Photographer: Kerem Uzel/Bloomberg

Erdoganomics Pushes Turkey Credit Risk Above Junk-Rated Russia

  • Turkey CDS widen most since Sept. on political turmoil in May
  • Nation’s debt riskier than Russia for first time in two years

Unpredictable politics and a clouding economic outlook have persuaded investors that Turkey’s debt is now a riskier bet than junk-rated Russia.

The cost of insuring Turkish bonds against non payment jumped in May by the most in eight months, with five-year credit default swaps widening 33 basis points to 273, surpassing Russia for the first time since mid 2014. The two first crossed on May 4 as Turkish bonds retreated in the midst of a political row between President Recep Tayyip Erdogan and former Prime Minister Ahmet Davutoglu, culminating in the premier stepping down.

While looming U.S. rate increases weighed on all emerging markets last month, Turkish assets came under further pressure as Erdogan, who has repeatedly called for looser monetary policy, moved to concentrate state power in his own hands. Even though Moody’s Investors Service considers Turkey investment grade, political turmoil has pushed its five-year CDS contracts 12 basis points above Russia which the agency downgraded to junk in 2015 as its economy bore the brunt of international sanctions in retaliation for its role in the Ukraine conflict and a collapsing oil price.

"It’s clearly Turkey’s increased political risk," said Viktor Szabo, a London-based money manager at Aberdeen Asset Management who helps oversee $11 billion of emerging-market debt, who has a short position on the lira. Investors are concerned about “the concentration of powers around the president, the lack of checks and balances, which leads to economic policy risks,” he said.

More Vulnerable

The yield on Turkey’s five-year debt climbed 54 basis points in May, second only to Brazil among 27 emerging-market peers tracked by Bloomberg. Russian yields on equivalent notes rose 18 basis points over the same period as a near 80 percent rally in crude oil this year revived interest in the energy-exporter and helped make the ruble the best-performing developing-country currency.

The lira was trading less than 0.1 percent higher at 2.9482 per dollar as of 4:45 p.m. in Istanbul on Wednesday, taking its depreciation this quarter to 4.5 percent.

For an article on the market reaction to Turkish political turmoil click here

Still, a Morgan Stanley survey of 18 bond investors found them “only marginally more negative on Turkey,” following Davutoglu’s resignation. Respondents said they view a likely referendum on whether to give more political power to the president as having minimal impact on the country’s political balance.

For Turkey, a net energy importer, oil’s rebound threatens to have a negative impact on the country’s finances. Its current-account deficit is set to widen this year to 4.6 percent of economic output, according to the median forecast of 25 analysts surveyed by Bloomberg.

The nation’s deficit and reliance on foreign funding leaves it more vulnerable to further pressure from a Fed rate increase, said Peter Schottmueller, head of emerging-market and international fixed income at Deka Investment GmbH, which is underweight Turkey’s local and hard-currency debt for most of its funds.

"Turkey is one of the presumed candidates that is suffering in the occasion of a surprise Fed hike," he said. "For Russia that is less relevant, as portfolio flows play a minor role in their financing needs."

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