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Turkey/Erdogan: bad policies spawn bargains

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Here is a career tip for newly hired Turkish central bank governors: whatever happens, do not raise interest rates. Naci Agbal ignored that pointer. He was dismissed by President Recep Tayyip Erdogan this weekend.

Agbal tried to tame mid-teens percentage inflation with successive interest rates increases. He had raised the policy rate by nearly 9 percentage points to 19 per cent since November. Turkish gyrations in borrowing costs reflect local conditions rather than a looming problem for all emerging markets.

Politicians should hate rising inflation. It irritates voters and spooks foreign investors. But the autocratic Erdogan worries less about the next election than the average leader. He wants to boost the economy at almost any price.

Markets reacted badly to another sacking at the central bank. The Turkish lira collapsed about 9 per cent versus the dollar and euro. Local share prices fell at twice that rate in hard currency terms.

That said, emerging equity markets have had a powerful bull run. They now look overbought. MSCI’s emerging market index recently touched a historical high after surging nearly two-thirds over the past year.

Turkish equities are still up around two-fifths in a year. But performance looks less stellar through a valuation prism. Stocks traded last week at just over six times forecast earnings. Relative to other emerging markets, Turkish valuations have not been so depressed for at least a decade.

The best bargains may be found in the fixed income market. Turkey’s 10-year dollar 11.7 per cent coupon bond this week offers close to a 17 per cent yield. That suggests a duration (sensitivity to interest rate movements) considerably lower than its UK gilt equivalent. That should get the antennas of some opportunistic portfolio managers twitching, even with heightened political risk.

Longstanding investors will feel less sanguine about this latest bout of lira weakness. European banks have the most exposure. Spanish institutions lead the pack, says RBC Capital Markets, with loans worth $82bn or 6 per cent of its gross domestic product. BBVA’s large stake in Turkey’s Garanti Bank is emblematic of the alliance.

Turkey’s new central bank governor, Sahap Kavcioglu, has been echoing Erdogan’s unconventional view that rate rises stoke higher prices. If Kavcioglu cannot find another way to restrain them, the phrase “Roaring Twenties” will apply — but only to the inflation rate.

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Europe

Bets on coronavirus recovery may come good

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Markets appear to have got the pandemic right. A plummet in shares as economies locked down gave way to a robust rally: investors trusted in a mix of vaccines, corporate adaptation and central bank stimulus. Mass vaccination programmes in the US and Europe are under way and in countries where they are most advanced like Israel and the UK, economies have unlocked and customers have come flooding back to shops and restaurants.

The virus takes advantage of our social natures to spread but markets had a different, equally human, trait in mind: ingenuity. That includes tech companies whose shares have been among the big winners as they kept businesses operating during lockdowns and new business models allowed shoppers to keep spending. Others too, have adapted, and lockdowns have become less damaging.

Even more important has been pharmaceutical innovation. Researching and developing vaccines has, likely, had among the greatest returns on investment of any human activity — as production accelerates the need to lock down, with its attendant economic costs, retreats. The next challenge — political rather than scientific — is to ensure a sufficient share make their way to poor countries. 

With little experience of pandemics, policymakers looked to the financial crisis. Fresh memories of what was in many countries a “lost decade” of meagre improvements in living standards, spurred central banks and governments to open the floodgates. The unprecedented monetary and fiscal stimulus has been notable for its speed as well as its size compared to the response in 2008, reducing long term damage: America’s vast spending, in particular, has added fuel to the rally and stimulus cheques have allowed retail investors to participate.

Claiming victory would be a mistake. The pandemic has been a story of reversals and countries that once looked to have the virus under control finding themselves overwhelmed. That includes, for example, Germany — lauded for its early response but struggling with a third wave — or eastern Europe, initially less affected than elsewhere but now among the most badly hit regions. Other countries which have reopened in the past had to swiftly lock down again as new waves spread. 

In 2009, the main US index rose 66 per cent in the 12 months after the trough but it took far longer, and successive crises in the eurozone, before economies would fully recover. Investors who got into the rally early were unlikely to regret it: cheap money helped power a decade-long bull market. This time the rebound has been similar as investors have learnt there is little to be gained from standing in the way of quantitative easing.

The big question remains the outlook for inflation. With little sign of economies returning to capacity after the financial crisis central banks kept rates low and asset purchases high, flooding the financial system with liquidity. A stronger recovery from the pandemic, thanks to a mix of government stimulus and households spending accumulated savings could see prices and wages start to creep up again — central banks may start to withdraw support too. The pandemic has also disrupted supply chains raising price pressures further.

Record first-quarter growth in China, where the recovery is more advanced, has already shifted the focus to “overheating” and the prospect of rate rises. An end to the persistent “lowflation” of the decade after the financial crisis would be a far better outcome for the whole world but it might mean markets have got ahead of themselves.



