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NEW PERSPECTIVES ON SOVERIGN RATING AND COUNTRY RISK: OUTLOOK FOR TURKEY

Outlook on Turkey. NEW PERSPECTIVES ON SOVERIGN RATING AND COUNTRY RISK: OUTLOOK FOR TURKEY . Mehmet Balcılar Updated: October 2013. Emerging markets vs. developed markets. The economic crisis is leading to a rethinking of the traditional risk paradigm. Developed Markets Risks.

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NEW PERSPECTIVES ON SOVERIGN RATING AND COUNTRY RISK: OUTLOOK FOR TURKEY

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  1. Mehmet Balcılar Outlook on Turkey NEW PERSPECTIVES ON SOVERIGN RATING ANDCOUNTRY RISK: OUTLOOK FOR TURKEY Mehmet Balcılar Updated: October 2013

  2. Emerging markets vs. developed markets The economic crisis is leading to a rethinking of the traditional risk paradigm Developed Markets Risks Emerging Markets Risks Political instability Market fundamentals Pre-Crisis Thinking Low Risk Low Growth High risk High growth Legal / Regulatory Structural issues Developed Markets Emerging Markets Currency (F/X) Environmental High Risk Low Growth High Risk High growth Market fundamentals Legal / Regulatory Post-Crisis Thinking Counterparty ‘Black Swan’ moment; risk came from where traditionally it was least expected; the model needs to be re-thought 2

  3. Recession is upon us but how long will it last? Recession is upon us but how long will it last? Sharp and Staggered Diminishing Sine Wave Sharp and Shallow Paradigm Shift Long and Contracted 3

  4. The Ultimate Roller Coaster Ride Experience … ? Source: Bloomberg http://www.kingdommagictravel.com/disneyworld/theme_parks/mgm.htm 4

  5. Story of a turkey, as told by NassimTaleb in the book The Black Swan LESSON 1: The Turkey and the Risk Manager 5

  6. The Improbable and the “Fat Tails” LESSON 1: The Turkey and the Risk Manager Source: Bloomberg, Incapital Europe Ltd. 6

  7. The Improbable and the “Fat Tails” (continued) LESSON 1: The Turkey and the Risk Manager Source: Bloomberg, Incapital Europe Ltd. 7

  8. The Improbable and the “Fat Tails” (continued) LESSON 1: The Turkey and the Risk Manager Source: Bloomberg, Incapital Europe Ltd. 8

  9. The Improbable and the “Fat Tails” (continued) LESSON 1: The Turkey and the Risk Manager 9 Source: Borsa İstanbul

  10. Use of mathematical models should eliminate any human bias in decision making Rise of “quantitative based investments” and “algorithmic based passive investments” Consider a risk manager trying to perform a stress test on the Turkish equities positions in the company’s portfolio LESSON 2: It’s Human Being who Builds Models What represents stress? What is “worst case”? Should we look back in history or simulate future returns? Which “benchmark” represents Turkishequities? Is the historical data enough? If not, how much more shall we stress them? What parameters should we use to run the simulation? 10

  11. An Example: BIST100 index dropped 12.80% on 21February2001 (source: BIST) This magnitude of daily fall has not been seen since then (a second closest one is -12.00% on 3 March 2003) Is this the right “stress” scenario for Turkish equities? Will we be too cautious as a result and hence invest too little into Turkish equities where we should have invested more? The risk of not investing enough !!! How about other investments that do not have such a long history? How about other investments that do not publish prices regularly? LESSON 2: It’s Human Beings who Builds Models 11

  12. LESSON 3: What is a Market? Spot the difference? A market is not a market without people 12

  13. LESSON 3: What is a Market? Mr. Market • Market is made up of people (the “wisdom of the crowd”) • But crowd could become “dumb” from time to time: • People “periodically synchronize their behaviour” through social interactions(Michael Mauboussin – CFA annual conference 2009) 13

  14. LESSON 3: What is a Market? Herding in BIST Figure (a) plots the market return. The shaded regions in Figure (a) correspond to regimes where herding is supported with negative coefficients on squared returns in Equation (3). Figures (b)-(d) plot the smoothed regime probabilities for the 3-regime nonlinear TVTP-MS model in Equations (3) through (5). The shaded regions in Figures (b)-(d) correspond to the maximum smoothed probability among the three smoothed probabilities. Regime 0 is the low volatility, Regime 1 is the high volatility and Regime 2 is the crash or extreme volatility. Source: Balcılar and Demirer (2013). 14

