TURKEY INSIGHT: With the lira through the looking glass, global finance questions whether Erdogan can sell eurobonds

TURKEY INSIGHT: With the lira through the looking glass, global finance questions whether Erdogan can sell eurobonds
By Akin Nazli in Belgrade August 2, 2020

Despite the many emerging market sovereigns that have successfully issued bonds on the international markets this year, Turkey, typically a leading issuer, has been notable by its absence, Global Capital commented on July 28 in a story entitled “Turkey bond question rises as reserves dwindle”.

“And with its foreign exchange reserves running lower, the risks of it not being able to come to market at all could be mounting,” the publication observed.

Since selling a $4bn dual tranche trade in February, Turkey has turned to its local market for funding, even issuing hard currency bonds to domestic investors. On July 28, Turkey went ahead with another such issue, namely a $3bn three-year dollar paper, while syndicate bankers were left wondering when Turkey would return to the global arena.

On July 30, Cbonds asked why Turkey remains out of the international bond market and pondered whether its international bonds would be worth investing in anyway.

“Turkey hasn't entered the international bond market since February 2020 when it placed 4.25% 13mar2025 and 5.25% 13mar2030 notes. Since then, it has been issuing bonds only in the domestic market,” Cbonds noted.

“However, even if it places Eurobonds in the international market, there are risks for investors. Among them, decreasing FX reserves (the lowest levels in 10 years) and lira weakness,” it added, concluding: “Although the sovereign can keep flooding the reserves via swap lines with other central banks and a banking regulation that obligates banks to increase reserves, there are no clues when the country's reserves will run out.”

Also on July 30, Global Capital went further in weighing up Turkey’s market difficulties, questioning the Turkish banking industry’s robustness in a story entitled “Lira dip raises spectre of currency crisis for Turkey with banks in crosshairs”.

It should not be forgotten that Global Capital is a leading sectoral publication for the global finance industry wont to distribute praise to financial institutions rather than question their financial robustness.

“Falls in the Turkish lira have reignited concerns about a currency crisis this week, with the Central Bank of the Republic of Turkey’s (CBRT) unorthodox exchange rate policy raising questions from investors about the robustness of the country’s respected banking sector,” the title reported.

“The [Turkish banking watchdog BDDK] has said that rules on minimum capital requirements and classification of problem or deteriorated loans would be relaxed until the end of the year... A flexible approach in enforcing the rules has been adopted by other regulators worldwide, such as the European Central Bank. Unlike other countries however, regulatory forbearance was already applied in Turkey before the pandemic, reducing the transparency and comparability of accounts,” Moody’s Investors Service said on July 28 in its July 2020 Emerging Markets Insight report.

On July 29, the BDDK fined HSBC Turkey TRY180mn—40% of its TRY470mn net profit in 2019—and Albaraka Turk TRY21mn for failing to comply with the “asset ratio” regulation, which came into effect on May 1.

Sekerbank managed to meet the ratio requirement by a narrow margin, BloombergHT reported.

On July 30, @Supheci_Kimse, a prominent Twitter account that provides in-depth analysis on Borsa Istanbul-listed companies, wrote on Twitter that foreign investors asked both Garanti BBVA and Akbank, Borsa Istanbul’s top two popular lenders, during teleconferences for Q2 financials: “How much of your FX liquidity buffer stays in swaps with the central bank?”

Akbank replied that it holds TRY26bn ($3.7bn) of its overall $9.7bn of FX liquidity in central bank swaps. Garanti said it held $4.5bn of an overall $9.3bn in central bank swaps as of end-Q2 but that the figures changed upwards to $6.5bn of $11bn due to decisions taken following the reported period.

“Since May, the CBRT has managed to keep its currency stable, mostly trading in a TL6.84-TL6.86 range against the dollar. The CBRT has defied foreign investor scepticism during that time, using unorthodox methods such as recycling state banks’ FX deposits to defend the lira’s exchange rate,” Global Capital also wrote on July 30.

“[President Recep Tayyip] Erdogan’s gamble on cheap money and propping up the currency has failed,” The editorial board at the Financial Times commented in a leader on July 30.

#Turkey's central bank and state lenders blasted through some $3.2 billion to defend the lira since Monday [July 27],” Emre Peker of Euroasia Group wrote on July 29 in a tweet.

Nothing has yet leaked as regards the national lender’s selling of dollars on July 30 and July 31.

