Leverage Dropping Most Since 2008 Leads Best Emerging Rally: Turkey Credit

Turkey is reducing government debt this year by the most since 2008, spurring the best bond rally in the emerging markets.

The Treasury plans to lower debt 16.5 percent by stepping up repayments, according to its website. Lira-denominated bond yields have plunged 175 basis points in 2012, the most among emerging markets, data compiled by Bloomberg show. The extra yield on Turkish dollar bonds over similar-maturity U.S. notes fell to a three-month low of 322 basis points on March 1, JPMorgan Chase & Co.’s EMBI Global index shows.

The second-fastest growth after China among major economies allowed Prime Minister Recep Tayyip Erdogan to cut debt to 39.8 percent of gross domestic product last year from almost double that when his party came to power a decade ago. While the nation’s $284.9 billion market for government debt is almost double the size of Russia’s, Turkey’s indebtedness relative to its GDP is below that of Brazil, India, Poland and Hungary, according to data compiled by Bloomberg.

“It’s one of Turkey’s strengths, as debt relative to GDP has come down a long way in the last 10 years,” said Kieran Curtis, a London-based fund manager who oversees about $3.5 billion in emerging-market assets at Aviva Investors Ltd. (MORAISS) “Fiscal policy is always going to be an important determinant of bond yields in a country like Turkey.”

The government aims to reduce its debt to 37 percent of GDP this year, according to the Treasury. That compares with 8.7 percent for Russia, 54 percent for Brazil and 57 percent for Poland, data compiled by Bloomberg show.

The Treasury sold 2.24 billion liras ($1.3 billion) of January 2022 fixed-coupon bonds today at an average annual yield of 9.7 percent, higher than 10-year debt sold on Feb 14. yielding 9.63 percent.

Economic Growth

Turkey’s $735 billion economy expanded 9.6 percent in the first nine months of 2011, boosting government revenue. The state had a budget surplus excluding interest payments on debt of 7.1 billion liras ($4 billion) in January, up from 4.8 billion liras a year earlier, Finance Minister Mehmet Simsek said Feb. 15.

Turkey plans to repay 13.8 billion liras of debt this month, while issuing 10 billion liras of new debt, according to government projections published Feb. 29. By the end of May, the government expects to shave another 3.1 billion liras from its net overall borrowings, according to the plan.

The government has benefited from lower borrowing costs because of cuts in Turkey’s benchmark interest rates. Central bank Governor Erdem Basci reduced the one-week repo rate by 75 basis points last year to a record low 5.75 percent.

Turkey paid just 3.3 percent of GDP in interest payments in 2011, down from 15 percent in 2002, the year Erdogan’s government came to power.

Private Debt

While public finances are improving, concern that private indebtedness and trade imbalances will deteriorate further has kept Turkey’s credit rating at junk. Standard & Poor’s rates Turkey two levels below investment grade at BB. Moody’s Investors Service has an equivalent rating of Ba2 and Fitch Ratings assigns a level one step higher at BB+.

Turkey’s current-account deficit, the widest measure of the balance of trade and investment, swelled to $77 billion last year. The gap poses “a risk to overall financial stability,” Frank Gill, an analyst at S&P, said in response to questions on Feb. 21.

The so-called private budget deficit, a measure of indebtedness for companies and households, is equivalent to 8.7 percent of GDP, compared with a surplus of 14 percent of GDP in 2001, according to figures from the central bank. Companies have a record 307 billion liras of debt maturing this year, data compiled by Bloomberg show.

Default Risk

“The private sector is highly indebted in foreign currency,” Lutz Roehmeyer, a fund manager who helps oversee about 11.5 billion euros ($15 billion) at Landesbank Berlin (BEB2) Investment in Berlin, said in response to e-mailed questions. The absolute level of government debt also “is still a very high amount,” he said.

Roehmeyer said he’s not adding to holdings of Turkish debt in part because yields are too low relative to historical levels.

The lira weakened 0.2 percent to 1.7722 against the dollar at 5:25 p.m. in Istanbul, trimming this year’s rally to 6.7 percent.

The cost of protecting Turkish bonds against default using five-year credit-default swaps fell 2 basis points to 228 today, according to CMA, which is owned by CME Group Inc. (CME) and compiles prices quoted by dealers in the privately-negotiated market. The spread was 181 for Russia, rated three levels higher at S&P, 185 for Poland and 155 for South Africa. 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.

Positive Impact

The yield on the benchmark two-year notes rose 1 basis point to 9.25 percent. That’s down from 11.01 percent at the end of last year in the biggest drop among 19 major emerging markets tracked by Bloomberg.

“The fact that the government is well-managed in its finances does have a positive impact on yields,” said Mert Yildiz, an economist at Renaissance Capital (RNCG) who works in London and Moscow. “It also has an impact on the risk premium. Both the CDS and the government bonds are pretty low relative to peers.”

To contact the reporter on this story: Benjamin Harvey in Istanbul at bharvey11@bloomberg.net

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

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