In this second part, emerging markets expert Michael Nicoletos discussed Turkey and Russia. What are the major issues that Turkey is facing, specially around its FX reserves? They have an energy problem as well, and will soon need to choose between the US and Russia. And how about Russia’s love-hate relationship with Europe? How does Nicoletos see it will end up?
Please watch Part 1 first, if you have not already. Michael talked about China’s household debt and how much is that? Can they ever recover from the Evergrande disaster? And how they got into it in the first place? Is CNY still valuable? How do the Chinese get dollars now with their very limited FX reserve? Should you use the digital Yuan? How much is China spending right now to up its GDP?
Michael Nicoletos have spent most of his life around markets, and I used to run a hedge fund for more than 10 years on emerging markets. He shut it down in 2019 to take a sabbatical and Covid 19 hit the world. Now, he is doing a lot of research on emerging markets and trying to see what the next steps will be in terms of the investment world. But in the meantime, he is also advising a few firms on their investment.
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This QuickHit episode was recorded on October 20, 2021.
The views and opinions expressed in this EM Meltdown: China, Turkey and Russia (Part 1) Quickhit episode are those of the guest and do not necessarily reflect the official policy or position of Complete Intelligence. Any contents provided by our guest are of their opinion and are not intended to malign any political party, religion, ethnic group, club, organization, company, individual or anyone or anything.
Show Notes
TN: Talking about EMs, and we talked about reserves, and you mentioned Turkey. Let’s talk about Turkey for a minute because you’ve made some really interesting statements about Turkey, and I’d like to really understand your perspective.
MN: Turkey faces some other issues. Turkey faces high inflation. More than 20% rates are around 19% of negative yields. The Lira has fallen more than 50% in the past few years. So you might see nominal GDP in Turkish Lira going up. But if you put it in dollar terms, it’s actually flat for the last ten years. It’s not flat, it’s flat-ish. So in Turkish Lira, the last ten years, the Turkish GDP has gone up 350%, which is a wow. But if you put it in dollars, it’s not flat, but it’s not something meaningful.
Now, if you look at Turkey and the devaluation, the President of Turkey, Tayyip Erdoğan, has tried to stop the Lira from falling. Right now, it’s I think at its all-time lows around 920 versus a dollar. But if you look at the FX reserve, which is very tricky and this is very interesting for Turkey, you’ll see that, okay, the number is ambiguous because depending on what source you see, you’re going to see another number. But let’s say it’s around $18 billion. Now, this is the gross number. If we deduct gold and all the other stuff and we also deduct the swap lines, and I will explain what the swap line is, this number falls around to $20 billion. And this could be negative according to some sources because the dollars are not there.
What has Turkey done? Instead of using its dollars to protect the Lira from falling, I’m not an advocate that you should do that, but that’s what they’ve been doing. They went to the banks and did swap lines with the banks. And the banks are using depositors dollars to buy back the Lira. So depositors right now don’t actually have those dollars in their account.
MN: Because the Turkish banks have made agreements with the central bank with swap lines, which okay, when your central bank gives you a swap line, it’s a guarantee if you’re a bank. And instead of, if you go and you see the headline number of the Turkey central bank, you won’t see it falling. But if you understand that they’ve been using depositors’ dollars to cover for it, you need to subtract that. So the number could be close to 20, maybe there are some allegations that it could even be negative. So if it’s negative, imagine. FX reserves in Turkey are pretty horrible.
You have, let’s say, $18 billion of gross FX reserve, and you have $130 billion of short term liabilities, within the next twelve months, Turkey has 130 billion of foreign claims. So again, this metric is not really good. Now, Turkey is estimated to grow around 8 or 9% this year. Again in Turkish Lira.
MN: If we take the Lira is down 25% this year. So this is an issue. Another issue is in Turkey, 60% of its current account is energy. They don’t have domestic energy, so they need to import energy and we know what’s been going on with the energy crisis and natural gas and oil going higher. So all these are main problems for Turkey right now, which I think will be forced to find a drastic way to… They don’t want to go to the IMF or the World Bank, but I think at some point they’ll have to go. And again here geopolitics come to play why they say geopolitics is because Turkey is in NATO. It’s the second biggest force in NATO. The US wants to keep it in NATO because wherever US doesn’t send military, Turkey does. Not many NATO allies send military forces wherever they go.