“Question really how much FX can the state banks sell to the point that people begin to doubt the broader durability of the banking system—therein this recycling of FX deposits to the defence of the currency is fine as long as deposits remain in the system,” Timothy Ash of Bluebay Asset Management wrote on July 29 in an emailed note to investors.

“As soon as there is evidence of deposit flight—which there has not been so far, and this also did not really happen in scale in 2018—then it turns into a whole new ball game. So far popular confidence in the banking system and the safety of deposits has been very solid,” he added.

#Turkey macro eerily resembles #Lebanon. A) Banks saddled with huge $ deposits that are increasingly parked at CB; B) tourism collapse is leading to $ shortages; C) explosive TL liquidity is adding to $ demand; & D) FX intervention is causing negative net reserves. Can’t end well,” Amer Bisat, managing director of BlackRock’s sovereign and emerging markets alpha team in its global fixed income department, wrote on July 30 in a tweet.

Comparing Turkey with Lebanon is a new fashion. After the Justice and Development Party (AKP) first took control of the government in 2002, Turkey was compared to Malaysia. Then, it was Iran. After the Idlib region across Turkey’s border with Syria turned into a base for jihadis, Pakistan was brought into the comparisons, due to the Tora Bora region of its neighbour Afghanistan.

Lately, Venezuela has also entered into picture.

North Korea also gets a run-out, given Turkey’s non-stop social media regulations. Turning into Syria is always a concern in Turkey too.

Central African countries have long been Turkey’s credit rating peers.

When will we get to direct comparisons with Afghanistan and Somalia?

Islamic State (ISIS) can also bear some mention as Ali Erbas (below), head of the Turkish state’s religious affairs directorate (Diyanet), earned notoriety for hanging about with a sword following the controversial reconversion into a mosque of Istanbul’s Hagia Sophia (Erbas explained that it is an Ottoman tradition to hold a sword at mosques that are symbols of conquest).

Turkey’s credit default swaps (CDS) closed July at around 550. Pakistan was above Turkey at around 580 while bankrupted Venezuela kept its unrivalled position with something over 70,000, followed by bankrupted Argentina with something over 6,000.

Turkey’s closest challengers were Ukraine at around 530 and Egypt with towards 430.

The Turkish lira’s (TRY’s) one-week (forward) implied volatility jumped on July 29 to 9.9% while its one-year implied volatility reached 18.95%, Reuters reported. Both figures were the highest seen in two months. 

“Turkey policy rate: 8.25% Turkey implied 1month rate in FX market: 26.24%,” Paul McNamara of GAM Investments wrote on July 30 in a tweet.

Turkish lira overnight rates on the London offshore swap market also leapt, moving to 15.5% from 3% a day previously.

Something's going wrong with bid-ask spreads on the London Turkish lira market. (@e507)

“The interest differential priced into one-year Turkish Lira FX forwards against the Dollar has risen to 21.1%. This number was 31.3% after the ‘sudden stop’ in capital flows in Aug. 2018, so still in moderate territory, though it exceeds anything across the major EMs,” Robin Brooks of the Institute of International Finance (IIF) wrote on July 30 on Twitter.

For currencies like South Africa’s rand, Turkey’s lira, Indonesia’s rupiah and India’s rupee, August is historically the worst month of the year, based on the average decline over the past five years, Bloomberg pointed out on July 28 in a story entitled “Emerging Markets Approach Awful August Amid Signs of Complacency”.

“Emerging-market currencies are always more vulnerable in August because volumes are understandably lower and therefore the illiquidity can exaggerate volatility,” Julian Rimmer of Investec told Bloomberg.

“Moreover, governments are invariably in a lesser state of preparedness for emergencies, again because so many people are away,” he added.

While traders and investors won’t be packing their bags for summer holidays given the pandemic, many of them will still take time off, Rimmer said, leading to the usual drop in liquidity over August that tends to exaggerate market moves.

On July 31, Reuters joined Bloomberg in asking, “It's August, what could go wrong?”, in its daily “Take Five” bulletin.

The Turkish lira topped the list.

The betting is open on the timing of Turkey’s ultimate collapse, Okan Muderrisoglu—who could be considered the voice of the palace administration in Ankara—suggested on July 28 in his column entitled “Even the river may sleep but spies in the market never do!” that there are those lurking in the market working to assumptions that the Turkish economy can be “infected” during autumn. The possibility of Joe Biden wining the US presidential election on November 3 led Muderrisoglu’s list of crucial matters.

