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Erdogan Faces Worse Deal in Sukuk Than Dollar Debt Market: Turkey Credit

March 01, 2012

Recep Tayyip Erdogan, Turkey's prime minister. Photographer: Michele Tantussi/Bloomberg

Recep Tayyip Erdogan, Turkey's prime minister. Photographer: Michele Tantussi/Bloomberg

Turkey, planning its first sale of bonds that comply with Islamic law, may have to pay about a percentage point more in interest than on bonds sold in dollars that don’t have religious restrictions.

Turkey, the second-biggest Muslim economy after Indonesia, will probably have to pay a minimum of 5.5 percent annually on five-year debt to be attractive, according to Samer Mardini, vice president of fixed-income and Islamic finance products at SJS Markets Ltd. in Dubai. That’s 120 basis points higher than similar maturity dollar debt, data compiled by Bloomberg show.

Prime Minister Recep Tayyip Erdogan’s government, which won power in 2002, has sought more religious freedoms in secular Turkey, including adopting rules that will permit Islamic finance. The U.K. canceled what would have been the first sale of Islamic debt by a Western government in February 2011, saying it didn’t offer value for money, while Luxembourg said in May it put an issue on hold as it saw no need for additional funding.

“Issuers generally pay a sukuk premium and a number of sovereigns have ruled it out recently because of that, the U.K. for example,” Thomas Christie, a fixed-income sales trader at Rasmala Investment Bank Ltd. in Dubai, said by e-mail yesterday. “Something with a 6 percent yield generally will have investors interested, perhaps a little tighter.”

Deputy Prime Minister Ali Babacan said on Jan. 31 that the government will sell its first sukuk this year, just as the market is becoming less competitive because of record investor inflows into emerging market dollar bonds.

Record Inflows

The yield premium demanded on Indonesia’s 2018 Islamic bonds over similar maturity dollar-denominated debt increased to 71 basis points today from four basis points on Dec. 28, data compiled by Bloomberg showed. The yield on the country’s dollar debt is 2.93 percent, compared with 4.31 percent on Turkey’s July 2017 dollar bonds. Indonesia is rated Baa3 by Moody’s Investors Service, the lowest investment grade status and two levels above Turkey’s Ba2 rating.

Emerging-market bond funds had net inflows of $7.83 billion this year through Feb. 22, according to Cambridge, Massachusetts-based EPFR Global. That’s the best start of the year in dollar terms since 2004 when EPFR began following the data, Cameron Brandt, director of research at EPFR, said in an e-mail.

Turkey is looking to the sukuk market after selling a total of $2.5 billion in 10-year dollar-denominated bonds in January and February. The Treasury will sell another $1 billion of yen bonds as part of a foreign borrowing program to raise 9.5 billion liras ($5.4 billion), a person with direct knowledge who declined to be identified because the plans are private said on Feb. 27.

Tapping New Market

“Resorting to a different source may benefit Turkey because tapping the same resources more and more may increase the cost of borrowing,” Afa Boran, a fund manager at Amwal in Doha, Qatar, said in e-mailed comments on Feb. 27.

Global sales of sukuk, which pay asset returns to comply with Islam’s ban on interest, climbed to $7.2 billion in 2012, more than double the $3.4 billion sold in the same period last year, according to data compiled by Bloomberg.

The government will issue Islamic bonds once parliament passes legislation setting the legal framework for the sales, Babacan said in January.

Erdogan’s Justice and Development Party, with roots in an Islamic movement banned by the Constitutional Court in 1997, won a third term in office in June last year with 49 percent of the vote, the biggest proportion in four decades. The victory cemented Erdogan’s political power over the military, which had objected to the weakening of Turkey’s secular rules that kept religion out of public life.

Egypt, South Africa

Turkey is following Egypt, South Africa and Nigeria into the Islamic bond market. South Africa will offer $500 million of the bonds, the National Treasury said on Feb. 22. Egypt will raise at least $2 billion from the sale of Islamic bonds and certificate of deposits to nationals living abroad, Finance Minister Momtaz el-Saieed said Feb. 6. Nigeria may sell as much as $1 billion of Islamic bonds out of Malaysia in 2012, central bank Governor Lamido Sanusi said on Nov. 15.

