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International Investors on Turkey’s Post-Downgrade US$1.5bn Bond Feat

Opinion is divided about the reasons behind Turkey’s recent success on the international debt markets, but questions remain over the country’s long-term investment potential.

Nov 11, 2016 // 2:11PM

Turkey’s latest foray into the bond market resulted in the successful issuance of $1.5bn notes due October 2026 at a yield of 4.875%, just inside initial price thoughts of 4.9%; the same notes were yielding 5% back in March.

While yields on the sovereign’s 2026 dollar bonds dropped 27bp since then, the decline was less than the EM average 70bp. With the US$3bn raised via issuances in March and May, this round allowed Turkey to reach its $4.5bn fundraising target for the year.

Strong fundamentals, with growth expected to reach 3.2% in 2016, 4.4% in 2017 and 5% in 2018, are cited as an important factor that allowed the country to survive the Moody’s rating downgrade without serious damage and avoid a panicked sell-off.

“Turkey has displayed a healthy rate of growth above 3%, budget deficit is 1.8%; many European countries would love to have that.  Even the current account deficit is being reduced, so it is clear where the fundamentals are and what the market is pricing in,” said Daniel Moreno, an investment analyst at Rubrics Asset Management.

Similarly, political risk associated with Erdogan’s push for constitutional reform that strengthens his own position appears to already have been accounted for.

“I believe markets ‘vote’ through the risk premium,” explained Greg Saichin, Global Head of Emerging Markets Fixed Income at Allianz Global Investors.

So far, 5-year Turkish credit default swaps have remained within the 125bp range corridor since March 2015. Even after the attempted coup the spike was 68 bps, reaching 288bps. “That’s hardly a signal for political mayhem,” Saichin said.

Saichin highlighted two key factors that prevented a mass exodus   from the market. Investors were already underweighting Turkey after the attempted coup and therefore the expected sell off following the downgrade was not excessive. You could also argue that the long end of Turkey’s curve (2043) already offers “interesting value” at 360bp SOT for a BB+ credit.

These figures appear to point to the markets’ recalibration of political risk in Turkey based on a measure of government stability, confidence in the macro environment, and economic prospects. The weak lira, it appears, is also benefiting some exporters and the current account.

Signs of structural reform are contributing to steady investment flows, insisted the country’s Prime Minister Binali Yildirim in a recent interview with the local press. They include cutting red tape and a comprehensive tax reform that is already underway.

The constitutional reform to give more powers to the president will also be a positive signal to the investors, an indication of growing stability, Yildirim said, although some foreign observers disagree.

“The only respite came in periods when Erdogan stepped back, inviting the more technocratic, market-friendly figures to run the economy, but that was a temporary situation,” explained Tatha Ghose, a senior EM economist at Commerzbank.

“The yield-seeking investor environment was willing to give him the benefit of the doubt. Now he’s taken back control and the market has misjudged the risk always present in autocratic states.”

Notably, the country has had a relatively strong portfolio investment stream, compared to its emerging market peers. South Africa, Brazil, Russia and others are losing the momentum gained in previous decades, with GDP growth falling to around or below zero, Turkey’s 3% is a bright spot in an otherwise bleak landscape.

In addition to that, with its Middle East neighbours Syria and Iraq consumed by regional conflicts, and a historically favourable geographic location, Turkey gains from a position of strategic importance for both East and West.

“This is true, insofar as political risk does not translate perfectly into risk premium, or weaker currency valuations on a consistent basis,” Saichin said. “I think headline risk translates immediately into knee jerk moves which tend to dissipate if other anchors are present. In the case of Turkey, a well-managed macro with competent technocrats, and a regional bid for Turkish assets are good anchors for mean reversion.”

Others, however, disagree, attributing strong investment performance simply to temporary factors.

“The long-term role of a country is always a factor when determining valuations, but it hardly affects the month-to-month tendencies,” argues Ghose. “We are seeing rapid deterioration of the economy since the coup attempt. Some asset classes are holding up better than others – but mainly in absolute terms, as evident from their similarly high performance in other emerging markets.”

This is reflected in the FDI figures, where Turkey (US$16bn in 2016), despite being far ahead in the Doing Business rating, has lagged behind EM competitors like Brazil (US$75bn) and India (US$44bn). So while high flows of investment portfolios make Turkey stand out among the rest, doubts arise over the long-term commitment of these investors.

“This kind of capital we are talking about is fleeting, it plays on the weakening lira with no FX risk and a good carry. For long term, you would look at the FDI trends and investment growth rate figures that don’t come directly from the government agencies – and it’s been a disaster for about two and a half years now,” argues Ghose.

With a gaping current account hole, the government is keen to bring in more foreign capital. Turkey worked hard to stabilise its relationship with Russia recently – a feud that has adversely impacted the countries’ bilateral trade and led to a decline in tourism.  The negotiations culminated in a preliminary agreement to revive the previously abandoned South Stream gas pipeline, which will be financed through a joint investment fund.

Earlier this month Azerbaijan earmarked US$20bn for investment in the Turkish energy sector, and there are ongoing talks with Gulf states, which are looking to diversify their portfolios away from the US – in part because of recently passed controversial legislation that would allow families of relatives impacted by the 9/11 terrorist attacks to sue foreign governments.

These discussions have even brought Turkey’s sovereign wealth fund plans back to the fore, although analysts that spoke to Bonds & Loans agreed that it was more of a “grand statement” as Turkey’s current account deficit wouldn’t allow for such a fund any time soon.

In November the Turkish government is to organize a roadshow with more than 20 leading global CEOs and investors from various sectors, with the aim of easing concerns and providing details on new investment opportunities in the country. Whether it can convince them and act on the promises made to these investors remains to be seen.

Middle East CEE & Turkey

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