Mega-Debt Pledge Puts Turkish Finances to Bonds in Peril

Suspension Bridge Construction on the Bosporous
Turkey’s public-private programs include a six-runway third airport for Istanbul that will cost about $13 billion to build, two highway projects with suspension bridges costing a combined $10 billion and 16 hospital compounds requiring total investment of about $7.8 billion. Photographer: Kerem Uzel/Bloomberg

Turkey’s pledge to guarantee the debt of contractors on public-works projects threatens to balloon government spending, a headwind for foreign buyers of the nation’s bonds.

The Treasury will insure 85 percent of the price of projects costing over 1 billion liras ($470 million) should an agreement fall through because of the contractor’s fault, the government said in its Official Gazette on April 19. It will guarantee the entire amount for causes unrelated to the firm, according to the notice.

While Turkey’s two-year note yields have fallen the most in major emerging markets since the ruling party of Prime Minister Recep Tayyip Erdogan won municipal elections last month, gains may be harder to achieve on longer-term debt, Murat Ucer, an economist at GlobalSource Partners in Istanbul, said by telephone yesterday. A decline in public debt to about 37 percent of gross domestic product last year could be reversed under the new legislation, he said.

“This is a quantum leap in the wrong direction,” Ucer, who co-authored a book about Turkey’s 2001 banking crisis, said by telephone yesterday. “This constitutes a significant threat to the good public-sector balance sheet story.”

Budget Burden

Declining public debt has been touted as a key economic strength for Turkey and was a campaign peg for Erdogan, who has vowed that the mega-projects wouldn’t be financed with taxpayer money or constitute a burden on the budget. Government debt as a percentage of GDP has dropped from about 79 percent at the end of 2003, according to data compiled by Bloomberg.

The value of Turkish infrastructure projects in the pipeline over the next five years has been estimated by Turkiye Garanti Bankasi AS at about $100 billion, or more than 10 percent of GDP. A Treasury spokesman who asked not to be named, citing policy, said he couldn’t comment on individual projects when asked to quantify potential exposure.

The lack of clarity is a concern from a governance perspective, Hakan Hakki Yilmaz, an associate professor of public finance at Ankara University, and Ferhat Emil, former deputy undersecretary of the Treasury and a lecturer at Ankara’s Bilkent University, said yesterday.

Trade Secret

“The regulation treats the details of assumption of debt as a trade secret and doesn’t allow them to be published in the Official Gazette,” Yilmaz and Emil said by phone yesterday. “We consider this to be risky in terms of transparency.”

The regulation says the guarantee applies to projects awarded on a build-operate-transfer basis, while build-lease-transfer projects worth over 500 million liras will also be eligible if they’re awarded by ministries of education or health.

In the wake of the 2001 crisis, Turkey placed limitations on state guarantees of this type, Ahmet Burcin Yeleri, a professor of public finance at Ankara’s Hacettepe University, said by phone yesterday. The new legislation reverses those safeguards and may expose the state to losses from companies with weaker balance sheets, he said.

“Small firms that lack the financial clout to compete in major projects will be included in state tenders thanks to this,” Yeleri said. “This can be used to provide a benefit to businessmen close to the political administration,” he said, adding that it wouldn’t necessarily be the case.

Third Airport

Turkey’s public-private programs include a six-runway third airport for Istanbul that will cost about $13 billion to build, two highway projects with suspension bridges costing a combined $10 billion and 16 hospital compounds requiring total investment of about $7.8 billion.

The financing of those projects had been a topic of debate in Turkey after the U.S. announced it would begin cutting monetary stimulus in January, threatening portfolio flows to emerging markets including Turkey and raising borrowing costs. The yield on Turkey’s two-year benchmark bonds has more than doubled since former Federal Reserve Chairman Ben S. Bernanke said last May that he was considering reducing the asset purchases.

“It looks like a way of getting on with these big projects when there’s no private-sector muscle, when the private sector somehow has difficulty securing these loans,” Global Source’s Ucer said. “Basically what you’re seeing is the government getting more involved in every sense.”

Corruption Allegations

The airport concession was won by a group led by Ankara-based builder Limak Holding AS, whose chairman Nihat Ozdemir was among businessmen called in for questioning in relation to a corruption investigation made public on Dec. 17. Limak is joined by Turkish builders Cengiz Insaat, Mapa Insaat, Kalyon Insaat and Kolin Insaat.

None of the companies implicated in the graft probe has been officially charged. Limak didn’t comment about the legislation after a phone call and e-mail to their Istanbul office yesterday.

Finance Minister Mehmet Simsek said today that it’s unknown whether the Treasury’s pledge to guarantee the debt of public-works projects will place a burden on the budget, and the guarantee should be seen as “insurance” according to BloombergHT.

While this year’s budget says total debt assumed by the Treasury can’t exceed $3 billion, the government will be allowed to double that amount without the parliament’s approval, the new law says.

Wrong Signals

Zeynep Holmes, regional director for Eastern Europe, North Africa and the Middle East at Standard & Poor’s, declined to comment on the new legislation. Turkey is rated junk at S&P and investment grade at Moody’s Investor’s Service and Fitch Ratings.

The yield on two-year Turkish notes rose 14 basis points to 9.84 percent at 5:12 p.m. in Istanbul, its biggest gain since April 3. The lira weakened 0.3 percent to 2.1392 per dollar, bringing its depreciation over the past 12 months to 16 percent. The cost to insure Turkish debt against default for five years using credit default swaps rose to 203, compared with 151 for Brazil and 70 for Poland.

“Past emerging market crises have shown that private debt can easily turn into public debt,” Inan Demir, chief economist at Finansbank AS in Istanbul, said in e-mailed comments yesterday. “This decision sends out wrong signals and it will add to investor concerns regarding economic policy making in Turkey.”

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