Bloomberg News

Basci’s Low Rates Avert Slump With Less Inflation: Turkey Credit

February 13, 2012

Feb. 13 (Bloomberg) -- Just a month ago, Turkish bond yields signaled that the economy was heading for a recession. Now, the nation is growing enough to keep the two-year expansion alive after the central bank slashed interest rates, credit market measures show.

“The central bank is silently easing to prevent a recession by allowing money market rates to go lower,” Aurelija Augulyte, an emerging-markets economist at Nordea Bank AB in Copenhagen, said by e-mail. “The yield curve now shows this.”

Government notes due in two years yield 40 basis points, or 0.40 percentage point, less than 10-year securities, compared with a premium of 163 basis points on Jan. 5, data compiled by Bloomberg show. Credit-default swaps on Turkey are falling faster than those insuring German bunds. Traders are also reducing wagers on swings in the lira, after the currency tumbled 18 percent last year to a record low against the dollar.

The catalyst for the turnaround, which has pushed two-year bond yields down faster than in any emerging market, was Erdem Basci, the governor of the Central Bank of the Republic of Turkey, who decided to provide funding at 5.75 percent in one- week repurchase agreement auctions for banks on Jan. 10, reducing lending rates he varied each day from as high as 12.5 percent.

Investor confidence was shaken last year when the central bank adopted a discretionary policy of using more than one rate in an attempt to control inflation without slowing the economy. Growth in Turkey’s gross domestic product outpaced all major developing nations in the first nine months except China’s.

Biggest Fall

Turkey’s local-currency debt is outperforming in emerging markets this year, a sign of confidence in the government’s policies. Sovereign lira-denominated notes gained 3.2 percent compared with negative returns for local bonds in both Brazil and China and an increase of 2.9 percent for Russian securities, JPMorgan Chase & Co. indexes show. Local-currency developing nation debt is up 1.7 percent this year, based on JPMorgan’s GBI-Emerging Market Broad index.

Some authorities in the market who declared the worst for Turkey’s economy have changed their minds. Benoit Anne, Societe Generale SA’s chief emerging-markets strategist in London, told clients in June that Turkish assets may slide because of central bank policy. He’s since made an about face, recommending investors buy into the country’s $283 billion debt market, which is bigger than Poland’s and twice the size of South Africa’s.

“We are going to see inflows rise further into Turkey’s local bond market over the next few weeks,” Anne said in e- mailed response to questions on Feb. 9. “It’s clearly one of my top picks in emerging markets at this point.”

Expanding Economy

Turkey is the third-biggest nation in Europe after Russia and Germany, with a population that grew by 1 million to 74.7 million last year, data on the state statistics agency’s website shows.

The $735 billion economy, the eighth biggest in Europe and about half the size of Russia’s, has expanded an average of 5.9 percent each year since 2002, when Prime Minister Recep Tayyip Erdogan was first elected, three times the pace in Europe. Growth reached 9.6 percent in the first nine months of 2011.

Appointed governor in April, Basci is a high school friend of Deputy Prime Minister Ali Babacan and holds a master’s degree in economics from Baltimore, Maryland-based Johns Hopkins University. He was an advisor to Babacan in 2002 before starting to work at the central bank as a deputy governor in 2003.

Engineering Lira Slide

The central bank stepped into the money markets in August after New York-based Bank of America Merrill Lynch and Goldman Sachs Group Inc., pointing to the record current-account deficit of $78.6 billion, warned that the nation’s growth rate threatened to send the economy off the rails.

The central bank cut benchmark borrowing costs by 50 basis points to a record low of 5.75 percent at an emergency meeting on Aug. 4, a week after deciding to keep them unchanged, in a move Basci later said was designed to help narrow the deficit by engineering a slide in the lira. He also set about selling $16 billion of the bank’s foreign exchange reserves, carrying out the longest streak of daily dollar auctions since 2001, when more than a dozen Turkish banks collapsed, to help stem the declines.

The central bank’s surprise August cut introduced “significant uncertainty and volatility,” analysts including David Aserkoff at JPMorgan in London said at the time.

Tighter Policy

Even as Erdogan, 57, accused unnamed special interests for encouraging higher interest rates and urged the central bank to keep borrowing costs down, Basci, 45, made it more costly for banks to borrow in October by introducing tighter monetary policy. He set a so-called rates corridor and started lending to banks at a cost of 12.5 percent as well as at the benchmark rate of 5.75 percent, in an effort to slow loan growth of 40 percent that he said was spurring imports and widening the trade gap.

Basci also raised banks’ reserve requirements to as high as 16 percent of deposits from 8 percent, and the government increased taxes on imported goods such as cars, alcohol, tobacco and mobile phones.

Bank of America Merrill Lynch said in an e-mailed report on Dec. 15 that the “complexity of central bank policy” meant the economy was now poised to slide into a recession, joining Goldman in warning of negative growth in the European Union candidate.

Lira Slump

By Dec. 28, the lira had declined an annual 18 percent against the dollar to a record low of 1.9224 and yields on two- year bonds rose 333 basis points from Sept. 5 to 11.01 percent.

Price rises caused by the lira’s weakness had pushed inflation to 10.5 percent in December from 6.3 percent in July. Basci told executives in the western city of Bursa on Jan. 6 that the “exceptional tightening” had quelled speculation against the currency and kept it from falling further. Four days later, Basci switched back to lending to banks at 5.75 percent, saying the current account deficit had peaked. The bank reserved the right to raise interest rates or start buying liras without warning, Basci said.

Reduced lending rates helped push down the average at which banks lend to each other by 295 basis points from Jan. 4 to 6.6 percent on Feb. 13.

