was to restore fiscal sustainability, safeguard financial stability, drive reforms conducive to economic growth and employment, and to modernise the government sector.
The economic adjustment programme ended in 2018 and a gradual recovery was underway before the pandemic hit. This has gathered stronger momentum in the past two years. The resumption of orthodox policymaking, following the return to power of New Democracy in 2019, has been an important pillar of support for long-term reforms. More recently, the services-led global recovery, notably tourism, has been beneficial.
While Greece has been through a major economic crisis over the last 15 years, the picture in Turkey has been one of gradual deterioration in macroeconomic policy and rising risk of a balance of payments crisis. Headline GDP growth masks a major decline in policy-making, growing macroeconomic imbalances, a weakening of the institutions, and consequent currency weakness.
President Erdogan is well known for his unconventional belief that higher interest rates cause inflation. The central bank was encouraged to maintain a highly accommodative monetary policy rate to support growth. This fanned inflation, deterred long-term saving in lira, added to pressure on the currency, and had other unintended consequences. For example, the Turkish house price index has risen four fold in the past two years, as this next chart shows. This is due to a sharp rise in demand for real assets in the face of high and rising inflation. The introduction of protected deposit rates only complicated this picture. Previous attempts to normalise policy have ultimately led to leadership changes at the central bank. Against this backdrop, annual inflation reached 80% late last year.
Turkey was one of the original emerging market economies dubbed the “fragile five” (the others being South Africa, Brazil, Indonesia and India); a term coined in 2013 to describe those emerging economies dependent on foreign capital to drive growth. This dependence left it susceptible to the whims of foreign investor sentiment, and capital flows. With just one exception, Turkey has recorded an annual current account deficit every year since 2003. Funding of the current account has become increasingly difficult and expensive due to rising global interest rates and reduced risk appetite from international investors. More recently the funding has also become more opaque, with net errors and omissions accounting for a significant proportion.
In addition to the central bank, other institutions have also been weakened over the past decade. At the same time though, President Erdogan has been shrewd in using Turkey’s geopolitical importance to maximum benefit, as we have discussed previously. Turkey has not joined Western allies in imposing sanctions on Russia. It has become a key transport hub for Russia, after Western airlines curtailed operations. Meanwhile, Russia’s state-controlled Rosatom has provided $20 billion in advanced funding to build a nuclear power plant in Turkey. At the same time though, a Turkish company has provided drones to Ukraine. Along with the United Nations, Turkey has also supported the agreement of the Black Sea Grain Initiative. Good relations with other Middle Eastern nations has also helped in procuring emergency financial support to fund the current account deficit.
A tale of two macroeconomic outlooks…
Greece
Macroeconomic conditions in Greece are now far more stable, with the fall in energy prices over the past nine months supportive. Meanwhile European Union funding, under the Recovery and Resilience Plan, will provide €30.5 billion between 2022-2026; split between €17.77 billion in grants and €12.73 billion in loans.
These investments and associated reforms are focused on delivering more sustainable long-term growth, with a significant emphasis on green and digital transitions. In fact, 37.5% of the plan is dedicated to achieving climate objectives, with a further 23.3% centred on the digital transition. Greece targets net zero emissions by 2050. Its draft National Energy and Climate Plan, published earlier this year and currently out for consultation, includes significant increase in electricity generation from renewables, as the chart below illustrates.
Tourism remains an important driver of GDP growth, and is estimated to directly contribute 20% of GDP. Around 25% of the workforce is employed in tourism. This is cyclical, but the outlook for this year continues to be encouraging, and the country is taking market share from other European countries. Headline GDP growth of around 2.6% is projected for this year.
Greece exited EU fiscal surveillance last year, in place for 12 years as part of its bailout agreements. The move provided the government with greater flexibility over budget spending. The primary surplus target (before interest costs are included) has been dropped and fiscal policy may ease.
The debt-to-GDP ratio remains elevated, having spiked to 206% of GDP during the pandemic, but has decreased to around 170% . The key point for Greece though is that the average government debt duration is 17.5 years, with its longest dated debt not due for repayment until 2070. Meanwhile, 99% of government debt is fixed rate, with an average cost of 1.5%.
We’ll come on to politics, but it is highly likely that New Democracy will retain power in upcoming second round elections on 25 June, thereby ensuring a continuation of the reform agenda. Assurance over the policy outlook would also add weight to the case for Greece to regain its investment grade debt rating. This outcome would bring Greece back onto the radar for large, long-term institutional investors, enabling cheaper and more stable funding for future investment.
Turkey
In Turkey, the long-term outlook for economic growth is supported by a young and growing population. Its proximity to the Middle East and North African markets, which also offer a long-term growth opportunity, may also provide an interesting export opportunity.
On a medium-term basis though, Turkey faces major challenges and we expect economic growth to remain below trend for the next two years or so. GDP growth is forecast at 1.9% this year, supported in part by reconstruction in the wake of a major earthquake earlier this year, and pre-election spending. However, the high level of foreign currency debt in the corporate sector, particularly banks, will need to be restructured. And there is high external debt rollover risk.
