TBY talks to Hüseyin Erkan, Chairman & CEO of the Istanbul Stock Exchange, on the current economic policy settings and developments in the local capital markets.
TBY The Central Bank of Turkey (CBT) is pursuing an experimental policy in lowering interest rates while increasing reserve requirements. In your opinion, what will be the net impact of this policy?
HÜSEYİN ERKAN It is an interesting—albeit unconventional—policy. There are mixed outlooks for the policy, but it seems like it is working. One of the hesitations that the government had was that Turkey’s economic success so far has drawn a lot of investments into Turkey, and especially “hot money”, i.e. short-term-oriented capital coming in and out of the country. This policy change is aimed at averting this challenge. On the one hand, lowering interest rates is still going to stimulate the economy, and raising reserve requirements will affect the entrance and exit of hot money, and will help promote longer-term investments in Turkey. Coming up with an entry or exit tax on capital movements is not popular and wouldn’t work in Turkey. With these policies the parameters can be changed very quickly, and depending on progress and international developments the CBT can lower or increase the reserve requirements. Changing interest rates so often is not desirable, but reserve requirements are easier to handle and help deposits to be longer term, and promotes longer-term investments. Regarding the stock exchange, foreign investors own two-thirds of the free float, and their average holding period is over a year. Combined with the fact that two-thirds of the free float belongs to institutional investors, accounting for 15% of the daily volume, we can easily see that the hot money issue is not affecting the equity markets. The problem is mainly in short-term instruments such as the fixed income and money markets. Net outflows from our equity market have only been $750 million, and our daily volume is over $2.2 billion. In 2010 net inflows were over $5 billion. In the month of January 2011 alone, net outflows were a little over $700 million.
How will the policy stand up following a likely improvement in Turkey’s investment grade?
The rating improvement to investment grade will herald an increased amount of capital coming into the country, and the policies undertaken are in preparation for that. Everybody else in the world is considering similar measures, and some countries, such as Brazil, have applied an exit tax, which hasn’t been so effective. Brazil is attracting a lot of foreign capital, and Turkey is now beginning to attract foreign capital in a similar way. Turkey has managed the effects of the crisis very well. The effect was sharp in 2008, but the recovery was quick. We saw the index drop quickly in 2008 as people lost confidence in the banks in the rest of the world and treated Turkish banks in the same manner. At the end of the 2008, investors saw the banking sector in Turkey declaring record high profits, and this continued in 2009 and 2010.
How do you expect the banks to react to a lower interest rate climate?
The expectation now is that, seeing as interest rates are low, the banking sector may not make as much money as in 2009 and 2010. Banking stocks are slightly lower, yet new capital is coming in, and this creates an opportunity. The banking sector has traditionally been making good money coming from government securities, which are now not as profitable. The government’s need for borrowing has gone down, with total public sector debt previously being around 85% of GDP; now it is down to about 42%. So there is room for growth. Banks have started issuing bonds to raise cheaper capital. Credit to the real sector has also been increasing, and it will increase even more in 2011, yet under the gaze of the banking regulator, which does not want to see a huge increase in credit extended to the real sector. There is huge growth in mortgage and real sector credits, and the banks haven’t utilized these areas well enough in the past. The growth story of the Turkish banking sector is not over. Mortgage credits outstanding are less than 10% of all credits in the banking sector, but in other developed countries and developing countries that is 30-40%, and even 50%. There is a huge growth potential for the banks. The banks will continue keeping the economy growing, and the interest in banking stocks will continue. In terms of the real sector, we have seen good growth in 2010 and in 2011 with lower interest rates and costs of borrowing, and new investments will continue. We just saw the production index was way above expectations—capacity utilizations have increased. This is also fueling growth. We will see the economy grow in 2011, and measures have been taken to smoothen that rate.
2010 was a bumper year for the ISE in terms of IPOs. What expectations do you have in 2011?
In the first 35 days of 2011 we had five public offerings. We have 10 more applications that we are reviewing as of February 2011. After a meeting that heralded the start of a national campaign on public offerings, 18 new companies joined between May 2010 and January 2011 compared to only four between January and May 2010. Obviously, increased awareness is helping. We have also taken steps to simplify the process of coming to market, and we are approaching companies all around the country and making it known that an offering does not mean a loss of control or incessant auditing.
Many new instruments and platforms were seen in 2010. How is this shaping the evolution of the stock exchange?
We introduced a warrants market, new fixed-income markets, a second repo market, and we have also launched a new market for SMEs. The warrants market is developing slowly as the investor base here is still very amateur. The SME segment is also unique in that it offers different IPO methods, trades differently, is more lenient on the disclosure periods of financial statements and independent audit requirements, and has also a tailored listing fee scheme. We have over a million investor accounts in the central depository, and these are all individual investors. Individual investors are the major force behind the liquidity in the market. When you look at the large amount of investors, the active ones are even fewer. Short-term investors generate the liquidity, but this liquidity has to be sustainable, and this means we have to increase the institutional investor base. The institutional investor base is really the type of investor that looks for more sophisticated investments. Warrants are a more sophisticated instrument, and individual investors do not know enough about them. It is a learning process, and it will take a while to develop the market, and we are pushing, through campaigns, to increase the supply of instruments coming to market, and the awareness necessary for them to be successful.
What industries do you believe have the most growth potential in Turkey?
I believe construction, electronics, automobile manufacturing, tourism, banking, and, in the next 5 to 10 years, software and services will develop quickly. The country will also remain strong in textiles, yet value-added products have to be introduced to the market as Turkey cannot compete against China.
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