Without Turkish rate rise, foreign investors may cut losses and run
LONDON, July 11
LONDON, July 11 (Reuters) - Foreign investors sitting on losses of 5-15 percent in Turkey are likely to cut and run without a swift and substantial interest rate rise to stabilise the plunging lira.
Foreign fund managers have yanked around $3 billion from Turkish stocks and bonds since the last week of May, central bank data shows, reversing only a tiny part of the investment inflows the country has received in recent years.
But the lira's 9 percent plunge against the dollar since early May has had a huge effect on the value of their holdings, which are now worth just over $120 billion - $30 billion less than a record high set at the start of May.
The lira rout has come on top of a 400 basis point spike in bond yields and a 20 percent fall in Istanbul stocks. Equity returns are currently at minus 16 percent for 2013 while bonds have lost 5 percent.
But a JPMorgan investor survey at the end of June showed foreign funds held only a small underweight on local bonds and retained a small overweight on the currency. That suggests worse may be to come unless the central bank jacks up interest rates.
"Turkey is in a very dangerous situation. We haven't really seen massive outflows yet but they could become very acute," said Luis Costa, head of CEEMEA currency and debt at Citi. "And you have to remember there is a $5 billion-a-month current account deficit that needs to be financed."
Turkey's balance of payments deficit and reliance on foreign short-term capital is widely viewed as its economic weak spot.
Data on Thursday showed the funding deficit had widened almost 20 percent to year-ago levels, making the central bank's blowing in recent days of $6.3 billion to defend the lira - more than a tenth of its useable reserves - look all the more risky.
"They've got a bunch of stuff going wrong at the same time," Paul McNamara, investment director at GAM, told Reuters Insider television. "They have had a big banking boom, very substantial current account deficit and inflation ticking up ... that's crying out for action to get the economy back under control, including higher rates."
The central bank has been reluctant to hike following a credit-fuelled boom, however, while Prime Minister Tayyip Erdogan, aware of the negative impact on Turks of higher borrowing costs, has blamed a "high interest rate lobby" for instigating widespread protests against his government.
Given the huge stresses that have rocked Turkey of late, it may seem surprising so little foreign money has fled.
Investors say the scarce liquidity has made it harder to exit positions and that volatility might have been even greater if the central bank had not squeezed the lira funding market.
Markets are also betting the central bank will have to throw in the towel and raise the upper end of Turkey's interest rate corridor by at least 100 basis points.
"In a market like this it depends on local (banks) to provide the bid, but they know a rate hike is inevitable so why would they buy bonds at this level?" Costa said.
RATE RISE PLEASE
Turkey's attraction for bond investors has been waning as real yields - the difference between yields and inflation - have shrunk, especially since its elevation to investment grade.
For taking on Turkish risk, fund managers want more reward. They say that with world central banks effectively in tightening mode, led by the U.S. Fed, Turkey needs higher rates to compete.
"If we get a strong commitment from the central bank that they are ready to protect the exchange rate and the commitment is backed by policy moves, then you can start to think of the attractiveness of high real rates," said Viktor Szabo, a fund manager at Aberdeen Asset Management.
But the adjustments investors want to see will be costly. A 400 bps rate rise would shock an economy, banks and population that have become used to loose monetary policy and cheap credit.
That will ultimately damp enthusiasm for Turkish equities, where foreigners hold over 60 percent of the free float.
"I find it impossible to see that Turkey gets through this without a recession," McNamara said. (Reporting by Nevzat Devranoglu in Istanbul and Natsuko Waki in London; Editing by Catherine Evans)
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