A Turkish sukuk will “tick two boxes being a European and sovereign sukuk, it will automatically serve to attract investors looking for quality paper as well as geographical diversification for their investments,” Hakim Azaiez, the head of Middle East and North African capital markets at Dinosaur Capital Management in London, said in an e-mailed response to questions on Feb. 15.

The government passed a law in February last year reducing the withholding tax on sukuk to 10 percent and exempting the sales from value-added, stamp and corporate taxes, putting them on par with non-Islamic bonds.

Sales on Hold

Shariah-compliant banks Asya Katilim Bankasi AS and Albaraka Turk Katilim Bankasi AS, a unit of Bahrain’s Albaraka Group, shelved issues last year citing the impact of the debt crisis in Europe.

Albaraka may offer $200 million of Islamic bonds by June with an annual return of about 6 percent “if market conditions improve and price pressure eases,” Chief Executive Officer Fahrettin Yahsi said in an interview during a banking conference in Istanbul yesterday.

Turkey’s $735 billion economy expanded at a pace of 9.6 percent in the first three quarters of last year, second only to China. The government forecasts that Europe’s eighth-biggest economy will grow at least 4 percent this year.

The cost to the Turkish government of selling sukuk may not be much greater than the dollar-denominated euro bonds it issued so far this year, said Bulent Topbas, fund manager at Istanbul- based broker and investment firm Strateji Menkul Degerler AS.

Eurobond Alternative

“I look positively upon an instrument that is an alternative to euro-bond investments,” Topbas said. “I don’t think yields on sukuk would be very different.”

The average yield for Shariah-compliant debt has fallen 20 basis points this year to 3.79 percent on Feb. 24, according to the HSBC/NASDAQ Dubai US Dollar Sukuk Index. Meanwhile yields on non-Islamic dollar bonds of emerging-market countries fell 52 basis points to 5.55 percent, according to JPMorgan Chase & Co.’s EMBI Global Index.

While Turkey may pay more to sell sukuk, costs are less on average because the borrowers are usually banks and governments that are rated higher than emerging-market countries, Aliasgar Tambawala, a Dubai-based investment manager at Mashreq Capital DIFC Ltd., said in e-mailed comments yesterday.

Default Risk

The cost of protecting Turkish bonds against default using five-year credit-default swaps was 238, compared with a spread of 166 for Indonesia, and 116 for Malaysia, which has the biggest sukuk market, according to CMA, which is owned by CME Group Inc. and compiles prices quoted by dealers in the privately-negotiated market.

Turkish contracts cost 22 basis points less than the average for countries in central and eastern Europe, the Middle East and Africa included in the Markit iTraxx SovX CEEMEA Index. The swaps pay the buyer face value in exchange for the underlying securities or the cash equivalent should a government or company fail to adhere to its debt agreements.

Turkey’s improved ties with the Arab world are encouraging more investors to seek a foothold in the country. Trade with the Middle East and North Africa has surged seven-fold during Erdogan’s years in power, reaching $35 billion last year, according to data published by the statistics agency in Ankara on its website.

Rising Exports

Turkey’s exports to the Middle Eastern countries rose 20 percent to $28 billion last year, one fifth of total exports, according to the statistics office. Tourist arrivals from the Gulf region rose 25 percent to 717,423 last year. Visitors from Kuwait jumped by 53 percent and by 37 percent from Saudi Arabia.

The Treasury’s sale would help banks and other companies sell Islamic-compliant debt by creating a local market, said Asya Katilim Chief Executive Officer Abdullah Celik.

“The sukuk will be useful in terms of pricing, because it would form a benchmark,” Celik said in an interview in Istanbul on Feb. 8. Bank Asya will issue $300 million of the bonds this year should market conditions permit, he said.

The lira weakened for the first time in four days, dropping 0.5 percent to 1.7567 per dollar. The currency has gained 7.7 percent so far this year. Yields on two-year benchmark bonds in liras rose 10 basis points, or 0.10 percentage point, to 9.23 today, in their first increase in three days. They fell 31 basis points in February, after declining 157 basis points in January, the biggest monthly drop since April 2009.

Turkey should offer a premium to investors over similar debt issued in the Middle East, which trades at about 5.25 percent over three years, according to Mardini at SJS Markets.

“If it is a five-year issue, it has to be above 5.5 percent to be attractive, Mardini said.

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

Recep Tayyip Erdogan, Turkey's prime minister. Photographer: Michele Tantussi/Bloomberg

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