Yields on Turkey’s 2013 debt fell 179 basis points this year to 9.22 percent on Feb. 13 after dropping the most last month in percentage terms since December 2008. The decline in 2012 is the fourth-biggest worldwide after Ireland, Portugal and Italy, data compiled by Bloomberg show. Yields had soared 390 basis points last year.

Global Risk

Kjetil Birkeland, a senior analyst at Standish Asset Management in Boston, said he expects confidence in Turkey will persist as long as economic developments in Europe don’t deteriorate. Global stocks fell for the first time in four days on Feb. 10 and commodities slid on bets a plan to help Greece avoid default might fail and spread contagion through Europe. Five ministers resigned from Prime Minister Lucas Papademos’ interim government that day as he pushed through a cabinet decision to approve the austerity measures. Labor unions embarking on a 48-hour strike clashed with police in Athens.

Turkey needs “an environment where Europe remains more or less stable and global growth does not deteriorate,” said Birkeland, whose firm manages about $90 billion in fixed-income, including $12 billion in emerging markets. “It will be very challenging to finance the current account deficit if Europe again comes under great stress and the flows into risky assets come to an end. In that case, we may see a much weaker lira and bond market.”

The lira gained 7.3 percent against the dollar this year to 1.7626 on Feb. 13. The lira’s implied volatility versus the dollar over 12 months fell to the lowest since August on Feb. 8.

Foreign Investment

Growing confidence spurred foreign investors to raise their Turkish bond holdings by $1.7 billion between Jan. 1 and Jan. 27 to $39.3 billion, central bank data show. Turkey’s credit is rated Ba2 by Moody’s Investors Service, two levels below investment grade, and an equivalent BB by Standard & Poor’s.

A decline in Turkey’s credit-default swaps, which reflect the cost of insuring the country’s debt against default, has also helped attract investors back to the bond market. Five-year contracts on Turkey’s debt fell by 22.3 basis points this year to 269 on Feb. 10, after more than doubling last year in the second-biggest rise on record, according to data provider CMA, which is owned by CME Group Inc. and compiles prices quoted by dealers in the privately negotiated market.

The cost of the swaps is 17 basis points below the average for governments in Eastern Europe, the Middle East and Africa. The swaps pay buyers face value for underlying securities or cash equivalent should Turkey fail to adhere to its debt agreements.

Yield Spreads

The extra yield that investors demand to hold Turkey’s dollar-denominated debt rather than U.S. Treasuries fell to a two-month low of 348 points on Feb. 9, according to JPMorgan indexes. The spread stood at 366 basis points on Feb. 10.

Societe Generale’s Anne now expects bond yields on two-year lira debt to slide another 81 basis points to 8.65 percent this year and the lira to surge 10 percent to 1.60 per dollar, in the most bullish call for the currency among 22 global banks surveyed by Bloomberg. The average estimate shows the lira at 1.76 by year-end.

The lira traded at 1.59 per dollar a year ago and reached its strongest level ever of 1.15 in August 2008, a month before New York-based Lehman Brothers Holdings Inc. collapsed.

Economic Stability

Speculation that Turkey’s economy is poised to keep growing increased last week after the statistics office reported on Feb. 8 that industrial production rose 2.7 percent in December from a month earlier, more than erasing a decline in November. The trade deficit also narrowed in December for a second month to $8.1 billion from $8.7 billion, the statistics office said on Jan. 31, beating analysts’ estimates and easing concern that the current account deficit threatened economic stability.

ING Groep NV expects the current account deficit to fall to $72 billion this year, an estimated decline of 32 percent from 2011, as Turkey’s economic growth eases to 2.5 percent, the bank’s London-based economist Simon Quijano-Evans said in an e- mail. A pick-up in economic activity in Erdogan’s biggest trading partner Germany will help exports and curb the trade gap, said Tatha Ghose, a senior emerging-market economist at Commerzbank AG in London, referring to a 1.7 percent rise in German factory orders in December.

“Orders will jump in the first quarter” for Turkish exports, Ghose said in e-mailed comments. “Therefore unofficially I expect 5 percent economic growth this year.”

IMF Forecasts

Ghose’s prediction is more bullish than the International Monetary Fund and the government. The Washington-based IMF forecasts that the expansion may slow to 0.4 percent this year. Babacan, the deputy prime minister, said on Jan. 26 that he’s sticking to his prediction of a 4 percent expansion, adding that the IMF’s forecast, made in January, was based on data from months earlier, when the economy was in worse shape.

Growth will be closer to the government’s own forecast, and Erdogan will take measures to ensure that happens, according to Gurman Tevfik, the chief executive of Is Asset Management, the biggest fund investment company in Turkey.

“Unlike European countries, Turkey has no other option than to grow because its population is young, increasing and needs jobs,” Tevfik said in an interview in Istanbul.

The expansion will hold as borrowing costs for banks and consumers fall and inflation slows to a forecast 6.5 percent by year-end, increasing the attractiveness of Turkish assets, Basci said at a news conference in Istanbul this month.

Demand for bonds may rise because the central bank has provided funding at its lower 5.75 percent rate every day for a month, Kieran Curtis, who oversees about $3.5 billion in emerging- market assets at Aviva Investors Ltd., said in e- mailed comments.

“This will make bonds look more attractive,” Curtis said from London. “The repo rate of 5.75 percent is where you would fund bond purchases.”

--Editor: Ash Kumar

To contact the reporters on this story: Selcuk Gokoluk in Istanbul at sgokoluk@bloomberg.net

To contact the editor responsible for this story: Gavin Serkin at gserkin@bloomberg.net


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