On July 30, Muderrisoglu warned in his column, entitled “The wisdom of the state will defeat the devious trick”, that those who were trying hard to create a “perfect storm” in political and economic turbulence should be headed off.

Muderrisoglu also claimed that he had uncovered, as he had done in the past, some of the people in question and has aired their dirty laundry in public with his piece.

However, there was no clue in his text as to “who” they were, never mind any enlightenment on what-when-where-how-why.

Foreigners have pulled more than $11bn out of the local-currency bond and equity markets so far this year.

With the foreign market players out of the exits, USD demand in exchange for TRY is now driven by domestic demand and the current account deficit.

Although they amount to no more than mere bank records on FX-denominated deposits taken in by local lenders (thanks to the huge amount of central bank swaps), data on Turkish residents’ FX holdings is seen as a gauge of FX demand among local holders of savings.

The overall figure of resident legal persons’ and real persons’ FX-denominated deposits at local lenders reached a fresh record high of $204bn as of July 24 as total FX-denominated deposits at local lenders, which also includes non-residents’ FX deposits, rose by $5bn w/w.

Analysts in a Bloomberg survey project Turkey’s current account deficit will widen to 2% of GDP ($12-15bn) in 2020.

Apart from the Argentinian peso, the Turkish lira is the only major emerging market currency to have fallen since the dollar peaked on March 23, unable to catch a break from the prospect of looser financial conditions that a weaker US currency affords EM economies, Bloomberg noted.

The underperformance is telling given how much money authorities have spent on currency interventions, it commented.

Turkey’s gross currency reserves have dropped almost 40% since the beginning of 2020 to $49.2bn. Reserves including gold stand at $89.4 billion.

As of the end of June, $54.4bn of that was money borrowed through short-term swaps.

Turkey’s net reserves should have risen by $93bn since the beginning of 2019 to the end of June. However, they have declined $0.9bn, Haluk Burumcekci of Burumcekci Consulting wrote on July 29 in his daily bulletin.

This $94bn, a discrepancy, is thought to have been sold via state lenders to support the embattled TRY.

Calculations suggest that Turkey burnt through $6bn of reserves in June, bringing total interventions in the lira market to $61bn in H1 that followed $33bn in 2019.

In April and May this year, about $11bn worth of reserves were burnt through each month.

Additionally, Turkish state lenders’ net FX deficit passed $10bn as of July 24, bringing the overall interventions estimate for since the beginning of 2019 to $104bn.

The Turkish central bank shorted a total of $632mn worth of USD futures at Borsa Istanbul’s derivates market from July 20 to July 31, @e507 observed (chart below).


On July 17, the central bank tapped $1bn from local lenders in a 3-month swap. On July 29, the central bank held a $1bn 1-month swap auction with local lenders.

At the moment, the consensus among Turkey watchers suggests that the government has woken up to troubles brought about by the latest loan growth mania triggered by its cheap money policies.

Discussions continue over whether it is too late for the government to step in to limit the scope of the lira fall.

“Turkey's average weekly ‘flow’ of new lending was TRY 16.7 bn per week in July, down from a weekly pace of TRY 23.1 bn in Q2. In the big picture, however, overall credit flow is still very elevated vs previous credit booms in 2017 and 2019, a risk factor for the Lira,” Brooks wrote on July 31 in a tweet.

The problem here is that Erdogan is yet to send any signal that he will accept a rate hike.

“It will be a bumpy path [for the lira] and periodic sell-offs will put the spotlight on the CBRT to hike interest rates. Political pressure would probably prevent an immediate response, causing pressure on the lira to intensify and raising the risk of another currency crisis,” Jason Tuvey of Capital Economics said on July 31 in a research note.

The central bank governor Murat Uysal on July 29 gave some indication during the quarterly inflation report release that the central bank is up for curbing the booming liquidity.

However, leading economists have observed that changing the funding composition or employing non-interest tools are approaches that have proven unsuccessful in previous attempts.

Given that there is no known option for a rate hike, and combining that scenario with the melting reserves and the unsettled currency, the expectations and rumours circulating right now suggest that stricter capital controls in Turkey are seen as almost inevitable as things stand.

The government economy officials’ insistence on acting as if nothing unusual is happening right now with the currency and reserves, meanwhile, remains good comedy material.

“Turkey - CBRT Uysal says “some volatility in Turkish reserves is ordinary”. LOL. This guy is really funny. Like $50-60bn in intervention to support the lira over the past year, if you look at the net reserve position, is just “ordinary,” Ash wrote on July 29 in a tweet.