Erdogan Cuts Wrong Deficit for Bondholders Watching Imports: Turkey Credit

Turkey’s ballooning trade deficit is causing the longest slump in the country’s bonds this year even as the government cuts the budget deficit to half the European Union’s target.

The Treasury, which plans to lower its budget shortfall to 1.5 percent of gross domestic product this year, may report a surplus for a second month on March 9, based on the ministry’s projections of spending and borrowing. The surge in oil prices to a three-year high threatens to ramp up spending on imports and worsen the current-account balance from a record 10 percent of GDP, according to analysts at Credit Agricole SA (ACA), Toronto- Dominion Bank (TD) and BGC Partners. (BGCP)

Turkish lira bonds tumbled for the past four days, the longest losing streak since Nov. 17, lifting two-year yields 27 basis points to 9.4 percent yesterday, data compiled by Bloomberg show. The rout drove the extra yield over two-year Polish zloty bonds to the highest since Jan. 26 at 482 basis points, up from 423 basis points on Feb. 22. Bond yields fell 2 basis points to 9.38 percent at 4:45 p.m. in Istanbul.

“Turkey seems weak to me as the current-account problem is still there and oil prices aren’t helping,” Suha Yaygin, the deputy chief of emerging markets at Toronto-Dominion in London, said in e-mailed comments yesterday. “Is Turkey ready for an oil shock?”

Budget Discipline

Prime Minister Recep Tayyip Erdogan said in a March 1 speech that “nothing could slow” Turkey’s march toward political and economic stability. “We’ll never concede on budget discipline, disciplined monetary policies and disciplined financial sector policies,” he said according to a transcript of his remarks from the state-run Anatolia news agency.

The lira was little changed after weakening for four days at 1.7898 against the dollar today, after hitting the lowest since Jan. 25 at 1.7956 yesterday. Investors are betting the currency may fall to 1.8130 in June, according to pricing of futures contracts.

The Treasury’s borrowing costs for two-year domestic bonds rose to 9.41 percent from 9.24 percent a month ago, according to the central bank after an auction of 2.51 billion liras ($1.4 billion) of debt yesterday.

“In a scenario where oil prices remain high, we would avoid Turkey,” Guillaume Tresca, an emerging markets strategist at Credit Agricole in Paris, said in e-mailed comments. “Turkey will be affected through two channels: inflation and the energy bill, which means a larger current-account deficit.”

Investor Confidence

Turkey’s worsening external balance crushed investor confidence last year even as the economy grew 9.6 percent in the first nine months, the most after China among the Group of 20 major nations. The current-account deficit at $77 billion in 2011 was the second-highest worldwide after the U.S. according to the International Monetary Fund. The lira tumbled 18 percent against the dollar last year and two-year yields soared 393 basis points.

Investor concern eased earlier this year on speculation a slowdown in economic growth would trim import purchases. The lira jumped as much as 10 percent and two-year yields fell 193 basis points, or 1.93 percentage points, between Dec. 28 and Feb. 20, data compiled by Bloomberg show.

Oil soared as high as $109.77 a barrel on Feb. 24 from $75.67 on Oct. 4 and traded at $105.18 in New York yesterday.

Every $10 increase in the oil price adds $4 billion to the cost of imports, or about half a percentage point of GDP, Energy Minister Taner Yildiz said on Feb. 28. That makes Turkey “one of the most exposed countries” to a rise in oil prices, according to Credit Agricole’s Tresca.

Inflation (TUCPIY) in Turkey slowed to 10.4 percent in February from 10.6 percent in January, a three-year high, the statistics office in Ankara said yesterday.

Government Debt

The external deficit is overshadowing Erdogan’s achievement in reducing government debt to less than 40 percent of GDP last year from almost double that when he came to power a decade ago. The Treasury expects debt will fall to 37 percent in 2012, below Brazil, India, Poland and Hungary, according to the government’s economic program published in November and data compiled by Bloomberg.

The government is planning a series of incentives designed to narrow the current-account deficit by encouraging industries which can supply raw or intermediate goods to the domestic market, reducing the dependence on imports. Economy Minister Zafer Caglayan said today the incentives may be announced next week.

Lower borrowing costs have helped Mehmet Simsek, Erdogan’s finance minister and a former Merrill Lynch & Co. (MER) economist, as he seeks to balance a goal of curbing the budget deficit while expanding the economy by at least 4 percent this year.

The government’s target for the budget deficit of 1.5 percent of GDP in 2012 would be less than a third of the 5.6 percent in 2010 and half the EU’s 3 percent target for euro accession countries.

Bonds Hurting

The budget gap may be 2 percent of GDP in 2012, according to the median of four analyst estimates on Bloomberg, compared with forecasts for 5.2 percent in South Africa, 3.5 percent in Poland and 3.2 percent in Hungary.

Turkish bonds are also being hurt by a global slump in riskier assets on concern that Greece’s bondholders may reject a debt swap plan and by a contraction in the euro region’s economy, which is Turkey’s biggest trading partner.

The extra yield investors demand to own emerging-market debt over U.S. Treasuries rose 10 basis points to 357 yesterday, according to JPMorgan Chase & Co. (JPM)’s EMBI Global Index. The spread for Turkish dollar bonds over U.S. Treasuries rose 8 basis points to 330.

“I do not see significant room for Turkish yields to come down in the short term,” Aziz Unan, a portfolio manager at Renaissance Asset Managers in London, said by e-mail. “However, in the medium term I think it makes sense as the government’s borrowing continues to be in a declining trend and debt-to-gross domestic product is below a very comfortable 40 percent now.”

Default Swaps

The cost to protect Turkish debt against non-payment for five years using credit default swaps fell three basis points to 235 today, bringing the decline this year to 56 basis points, according to data provider CMA, which is owned by CME Group Inc. (CME) and compiles prices quoted by dealers in the privately negotiated market. The Markit iTraxx SovX CEEMEA Index of eastern European, Middle East and Africa credit-default swaps fell one basis point to 269, according to data provider CMA.

The contracts pay the buyer face value in exchange for the underlying securities or cash equivalent if the issuer fails to comply with debt agreements.

“The impact of the sharp increase in oil, which took place in February, will be felt in Turkey’s external balances in February and mostly in March,” Ozgur Altug, chief economist at BGC Partners in Istanbul, said by e-mail. “Investors have to live with the fact that Turkey’s current-account deficit will remain high until at least 2016.”

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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