Turkish bond yields are rising faster than the rest of emerging-market debt and still can’t entice the world’s biggest investors, who say policy makers won’t curb inflation unless they take steps to slow growth.
Yields on Turkish government two-year notes climbed to 10.9 percent yesterday from 8.4 percent at the end of September, the largest increase among 16 developing nations tracked by JPMorgan Chase & Co. Aviva Investors Ltd.’s Kieran Curtis says rates need to reach 11.5 percent before he considers buying. Dmitri Barinov, a fund manager at Union Investment Privatfonds, is waiting for 15 percent.
Money managers are concerned the worst is yet to come in Turkey’s $196 billion fixed-income market because the central bank has committed to fighting the 7.7 percent inflation rate without raising benchmark borrowing costs, a policy Fitch Ratings calls “unorthodox.” Yields increased more than in Hungary, which Moody’s Investors Service cut to junk last week, and Egypt, rocked by clashes between protesters and security forces, according to data compiled by Bloomberg.
“Many investors haven’t been entirely comfortable with monetary policy or convinced that these measures would sufficiently slow domestic demand,” said Kjetil Birkeland, who helps oversee about $11 billion in emerging markets as a Boston-based senior analyst at Standish Asset Management. “In an environment when investors have a lot of risks to deal with, this is another uncertainty.”
Turkey, the seventh-largest developing nation by gross domestic product, faces the same challenges as other emerging markets as Europe’s sovereign debt crisis slows the region’s economy and reduces investor demand for riskier assets. What makes Turkey different is the central bank’s attempt to stem the fastest inflation in a year without damping GDP growth that slowed to 8.8 percent in the second quarter from 11.6 percent in the first three months of 2011.
Deputy Prime Minister Ali Babacan said in an interview with Bloomberg HT television in London on Nov. 23 that a 4 percent growth target for 2012 may be hit by the debt crisis. The expansion may slow to 2.2 percent next year from 7.5 percent in 2011, Ed Parker, a London-based managing director at Fitch, wrote in an e-mailed statement. Developing economies will probably expand 6.1 percent in 2012, down from 6.4 percent this year, according to September estimates from the International Monetary Fund in Washington.
Foreign funds that doubled holdings of Turkish government bonds to a record $44 billion in the 12 months through April have since cut their investments by $8.7 billion, according to the central bank. Investors withdrew as inflation exceeded the central bank’s target and policy makers introduced a dual interest-rate system to reduce lending, support the lira and shield Turkey’s economy from Europe’s woes.
European Union countries purchased 47 percent of Turkish exports this year through September, up from 46 percent in 2010, according to government data. The euro area has entered a “mild” recession and may expand 0.2 percent in 2012, the Paris-based Organization for Economic Cooperation and Development said on Nov. 28.
Instead of raising the one-week repurchase rate from a record low 5.75 percent to drain money from the economy, Central Bank of Turkey Governor Erdem Basci said on Oct. 26 that policy makers will vary banks’ borrowing costs daily between the benchmark and an overnight rate of as much as 12.5 percent.
Since then, the central bank has lent about 188 billion liras ($102 billion) at the lower level and about 119 billion at the higher rates, according to its website.
Yields on Turkey’s two-year debt fell 46 basis points to 10.4 percent today after China cut banks’ reserve requirements for the first time since 2008 and six central banks acted together to make additional funds available to ease strains from Europe’s debt crisis. The lira strengthened 1.3 percent against the dollar.
“It is difficult to predict and understand” where interest rates will be, said Tim Ash, the head of emerging-market research at Royal Bank of Scotland Group Plc in London.
Policy makers face a “very delicate balance,” Babacan said in an Oct. 26 interview in London. “On one hand, inflation is very important, so we don’t want to hurt our inflation targets. But meanwhile we don’t want to fall into a recession.”
The strategy has confused investors. Fitch cut the outlook on Turkey’s BB+ credit rating, one step below investment grade, to stable from positive on Nov. 23. Bonds rated below BBB- at Fitch and S&P, or below Baa3 at Moody’s, are called junk securities.
The current-account deficit, the second-highest worldwide after the U.S., will grow to 9.8 percent of GDP this year from 6.5 percent last year, Fitch’s Parker said. Policy makers will miss their inflation target for the fourth time in six years as the rate rises to 9.2 percent, he said.
Investors are waiting for yields to climb to 12.4 percent before buying, according to the average of five estimates by money managers and strategists surveyed by Bloomberg News.
