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Iraq Imperils Turkish Exports as Deficit to Bonds at Risk

Iron And Steel Led Turkey's Exports To Iraq Last Year
This is an undated company photo of a worker stoking molten steel at the Erdemir's Steel Factory in Eregli Karadeniz, Turkey. Iron and steel led $12 billion of Turkish exports to Iraq last year, according to the Statistics Institute. Source: Erdemir via Bloomberg

Turkey’s progress in cutting the biggest current-account deficit among emerging markets in Europe, the Middle East and Africa is under threat as fighting disrupts exports to neighboring Iraq.

Shipments to Iraq, Turkey’s biggest market after Germany, slid 21 percent in June from a year earlier, the Turkish Exporters Assembly said July 1. A prolonged crisis caused by the advance of Islamic State militants may weigh on the trade gap as exports drop and oil prices rise, the Turkish central bank said last week.

The bond market is already wobbling. Yields on two-year notes climbed 13 basis points this month, after a half-point improvement in the deficit to 7.48 percent of economic output in the first three months helped fuel the best rally in emerging markets in the second quarter. While a doubling of interest rates in January reined in spending on imports, the central bank has cut borrowing costs for the past two months.

“The Iraqi crisis is credit negative for Turkey,” Alpona Banerji, a senior analyst at Moody’s Investors Service in London, said in comments relayed by a spokeswoman over the phone on July 3. “A prolonged conflict would have a material effect on both Turkish exports and growth.”

Iron and steel led $12 billion of Turkish exports to Iraq last year, according to the Statistics Institute. About 300 Turkish companies and 10,000 workers have been reconstructing the war-torn nation’s roads, bridges, dams and hospitals, the Anadolu Agency reported on July 1. Most have left since the oil-rich northern city of Mosul was captured last month by the al-Qaeda splinter faction formerly known as the Islamic State in Iraq and the Levant, or ISIL, according to state-owned Anadolu.

Crude Imports

The attack against OPEC’s second-biggest oil producer sent Brent crude oil futures to the highest in more than nine months on June 19. Turkey relies on imports for almost all of its energy needs, amounting to $56 billion in oil and gas last year, according to Economy Ministry figures.

“The Iraqi issue has a direct link to Turkish imports through its impact on oil prices,” Ozan Gaziturk, the chief economist of Sekerbank TAS in Istanbul, said by phone July 2. “That and reduced imports can have a widening impact on the current-account deficit.”

The lira has depreciated 8.4 percent over the past year, more than any other emerging-market currency in the EMEA region, data compiled by Bloomberg show. While two-year government note yields have climbed this month, they’re 182 basis points lower this year at 8.28 percent today.

Trade Route

The decline in sales to Iraq during the first month of the fighting was more than offset by increased demand for Turkish goods in Europe, lifting exports by 6.6 percent in June. Moody’s says about 15 percent of total exports are vulnerable to the crisis because Iraq, in addition to being a major market for Turkish goods, is a crucial trade route.

The risk to the current account adds to concern over when the U.S. Federal Reserve will boost interest rates, limiting the appetite for Turkish debt, according to Piotr Matys, an emerging-markets analyst at 4Cast Ltd. in London.

“The prevailing risk of rising oil prices, driven by potential escalation of the Iraq crisis, and growing expectations for the Fed to raise interest rates sooner than currently anticipated, are the main factors that might undermine investors’ sentiment,” Matys said by e-mail on July 4.

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