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Lira Rally Unmatched by Default Swaps After Rout: Turkey Credit

Erdem Basci, governor of Turkey's central bank. Photographer: Goh Seng Chong/Bloomberg
Erdem Basci, governor of Turkey's central bank. Photographer: Goh Seng Chong/Bloomberg

Feb. 17 (Bloomberg) -- Turkish central bank Governor Erdem Basci is failing to win the confidence of foreign investors following a rout in credit markets last year even as his interest rate cuts restore faith the economy will keep growing.

The cost to protect Turkish debt against non-payment using credit-default swaps fell 25 basis points to 266 this year, less than half the decline for Russia and Poland and trailing all major emerging markets as of yesterday’s close, data compiled by Bloomberg show. At the same time, lira-denominated bonds have rallied the most among the largest 19 emerging markets worldwide, with yields falling 227 basis points to 9.21 percent, Royal Bank of Scotland Group Plc indexes show. The lira rose 7.6 percent this year.

Basci, 45, sparked a tumble in bonds and the currency lat year with a dual interest rate policy that allowed him to lend at rates as high as 12.5 percent, stoking concern the second-fastest growing major economy was heading for a recession. While he resumed lending at the lower 5.75 percent rate last month, the nation’s record current-account deficit at more than 10 percent of gross domestic product makes it the most vulnerable economy in the region, according to Goldman Sachs Group Inc.

“What you’re seeing in credit-default swaps is that there’s still a negative bias on Turkey,” Navin Agarwal, an emerging-markets credit trader at Barclays Capital in London, said in a Feb. 15 interview. “Most investors are still underweight Turkey, which means they’re still waiting for the numbers to show an improvement in the current-account deficit.”

Lira Tumble

The lira plunged 18 percent against the dollar last year, the biggest tumble in the world, and credit-default swaps more than doubled to 291 basis points. Yields on government two-year bonds surged 333 basis points from Sept. 5 to 11.01 percent by Dec. 28.

The correlation between the currency and default swaps has fallen to 0.71 since Basci introduced the dual rate policy on Oct. 26 from 0.97 in the year until then, according to regression analysis using data compiled by Bloomberg and data provider CMA. A reading of 1 would show the two markets moving in unison.

Turkish default swaps fell 10 basis points, or 0.1 percentage point, today to 256, compared with 214 for Russia and 219 for Poland, according to CMA, which is owned by CME Group Inc. and compiles prices quoted by dealers in the privately-negotiated market. Turkey’s credit ratings are four levels below Russia and six levels below Poland, at Ba2 from Moody’s Investors Service.

‘Macro Wobble’

The cost of the contracts may increase to as much as 350 basis points in the next six months should Turkey experience a “macro wobble,” Barclays’ Agarwal said. They’re likely to trade between 270 and 290 in the absence of any crisis, he said. The swaps pay the buyer face value in exchange for the underlying securities or cash equivalent if the issuer fails to comply with debt agreements.

The lira gained 0.3 percent to 1.7569 per dollar at 6:20 p.m. in Istanbul, its strongest in a week. The currency’s rally this year, the second-biggest advance among currencies in the Europe, Middle East and Africa after the forint, came as the central bank sold $16 billion of its foreign-currency reserves between August and January, according to central bank data compiled by Bloomberg. This year will be “a year in which the Turkish lira is one of the currencies that strengthens the most,” Basci said Jan. 6.

“It’s been an interesting divergence, the lira has been supported by the central bank’s very strong verbal interventions,” Manik Narain, head of emerging-market currency strategy at UBS AG in London, said in e-mailed comments yesterday. “Underlying issues around the speed of current-account rebalancing and the commitment to inflation targeting are still lingering.”

Yields Fall

The extra yield investors demand to hold Turkey’s dollar-denominated bonds rather than U.S. Treasuries declined seven basis points to 349, according to JPMorgan Chase & Co.’s EMBI Global index. Yields on benchmark two-year lira bonds fell 15 basis points to 9.21 percent, their lowest since Oct. 20, and are down from 11.48 percent at the end of last year. Yields on Turkey’s dollar-denominated bonds due in September 2022 fell to 5.4256 percent from 5.581 percent the day before and 5.728 percent on Feb. 1.

Basci has sought to slow the economy without causing a recession by reducing banks’ liquidity after record-low interest rates last year contributed to loan growth approaching 40 percent, fueling import purchases and widening the trade deficit.

Highest Deficit

Investors grew concerned as Turkey’s 9.6 percent economic growth in the first nine months, the fastest pace among major economies after China, caused the current-account deficit to reach $77 billion, the highest in the 34-nation Organization for Economic Cooperation and Development after the U.S. and Italy.

The pace of consumer price increases, which climbed to a three-year high of 10.6 percent in January, will fall to 6.87 percent within 12 months, according to a central bank survey of economists and business people published Feb. 8. The prediction was 6.91 percent two weeks earlier.

Prime Minister Recep Tayyip Erdogan, 57, is forecasting Turkey’s economy, the eighth biggest in Europe at $735 billion and about half the size of Russia’s, will grow at least 4 percent this year. GDP may expand 3.4 percent, according to a central bank survey published on Feb. 8. The economy has grown an average of 5.9 percent each year since 2002.

Risk Premium

“Despite the rise in CDS, we see foreign investor flow especially into money markets,” Tufan Comert, strategist at Garanti Securities in Istanbul, said by e-mail. “This suggests that foreign investors are really interested in lira assets, but they just don’t trust that all is going to go well. That’s why they are hedging themselves against the risks.”

The risk premium stems primarily from Greece’s debt crisis and uncertainty about Europe and how any fallout could affect Turkey, rather than uniquely Turkish problems related to the economy or central bank policy, Comert said. “If the Greek problem is solved somewhat for the short-term, we expect to see a fall in CDS in line with an appreciation in the lira,” he said.

New York-based Bank of America Merrill Lynch and London-based HSBC Holdings Plc say Basci probably won’t succeed in striking the right balance between moderating growth and controlling inflation, predicting a possible recession in the first half of the year. Goldman Sachs abandoned forecasts for a recession this year on Feb. 10, predicting 2012 economic growth of 2.5 percent. Frankfurt-based Commerzbank AG anticipates a 5 percent expansion.

Index Climbs

Speculation the economy will keep growing helped Turkey’s benchmark stock index surge 19 percent this year, making it the second best-performing national measure on a dollar return basis after Egypt, according to data compiled by Bloomberg.

Turkey’s central bank is unable to influence credit-default swaps in the way it can the lira and bonds, Benoit Anne, London-based head of emerging-markets strategy at Societe Generale SA in London, said in a phone interview on Feb. 15.

“The local bond market has been able to take advantage of aggressive liquidity management policy by the central bank,” Anne said. “That driver doesn’t play much role at all when it comes to the sovereign debt market, which is driven by sovereign risk.”

To contact the reporter on this story: Benjamin Harvey in Istanbul at

To contact the editor responsible for this story: Gavin Serkin at

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