  15. LESSON 4: The Unintended Consequence of De-regulation and Globalization Source: Financial Times 15

  16. LESSON 4: The Unintended Consequence of De-regulation and Globalization Source: Bloomberg, Incapital Europe Ltd. 16

  17. Outlook on Turkey Sovereign Rating and Country Risk

  18. Sovereign Rating versus Country Risk Many analysts use sovereign debt ratings as a proxy for country risk sovereign ratings capture the risk of a country defaulting on its commercial debt obligations and country risk covers the downside of a country’s business environment including legal environment, levels of corruption, and socioeconomic variables such as income disparity.

  19. Sovereign Rating versus Country Risk • Conflationin the market of sovereign and country risk is starting to cause meaningful difficulties in corporate credit modelling because levels of sovereign and country risk are diverging for some nations. • it’s not clear that the sharp rise in sovereignrisk in Greece has been accompanied by an equivalent rise in country risk or, conversely, that • today’s robust sovereign debt ratings for China incorporate what we consider to be that nation’s continuing high levels of country risk.

  20. Sovereign Rating versus Country Risk: Do they match?

  21. Outlook on Turkey Underlying fundamentals ensure a strong long term outlook for Turkey, which is on track to become the 9th largest economy in the world by 2050 Country Facts & Macro Economic Data 21 Source: Goldman Sachs (October 2008), Economist Intelligence Unit (May 2009)

  22. Outlook on Turkey Underlying fundamentals ensure a strong long term outlook for Turkey, which is on track to become the 9th largest economy in the world by 2050 Outlook • Short Term Outlook: Turkey’s high current account deficit gives it a high beta to global economic downturns. Accordingly, the currency has substantially depreciated since August 2013of this year but somewhat recovered in the past month • However, relative to 2002the fundamentals are stronger with a healthy banking system and manageable public debt position • Demographics: Turkey benefits from one of the youngest populations of any emerging market • Productivity: 25% of Turkey’s labor force is still employed in the agricultural sector; however, a period of increasing urbanization (from 25% in mid-1900s to 70% today) will lead to further increases in productivity and employment • Reform: Turkey’s economy is well positioned long-term due to a range of successful economic policies enacted after the 2001 crisis and political reforms executed in pursuit of EU membership Turkey expected to emerge as the ninth-largest economy in the world by 2050 GDP In 2050 (US$ trillions at 2007 prices) 22 Source: Goldman Sachs (October 2008), Economist Intelligence Unit (May 2009)

  23. Outlook on Turkey Financing requirement Debt Financing Source: Deutsche Bank

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  26. Outlook on Turkey CDS Premiums (Sept 10th, 2013) • CDS premium of Turkey is significantly low compared to most of the European countries, but rising, with a recent turn down.

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  28. Outlook on Turkey Total Credits and Consumer Credits (Billion TL) • Credits and specifically consumer credits increased in parallel to the growing domestic demand. • Total credits increased by 3.48% on a monthly basis in June 2013.

  29. Outlook on Turkey Financial Markets • Comparing to previous year, total assets of the banking sector increased by 19.9% and reached 1,527 trillion TL in May 2013. • Capital Adequacy Ratio of Turkish Banking Sector is 16.34% in June 2013.

  30. Outlook on Turkey Government Debt / GDP (%) • Debt/GDP ratio of Turkey was 36.1% in 2012, which was below the level in 24 EU Countries and the Maastricht Criteria (60%).

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  41. Concluding Thoughts…. • Risk management became a “science” over the last 10 years • Reliance on mathematical and statistical models • Try to eliminate human judgment • Statistical properties in financial markets change (e.g. correlation, volatility) • Robustness in traditional risk management models / processes were challenged during the credit crisis • Financial markets are frequently affected by behavioral aspects – they evolve and adapt • Can human factors be completely eliminated?? • Traditional “static” risk management through diversification (e.g. mean / variance optimization) has limitations 41

  42. Concluding Thoughts…. • Specialists are people who know more and more about less and less, until they know everything about nothing. • Acknowledging limitations in models, and consider aspects of human behavior become more important 42

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