October 11, 2017 / 1:32 PM / 2 years ago

With high inflation, Turkish lira lacks yield buffer

LONDON (Reuters) - Recent declines in inflation are providing emerging markets with a substantial yield buffer against volatility caused by domestic politics or rising yields in the West. The one major exception is Turkey.

FILE PHOTO - Turkish Lira banknotes are seen in this October 10, 2017 picture illustration. REUTERS/Murad Sezer/Illustration

Turkey's lira fell this week after a visa spat erupted with the United States, and its bond yields spiked to their highest since 2009 of around 11.4 percent, according to JPMorgan's GBI-EM index of emerging debt. The index average is around 6 percent TRY= .JGEMCTK.


But Turkey’s high nominal yields are deceptive. With inflation at 13-year highs due to a government-sponsored credit boom, Turkey is an outlier in emerging markets, where prices have mostly slowed this year, outpacing falling bond yields. That means emerging market yields are high in real terms, i.e. adjusted for inflation.

But Turkish inflation is at 11.2 percent while the central bank’s weighted average cost of funding CBTWACF=, its main gauge for borrowing costs, is around 12 percent. That implies barely positive real yields, something that becomes painfully apparent whenever volatility hits.

Paul Greer, senior trader at Fidelity International, calculates real yields in emerging markets are around 3 percent.

With equivalent U.S., euro zone and Japanese yields effectively zero, the 300 basis-point spread between emerging and developed “real” 10-year yields is the widest in a decade, according to Greer, who sees that as sufficient to shield the sector from turbulence.

But Greer is not “enthused” about Turkish lira bonds, seeing real yields comparing poorly with emerging market peers.


The central bank meanwhile could be constrained from raising interest rates because of President Tayyip Erdogan’s fixation with speeding up economic growth.

“The reason people are concerned is that, though levels of nominal interest rates in Turkey are high, they still imply real rates below 1 percent,” Nomura economist Inan Demir said.

“When there is a sudden escalation of political tensions and the real rate is that low, the risk-reward profile in Turkey is not attractive... We need to see an increase in the risk premium offered by lira via higher interest rates.”

The low yields add to Turkey’s other big problem - a balance of payments deficit that hovers around 4.5 percent of GDP, wider than most other big emerging economies.


But Turkish real yields may be on their way up. The central bank forecasts 2018 inflation falling to 6.4 percent and if it keeps monetary policy tight, that will increase bonds’ premium.

“We look at real yields on an expected basis,” said Rob Drijkoningen, head of emerging debt at Neuberger Berman.

“In Turkey it’s fair to assume that inflation is topping out and will start coming down next year so based on that we still think there is decent real yield.”

Reporting by Sujata Rao; graphics by Ritvik Carvalho; Editing by Gareth Jones

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