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The curse of the emerging world

In a matter of days, my contrarian argument that the IMF agreement was not a done deal has morphed into the consensus view. The hopes of the few optimists were shattered after Central Bank, or CBT, President’s admission of a Plan B last week; the very same Durmuş Yılmaz had noted that an IMF deal would be a good idea only three weeks earlier.

I remember first voicing my doubts over the deal chatting with a bond trader mid-March, right before the CBT delivered the expected 1 percent cut. The trader was extremely bullish on Treasuries, given that the CBT would continue with rate cuts and the stand-by would materialize shortly after the local elections at the end of the month. Fast-forward one month, and the bond market was indeed rallying strongly in mid-April. After all, now that the government had revised its macro targets, an IMF deal was imminent. With expectations of another 1 percent cut (the Bank ended up delivering 0.75 percent) and the rosy global environment, no wonder Treasuries rallied.

If anything, the inconsistencies in the revisions, especially on the fiscal side, should have hinted that something was amiss. In fact, I was irked enough to question the wisdom of crowds, risking of looking like a complete fool. Each day after that has brought more people to my camp, with Yılmaz’s comments and the plethora of analyst reports popping up in my mailbox right afterwards sealing the matter. However, notwithstanding the bond pullback, Turkish assets held quite well. To understand this interesting phenomenon as well as the government’s IMF strategy, we must look at the bigger picture in the emerging world.

The rise of the emerging markets

In fact, Turkish assets have not been that spectacular when compared to other emerging markets, or EM, for the last couple of months: It is the emerging world as a whole that has been performing well. Part of this reflects the continuation of the global green shoots scenario: Never mind that U.S. banking woes have yet to resolve and housing prices, where all the mess began in the first place, have yet to stabilize. In fact, with these two hanging in thin air, my only necessary condition for revival that is satisfied is the inventory depletion. Yet despite many major economists thinking along these lines, the optimism continues unabated.

To give markets some credit, one place where there is marked improvement is the credit front. With central banks throwing everything but the kitchen sink, funding costs and counterparty risks have returned to pre-Lehman levels. Similarly, risk aversion, while still high, has fallen remarkably. With markets flushed with liquidity and carry trades once again profitable, hedge funds and the like have turned to EM. With all the conditions that drove EM to negative territory in the first quarter reversed and the reemergence of decoupling (what The Economist calls version 2.0), no wonder EM are once more in vogue.

This emerging market-friendly environment is actually Turkey’s curse, as it is causing the government to drag its feet towards the Fund. Never mind that Turkey is, despite the PM’s claims that the crisis would pass tangent or just brush past in the worst-case scenario, in the bottom tenth percentile in terms of growth performance, not only at last year’s numbers, but also according to the IMF’s 2009 projections. Without a coherent fiscal framework that will put the much-needed structural reforms in place and take care of debt sustainability, the crisis may not pass easily, either- despite the PM’s declaration on Friday.

It is really fun to ride the emerging market wave- until a great white spots you and bites right through your board. Once you end up missing a leg or an arm, it is not much use to cry for the lifeguard.

Emre Deliveli is a freelance consultant. His daily Economics blog is at http://emredeliveli.blogspot.com/.
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