LONDON Aug 2 Turkish stock and bond markets have delivered world-beating returns this year to investors who have come to see Istanbul as an oasis amid the escalating political tensions of the Middle East and the crisis in recession-hit Europe.
Dollar-based returns on Turkish stocks are over 30 percent so far in 2012, making it the best performing emerging equity market after Egypt.
Local bonds have returned 17 percent in dollars, almost double the figure for the broader emerging markets index.
Some of these stupendous market gains may be down to a bounce back from a disastrous 2011, when Turkish equities fell 20 percent and the lira plunged 18 percent to the dollar.
But this year's improving balance of payments picture and the perceived success of central bank policies have been the real catalyst.
Investors note that Turkey's massive current account deficit has contracted by almost a third this year due to lower oil import costs and a surge in exports. Inflation is expected to end 2012 at almost half last year's levels.
While economic growth has slowed from last year's roaring 8 percent level, companies for the most part remain in good shape, with banks seeing 15-18 percent loan growth and exporters benefiting from last year's currency depreciation.
All this offers a stark contrast to its neighbours, the euro zone as well as the Middle East.
"In the context of what's around it, Turkey looks in pretty good shape," said Jeff Chowdhry, who helps run $4.5 billion at F&C Investments. Chowdhry added to his position earlier this year and has a double overweight on Turkish equities.
"It's a country with high nominal interest rates and relatively stable political environment and that is attracting investors."
Foreign fund managers have poured almost $8 billion this year into Turkish bonds, central bank data shows, while stock markets have taken in a net $2 billion.
According to Bank of America/Merrill Lynch's monthly survey, Turkey was investors' second-biggest overweight position in emerging markets last month after Russia.
Turkish bonds have benefited from yield-seeking investors' mass stampede into emerging debt, triggered by the fall of German and U.S. yields into negative or near-zero territory.
That includes Japanese retail investors who have poured a record $2 billion into Turkey via special bonds called uridashi.
"There is a desire globally to lap up the yield Turkey has to offer, especially as easing inflation and the current account deficit have strengthened central bank credibility," said Manik Narain, emerging markets strategist at UBS.
"Within emerging markets Turkey offers some of the highest yields."
FLOWS AMID TURMOIL
The gains come at a time of an increasingly bloody uprising in neighbouring Syria, turmoil in Egypt and renewed speculation over whether Israel will make a military strike against Iran.
For Turkey, which imports 95 percent of its energy needs, the worry is of another oil price shock that would blow out the current account deficit again, push up inflation and slow the economy further, hitting consumption and company profits.
Turkey's army this week held tank exercises on its eastern border, highlighting its unease over a Syrian power vacuum that could embolden its own 27-year Kurdish separatist movement.
Such an escalation in political risk would in the past have sent shock waves through Turkey's financial markets. Yet investors' cost of insuring exposure to Turkey via credit default swaps has actually fallen by over a third this year.
To many, that is evidence of investors' faith in Turkey's economy and its Islamist-rooted, conservative government.
"Investors have found it has paid in recent years to fade any political developments in Turkey. Markets are less concerned about political upheavals than they used to be," Narain said.
Turkey may even be benefiting from the turmoil in its neighbourhood. For instance, the fall in its trade deficit is partly due to the bumper gold exports to sanctions-hit Iran. Iran was the biggest single destination for Turkish exports in June, taking in almost 500 percent more than a year earlier.
Gulf cash is also pouring into Turkey.
"Before the euro zone debt crisis began many Arab investors wanted to invest in Europe and the United States," said an executive at an Islamic Bank in Istanbul.
"Now some of these investors have turned to Turkey." (Additional reporting by Alexandra Hudson in Istanbul; Editing by Nick Tattersall)