Turkey at a crossroads
Grant Webster and Roger Mark look at how markets have reacted to uncertainty around this month’s historic elections in Turkey and find a more nuanced outlook for fixed income investors than recent market moves imply.
3 May 2023
Politics in Latin America has a habit of taking investors by surprise, and the rise of populism in recent years has only amplified this. Crucially for active investors, markets also display a tendency to over-react to political headlines, and this can create a dislocation between market prices and fundamentals.
Colombia is a case in point. Going against our – and many others’ – expectations, President Gustavo Petro has sacked his credible and prudent finance minister, José Antonio Ocampo, as part of a sweeping new cabinet reshuffle. As we mentioned in our notes following a recent trip to the country, Ocampo appeared intent on ensuring Petro’s reform agenda respected the country’s fiscal rules. His replacement, Ricardo Bonilla, has also pledged fiscal prudence and has a track record of sound economic management from his time as finance secretary for the city of Bogota under Petro’s mayorship. However, Bonilla has a lower profile than Ocampo and is personally close to the president, making him less likely to stand up against Petro should fiscal pressures mount in future. Even so, the market reaction – FX selling off and hard currency debt pricing in two downgrades to Colombia’s credit rating over the next few years, at the time of writing – appears overblown.
Firstly, we think the reshuffle is the symptom of a frustrated president rather than a sign of a radical shift in direction. Secondly, as we have written previously, what matters more than the executive’s make-up is its ability to push through its agenda. Institutions in Colombia are strong, meaning Congress, the Senate and the Constitutional Court should continue to prove an effective balance – limiting Petro’s ability to pass a health reform that risks inflicting grave damage on macro fundamentals. Finally, if – as we expect – Bonilla emphasises the importance of stability and central bank independence when he holds meetings with investors, this should help calm markets.
There are, however, certain things the Petro administration could try to achieve without the blessing of Congress or the courts and some of these would be damaging to the long-term outlook for the country. These could include measures that erode Colombia’s institutions; the appointment of political allies to key posts; and the freezing of administered prices. The result, we think, could be a one-notch rating downgrade – less than what is priced but significant all the same.
Nearer term, there is a tail risk that Petro mobilises his supporters. While his poor relationship with unions and rapidly falling popularity makes this appear unlikely, this – and a possible emergency decree/state of emergency by Petro to reduce checks and balances on the executive – is an important risk for investors to monitor. That said, we think it is highly likely that the Constitutional Court would block such attempts.
For now, we think the country’s fundamentals remain robust and the market is underpricing these.