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Biden imposes tough new sanctions on Moscow

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US president Joe Biden has imposed sweeping new sanctions against Russia including long-feared measures targeting its government debt in a sharp escalation of Washington’s confrontation with Moscow.

The first anti-Russian measures from the Biden administration also include the expulsion of 10 Russian diplomats from the US and sanctions against 38 entities, individuals and companies accused of taking part in efforts to interfere in US elections and conduct cyber attacks.

On Wednesday, the US for the first time formally blamed SVR, Russia’s foreign intelligence service, for the SolarWinds hack, which affected at least nine federal agencies and 100 companies. One senior administration official told reporters the hack gave Russia “the ability to spy on or potentially disrupt more than 16,000 computer systems worldwide”.

News of the measures sparked a sell-off in Russian assets and a warning from the Kremlin that they would harm efforts to reduce tensions between the two countries.

The fresh sanctions ban US financial institutions from trading in newly issued Russian state debt, known as OFZs, and bonds issued by the Russian central bank and National Wealth Fund. The ban affects debt issued after June 14.

Measures targeting new state debt have long been viewed as a “nuclear option” for the US and a milestone in Washington’s sanctions regime against Russia, which has steadily expanded since the first round of restrictions were imposed by the Obama administration in response to Moscow’s 2014 annexation of Crimea.

In remarks at the White House on Thursday afternoon, Biden played down the severity of the actions, saying the US wanted a stable, predictable relationship and was “not looking to kick off a cycle of escalation and conflict with Russia”.

“I was clear with President (Vladimir) Putin that we could have gone further, but I chose not to do so,” Biden said, referring to recent telephone conversations between the leaders. The US president said he was still prepared to take further action to respond to Russian aggression “in kind”.

The senior administration official said the new sanctions package would “impose costs for Russian government actions that seek to harm us”. The official added some US responses would “remain unseen”. The moves come after strong condemnation from Washington and other Nato powers over Russia’s heavy military build-up close to its border with Ukraine.

The package includes sanctions on 32 individuals and organisations accused of interfering in recent US elections, and six Russian technology companies alleged to support the country’s intelligence services, in view of the SolarWinds hack.

The rouble dropped as much as 2.2 per cent in early trading on Thursday to about 77.5 to the US dollar. It trimmed some of its initial losses and was down 0.7 per cent to trade at 76.41 by 2pm London time.

The decline in the value of the Russian currency erased gains made earlier in the week after a Tuesday call between Biden and Putin, in which the leaders discussed a potential joint summit aimed at easing tensions.

Moscow’s benchmark Moex stock index was down 0.6 per cent, while the market’s dollar-denominated RTS index was 1.8 per cent lower.

© Alexei Druzhinin/Kremlin/EPA/Shutterstock

The country’s benchmark 10-year bond yield rose 0.19 of a percentage point to 7.24 per cent, a touch below recent highs. Bond yields rise as prices decline.

The EU and Nato both issued statements expressing “solidarity” with the US over the sanctions.

Dominic Raab, British foreign secretary, said the US and UK were aware of Russia’s actions to undermine their democracies. “[We] are calling out Russia’s malicious behaviour, to enable our international partners and businesses at home to better defend and prepare themselves against this kind of action,” he said. “The UK will continue to work with allies to call out Russia’s malign behaviour where we see it.”

The UK’s security review, published last month, identified Russia as the “most acute threat” to its national and collective security, citing “hostile and destabilising” activity by Moscow.

Russia’s foreign ministry responded to news of the sanctions by summoning the US ambassador to Moscow for what it said would be a “difficult” discussion.

“Such aggressive behaviour will certainly be strongly rebuffed, and the response to sanctions will be inevitable,” ministry spokeswoman Maria Zakharova told reporters. “Washington must realise that it will pay for the degradation of bilateral relations.”

The Kremlin said earlier on Thursday that fresh sanctions could scupper efforts to arrange the planned summit between the two leaders.

However, in his remarks on Thursday, Biden said he thought the summit would still take place in Europe this summer, adding teams from both countries were discussing the event.

The Biden administration began drawing up measures to punish Russia following the SolarWinds hack, which officials said at the time was “likely of Russian origin”.

Russia has denied involvement and said it had never attempted to influence foreign elections.

The US has also condemned the recent arrest and jailing of Russian opposition activist Alexei Navalny after his recovery from a suspected assassination attempt, and accused Moscow of threatening Ukraine by deploying tens of thousands of troops to the country’s border.

A senior administration official said the US was not taking any countermeasures in view of a US intelligence assessment that concluded with only “low to moderate confidence” that Russian intelligence officers paid the Taliban to attack US and allied personnel in Afghanistan in 2019 and perhaps earlier. The official said the US would instead issue “strong direct messages” to Moscow.