“We prefer a more stable framework for monetary policy” that includes a higher benchmark interest rate, said Curtis, a London-based emerging-market money manager at Aviva, which oversees about $420 billion. “If there was more certainty about policy they would be good value. Unless we get that, it will take higher yields for us to buy.”
The central bank declined to comment on interest rates and the lira in an e-mail to Bloomberg News.
Higher yields in Turkey relative to other emerging markets and forecasts for a stronger currency may attract buyers, according to Ismail Erdem, who helps oversee the equivalent of $2.7 billion as regional director for the Middle East and North Africa at Taaleritehdas Fund Management Co. in Helsinki.
“Foreign capital will buy bonds in a country with an appreciating currency and 10 percent yields,” he said. “I have a positive view of Turkish bonds for the medium term.”
Turkish yields were 416 basis points, or 4.16 percentage points, higher than the rate on JPMorgan’s gauge of local-currency emerging-market debt as of Nov. 28, the widest gap since July 2009. Rates on two-year notes are 321 basis points above the inflation rate, compared with an average of 599 basis points since April 2005, data compiled by Bloomberg show.
In Hungary, where the government has requested financial aid from the IMF and local-currency debt has the same BBB-rating from Standard & Poor’s as Turkey, yields have climbed to 8.8 percent from 7 percent in September.
One-year bills in Egypt, rated four steps below Turkey at S&P, increased to 14.9 percent from 13.9 percent two months ago. Fighting in Cairo between protesters and security forces threatened to disrupt elections this week.
Yields on two-year debt of Greece, which is in talks with bondholders over a potential 50 percent writedown, have surged to 130 percent from 62 percent at the end of September, according to data compiled by Bloomberg. Italy’s two-year notes yield 7.1 percent while Spanish debt yields 5.6 percent.
Turkish policy makers set the stage for higher rates by cutting the repo rate three times from 7 percent a year ago, the most of any major developing economy, to weaken the lira and narrow the record current-account deficit.
The 12-month gap widened to $77.5 billion in September because of high oil prices, “unnecessarily strong domestic demand” and falling exports to Middle Eastern countries hit by social unrest, Finance Minister Mehmet Simsek said in televised remarks to journalists in Ankara on Nov. 15.
Prime Minister Recep Tayyip Erdogan endorsed the cuts in a May 3 speech in Istanbul where he said interest rates should be close to zero after inflation. He told parliament in July that the central bank would “continue to decide on its monetary policy in an independent manner.”
The benchmark interest rate, which has averaged 5 percentage points above annual inflation since 2002, is now 1.9 percentage points below, data compiled by Bloomberg show.
Lower rates succeeded in weakening the lira, which depreciated about 19 percent since December to an all-time low of 1.91 to the dollar last month. At the same time, reduced purchasing power increased inflation in October above the central bank’s 5.5 percent target. Consumer price inflation may end the year at 8.3 percent, according to the central bank. The government projects CPI will slow to between 5 percent and 6 percent next year, said Babacan, the deputy prime minister.
“The inflation outlook does not look bond-friendly,” said Barinov, a Frankfurt-based money manager at Union Investment, which oversees about $225 billion. “To increase exposure I need to see more decisive measures” from the central bank, he said.
Policy makers have changed tactics and are supporting the lira, spending about $9 billion to back the currency since August. Foreign-exchange reserves have declined 9.2 percent from this year’s high in July to $85 billion as of Nov. 18.
There’s “fundamentally no room” for the lira to weaken, Governor Basci said at an Oct. 21 conference in Warsaw. The currency is “slightly undervalued,” he said in Ankara on Oct. 26, when the lira traded at 1.7581 against the dollar, or about 5.3 percent stronger than the level yesterday.
Now, expectations for tighter policy are increasing. The lira will strengthen 12 percent against the dollar within a year, according to the median of 18 analyst forecasts compiled by Bloomberg. Including interest rates, the currency would return 23 percent, the most of any developing currency after Poland’s zloty, the data show.
“When rates go up high enough for the currency and inflation to have stabilized, at that point people will come back into bonds,” said Amer Bisat, a money manager at hedge fund Traxis Partners LP in New York and former senior economist at the IMF. “But I don’t think we’re there yet. We’re still in the early phase.”
Yield estimates for Turkish bonds: Aviva Kieran Curtis 11.50% Union Investment Dmitri Barinov 15.00% Citigroup Luis Costa 12.00% UBS Securities Serhan Gok 11.50% Toronto-Dominion Suha Yaygin 12.00%