So Turkey is trying to play both sides right now. Trying to be the good guy with Russia, good guy with NATO. Trying to get the most out of both sides. But I think time is ticking and they will be forced to take some form of decision on what they want to do in the future because they’re running out of time in terms of their FX reserves.
TN: Yeah, it sounds like it’s pretty short time. Wow. Okay. So looking at the energy issues, not just what Turkey faces, but that Europe faces, I want to spend a little bit of time talking about the Russia-Europe relationship and what you’re seeing there. Will Russia provide sufficient gas to Europe this winter? And, from a financial perspective, how much will Russia benefit from that? Just generally.
MN: Yeah. Okay. But the thing is here the following: Europe trying to transition to a more green related economy. The planning was pretty horrible. I would say they wanted to do it fast and they wanted to say “blackmail” corporations to go to more green energy. What did they do then? They created the CO2 emissions credits. So if you were polluting above a level, you were forced to buy CO2 credits in order to cover for that. And that was like an indirect tax, making it less efficient for corporations to use that form of energy so they would be forced to go to other forms of energy.
Now, from going to coal to, let’s say, totally green. It takes some time to create the wind turbines and the sun. And actually Germany shut down all its nuclear reactors because of Fukushima.
TN: They have a lot of low-end Taiwanese fabs transition to photovoltaics with all of the incentives they were providing. I mean, for a long time, low-end fabs across Asia were just doing a very quick transition to a PV, and it was just a kind of back up the truck moment where they were just taking all the dollars they earned or Euros or whatever currency they could because Germany and all these other places were incentivizing them to do it. And they were low-end PVs. They weren’t high-end. They were just bog standard photovoltaics.
MN: No, no. Okay, but besides that, what did the European Commission do? There are auctions every now and then of CO2 credits. But the auctions are arbitrary. So the Commission, whenever it wanted the prices to go up, they did not do the auctions. So then the supply of credits was less and less. CO2 credit emissions went through the roof. So suddenly, if you use natural gas as an energy, it went even higher. And this created the viscious loop, creating the natural gas prices to go even higher.
In the meantime, Europe was negotiating with Russia about Nordstream, too. So Russia, which is a pretty good strategic and geopolitical player, realized that Europe was going back as being back in the corner and said, unless you sign whatever I want, let me put it in layman’s terms. I’m not going to pump anymore natural gas. Europe says, no, we have to sit down. We have to discuss. Okay, I’m not pumping. So one brings to another. And every time that Europe trying to play hardball, Russia says, okay, there’s no such a problem. I’m not going to be pumping and prices go higher and higher.
So I guess that at some point Europe will need to sign anything Russia wants at this moment. And will try to negotiate some form of an agreement which will be obviously not, it won’t be good. But it will be much better than the current prices that we’re seeing now. And because of the energy prices going higher, Russia is benefiting on a macro level, benefiting on a geopolitical level, and it’s gaining a lot of strength in the region.
TN: Hugely. Yeah. Hugely.
MN: So the two are interconnected. It’s not one or the other. So the energy crisis has helped Russia, and Russia has exploited Europe’s inability to act smoothly and fast.
TN: It’s very interesting. Okay. Just to close this out because I know we’ve been going on for a while. I’m just curious about Russia’s position with Europe, say, over the medium term. Do you see Russia and Europe growing closer? Do you see that relationship becoming tighter, or do you see that eventually becoming an antagonistic relationship? Are there substitutional energy sources that Europe can utilize and that eventually becomes an antagonistic relationship again? Just in general terms. I don’t necessarily political specifics. But how do you think that plays out?
MN: Well, I’ll use Henry Kissinger’s famous quote that was back, like 40 years ago. He said, “When I called Europe, who do I call?” So right now, you have, in Germany you just had elections. They haven’t formed the government. It might take months before they form a government.
In France, there are elections in April. It seems that the right could be a threat to Macron. And we don’t know what the “right’ means in France. It could be Le Pen or it could be someone else, but it could be anything right now. So right now, I don’t see a leader. If Macron wins, he could be the next leader of Europe. But right now, there’s a leadership problem within Europe.
So as long as there’s a leadership problem within Europe, in my view, there’s a vacuum. And I think Russia will exploit it to gate as much influence as it can. And I cannot foresee the future. But in the next six to eight months, I think Russia will try and get as much influence as it can and try to exploit that vacuum.
TN: I think you’re right. They’re very smart. They’re very smart political players.