Erdogan Crisis Driving Bond Risk Closer to Russia: Turkey Credit

Turkish Prime Minister Recep Tayyip Erdogan’s stand-off with protesters is threatening to send investor perceptions of the nation’s credit risk above Russia’s for the first time in seven months.

The cost to protect against losses in Turkish debt using credit-default swaps rose 57 basis points since May 31, when anti-government demonstrations erupted, to 188 today, according to data compiled by Bloomberg. That’s narrowed the gap with higher-rated Russia to seven basis points from 25 at the end of last month, the data show.

The unrest is threatening to drive away investors, who had been lured to Turkey by higher yields, falling debt levels and credit-rating upgrades. The yield on the nation’s January 2030 dollar bond has climbed 74 basis points since the protests began, compared with a 48 basis-point increase for Russia. Hundreds of riot police raided Istanbul’s Taksim Square today.

“Many preferred Turkey to Russia on the view that it had become politically stable, transparent and democratic, contrasting with Putin’s Russia,” Richard Segal, head of international credit strategy at Jefferies Group Inc. in London, said in e-mailed comments yesterday, referring to President Vladimir Putin. “That comparison is being revisited. It’s another sign that the long-term bullish Turkey story has come to an end.”

Ongoing Clashes

Riot police retook Taksim Square using tear gas and water cannons against protesters in what marked the most serious challenge to Erdogan’s authority after more than a decade in power. Speaking in Parliament, Erdogan accused businessmen of fueling the chaos and lashed out at the media for its “comprehensive attacks,” referring to demonstrators as pawns of financial speculators seeking to drive borrowing costs and profits higher. Protesters in the square have said they are motivated by a threat to their freedoms from an Islamist-rooted government increasingly unwilling to countenance dissent.

The lira gained as much as 0.6 percent and traded 0.3 percent stronger at 1.8964 against the dollar at 4:04 p.m. in Istanbul today, after central bank took tightening measures.

The amount of funding at policy rates may be reduced temporarily and can be below the minimum amount declared for ordinary days, the central bank said in a statement. If bank deems it necessary, unsterilized foreign-exchange sale auctions and direct interventions can be used, the bank said.

Yields Soar

Credit-default swaps climbed 16 basis points to 188 and the yield on Turkey’s two-year notes rose 32 basis points, or 0.32 percentage point, to 6.82 percent. The rate has jumped 203 basis points through from a record low on May 17. The sell-off in the past three weeks comes amid growing speculation the Federal Reserve will curb its $85 billion a month purchases of Treasuries and mortgage bonds used to stimulate the U.S. economy.

“Heightened political tensions in major cities and lessening appetite for emerging-market assets due to Fed tapering are seen as risk factors for Turkish investors,” Isik Okte, a strategist for the investment unit of state-run lender Turkiye Halk Bankasi AS in Istanbul, said in e-mailed comments yesterday. “As the investment community debates which investments going forward are the riskiest under Fed tapering, Turkey fixed income and equities are on most investors’ lists.”

Foreign investors sold $1.1 billion of Turkish lira debt in the week ended May 31, according to the latest central bank data.

Russian Protests

The lira has weakened 5 percent in the past month, the worst performing emerging-market currency after South Africa’s rand in Europe, the Middle East and Africa. The ruble slipped 0.6 percent against the dollar today and credit swaps on Russia rose 13 basis points to 195.

The biggest Russian protests during Putin’s more than a decade in power following parliamentary elections in December 2011 sparked the first monthly decline in 10-year ruble bonds in three months. That slump was followed by a three-month rally.

Turkey was raised to Baa3, the lowest investment-grade ranking, by Moody’s Investors Service on May 16. That’s two steps below Russia.

The protests in Turkey may wind down as they did in Russia, according to Marco Santamaria, who helps oversee $24 billion in emerging-market debt at AllianceBernstein Holding LP in New York.

Default Risk

“If the unrest continues, it is entirely conceivable that Turkish CDS spread might widen beyond Russia’s,” Santamaria said by e-mail yesterday. “I would not expect the situation to deteriorate much. In much the same way Russia did last year, I suspect the protests will tend to settle down.”

The amount of Turkish debt protected by credit-default swaps is rising, with a total of 9,321 contracts covering a net $7.5 billion of debt outstanding as of May 31, up from $6 billion a year ago, according to the Depository Trust & Clearing Corp. Turkey is now the eighth most-protected government, compared with 11th last year.

The contracts, whose price increases as perceptions of creditworthiness deteriorate, pay the buyer face value in exchange for the underlying securities or the cash equivalent should a borrower renege.

Credit-default swaps on Turkey were the third most actively traded among 1,000 entities tracked by the DTCC in the week through May 31, following Brazil and Italy.

“Turkey was a hype recently, seeing massive capital inflows, stable currency, ratings upgrades, improving growth outlook,” Viktor Szabo, who helps oversee $11.8 billion at Aberdeen Investment Management Ltd. in London, said in e-mailed comments yesterday. “Capital outflows may take away all that. It was a one-way flow for quite a long time, so it’s time for some correction.”

Before it's here, it's on the Bloomberg Terminal.