Although it has fallen back in recent months, inflation remains unanchored, with the headline rate at close to 40%; the official inflation target is 5%+/-2%. The key monetary policy rate now sits at 15%, having been hiked from 8.5% this week under the leadership of the new central bank governor. The policy pivot underwhelmed even the most pessimistic expectations though, and further hikes will likely be needed to return inflation even close to target. While a return to more orthodox policy would be welcome, central bank independence has been compromised in recent years, and credibility will take time to be restored, assuming that policy remains on a conventional path in the meantime.
Since the election, the authorities have allowed the lira to depreciate. This was almost inevitable as spendable foreign-exchange reserves are close to $7 billion, which is a historic low. An expected record-breaking tourism season, with US dollar inflows of up to $40 billion should be supportive on a near-term basis. Together with some efforts to improve policy, this should buy the economy some time and avert an imminent balance of payments crisis. But there is a long road ahead.
Do elections re-enforce the outlooks?
Greece and Turkey both held parliamentary elections in May, with the outcomes favourable for the incumbent governments.
In Greece, the centre-right New Democracy party fared far better in the first round than most opinion polls had expected, with a double-digit lead over the main opposition party. The party was close to a majority and could have sought to rule in coalition. However, after the strong first round showing, New Democracy prefers to move to a second round, when the wining party is granted up to 50 bonus seats. If first round results hold, this would give it a majority. As a result, the political dynamic in Greece remains supportive of the reform agenda for at least the next four years. Unsurprisingly, this outcome has been well received by financial markets.
Turkey held both parliamentary and presidential elections in May. The ruling Justice and Development Party, or AK party, coalition secured a majority in parliament. Meanwhile, President Erdogan was re-elected to another five-year term after a second round run-off.
On paper, these results would imply no change in trajectory for policy and the economy. However, since the elections, President Erdogan has moved to appoint a credible finance minister in Mehmet Simsek, and a central bank governor in Hafize Gaye Erkan. As we noted above, but it is worth re-iterating, a return to credible policy making in Turkey would be welcome, there is much scepticism as to how long this will last. Previous attempts to instil more traditional policy approaches have been abandoned as soon as economic activity began to slow. With municipal elections due in 2024, there may be pressure to change course once again. Furthermore, the scale of the challenges facing the economic team are more significant than in the past.
What do valuations look like?
Valuations on a combined z-score basis, that is relative to their own historical average, are in aggregate cheap for both markets. This combined measure incorporates trailing price-earnings, 12-month forward price-earnings, price-book, and dividend yield. Although Greece may not look as attractive relative to other EM on a z-score measure, it offers a more stable and reform driven economic growth outlook relative to other markets with a far lower risk profile than historically.
Relative to wider emerging markets, both markets are well below the index average on a 12-month forward price-earnings and price-book measure.
While valuations may look reasonably cheap in both markets, currency is a key concern for investing in Turkey. Given the macroeconomic challenges it faces, the lira is likely to remain under pressure on a near-term basis. The chart below shows the Turkish lira per US dollar exchange rate, and illustrates how currency pressure has eroded returns over time, especially in the last few years.
What are the risks?
Risk perceptions with regard to Greece have decreased significantly in recent years. More controlled fiscal policy, in the wake of long-term bailouts, was a positive. The return of New Democracy in 2019 provided greater confidence over financial sustainability. As a result, the cost of insuring Greek debt has fallen, and is now below that of fellow eurozone economy, Italy. By contrast, the cost of insuring Turkish debt has tripled over the last five years. The chart below shows this, measured by collateralised default swap spread on the five-year government bond.
Greece is not immune to deterioration in the global macroeconomic outlook though, given its high debt-to-GDP ratio. As such, deterioration on the external side, and a sharper rise in global rates, would have implications for tourism and growth more broadly. A surprise second round election result, which we do not expect, could also change the dynamic with regards to reforms.
In Turkey, the risks remain significant and downside risk remains for the currency. A spike in energy prices could add pressure on the current account deficit, adding to financing pressure. Current account financing and debt rollover is already subject to global investor sentiment, as well as progress with domestic reforms. If perceived improvement in policy making disappoints, which this week’s rate hike will not help with, this would exacerbate these issues.
Our view
We continue to favour Greece. It is highly likely that New Democracy will retain power in upcoming second round elections, thereby ensuring a continuation of the reform agenda. Greece is still early in its recovery from a depressed position. The outlook for economic growth is strong, with support from the EU Recovery Fund, and valuations for the market in aggregate remain attractive.
We maintain a negative view on Turkish equities. Severe imbalances in the economy persist, and there is ongoing currency risk. The appointment of a new finance minister and central bank governor brings experience and an expected more orthodox approach to policymaking. However, a lack of government credibility, following a series of policy U-turns in recent years, means we remain cautious. This said, if macroeconomic stability can be restored, Turkey offers a range of potential stock opportunities. There are a large number of interesting companies with strong management teams to invest in.
While initial measures are being taken in Turkey to adjust policy and move the economy to a more sustainable footing, significant risks remain. In the meantime, markets will question the longevity of this commitment. Across the Aegean, the outlook is the brightest in over 15 years.
Source: Schroders