The share of Russia’s rouble-denominated Treasury bonds held by foreigners fell to a more than five-year low of 20.2 per cent in March, down from more than 30 per cent a year earlier.

The sanctions will test the Russian finance ministry’s plans to soften the impact of restrictions against its sovereign debt. Potential countermeasures include a pause in issuance and regulatory easing for Russian borrowers, deputy finance minister Vladimir Kolychev told the FT late last year.

The ministry is also confident that, if needed, it can replace foreign OFZ holders entirely through domestic demand.

After cancelling a bond sale in March due to market volatility and sanctions fears, Russia sold a record Rbs354bn ($4.6bn) in OFZs a week later, with most of the issue going to Kremlin-run banks.

Additional reporting by Max Seddon in Moscow, Lauren Fedor in Washington and Hannah Murphy in San Francisco



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Biden will not change Putin but is right to talk to him

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The west’s approach to Vladimir Putin’s Russia regularly falls prisoner to the perennial debate about realism and idealism in foreign policy. The choice is posed as between engagement and confrontation, the pursuit of interests and defence of values.

As Putin apparently threatens war in Europe by overseeing a menacing build-up of Russian troops on Ukraine’s eastern border, two thoughts arise. The Russian president is not about to change his ways. And the US and Europe have to deal with him.

Putin has been a big loser from Joe Biden’s presidential victory. Donald Trump fell under his spell. When they met in Helsinki in 2018, the then US president said of the evidence of Russian meddling in the 2016 US election, that he preferred the word of a former KGB operative turned Kremlin autocrat above that of his own intelligence agencies.

Trump offered Putin the respect he craves. It is always a mistake to underestimate the role of vanity in politics. Putin never forgave Barack Obama for an off-the-cuff reference to Russia as a “regional” power. Above all, Putin wants to be treated — and seen by Russians to be treated — as the leader of a nation that still stands as an equal with the US. The lopsided alliance he has forged with China will never serve as a substitute.

Biden’s victory has derailed eternal Kremlin hopes of splitting the Atlantic alliance. Washington’s relations with its European partners are warmer than for many years. German chancellor Angela Merkel looks increasingly friendless in her stubborn backing for the Nord Stream 2 pipeline being built to carry Russian gas under the Baltic Sea. French president Emmanuel Macron has failed in his efforts to recalibrate the relationship with Moscow.

Western diplomats are not sure what to make of the latest troop build-up. It contains an obvious warning to Kyiv not to seek to overturn the ceasefire with the pro-Russian separatists who seized territory in Ukraine’s Donbas after Moscow annexed Crimea in 2014. And there is a message to the US and Nato not to write a blank cheque for Volodymyr Zelensky, Ukraine’s president, and his government. 

Whatever the Kremlin’s ultimate military intentions, the deployments have served Putin’s purpose in grabbing the attention of the White House. Until this week Biden had largely ignored him, while offering a blunt assessment of the Russian regime. Putin is a “killer”, he remarked last month. Moscow was put on notice that the US would respond vigorously to cyber attacks and meddling in US elections.

The US president’s offer this week of a summit on neutral territory to discuss Ukraine and a clutch of other issues looks calculated to appeal to Putin’s vanity. Success or failure, a summit will offer clarity. And if it can take some of the tension out of the relationship by massaging Putin’s ego, why not.

It will not presage, however, a fundamental change in the relationship. The “reset” story has been played out many times during the past decade or so. The offer of a fresh start has come from several western leaders.

Logically, Putin should be attracted to the idea. Russia can survive US and European sanctions, but it badly needs western investment and technology. Its long-term strategic interests lie in a close economic relationship with Europe. If the Kremlin is in search of threats, it would do better to take a close look at China’s Eurasian ambitions.

Russia’s interests, though, are not Putin’s. His priority is the preservation of his own power and wealth. Autocrats need enemies. The supposed threat from the US and its allies sustains his populist pitch to Russian nationalism.

The question then becomes how much room there is for co-operation — whether on nuclear arms control, backing efforts to restore the nuclear agreement with Iran, or promoting stability in Afghanistan when US troops complete their withdrawal this year. The answer must be that the possibilities are worth exploring. Putin has already accepted Biden’s offer to extend the last remaining strategic arms treaty.

The notion of a binary choice between realism and idealism has never held much credibility. The argument that usefully can be had is not about the fact of engagement, but about its nature. Where does the line fall between securing interests and compromising values?

The idealists have a point when they say that the some of the overtures to Moscow in recent years have looked more like capitulation than engagement. Biden seems to have got the balance about right. Where it can, the west should work with Russia. Just not on Putin’s terms.

philip.stephens@ft.com



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