What a difference one year makes. Turkey was able to raise $8bn of dollar funding in 2017, plus a €1bn euro benchmark and a ¥60bn ($530m) Samurai bond, according to Dealogic. The sovereign could scarcely put a foot wrong, pumping out successful deals and paying 6% for 10 year dollar funding.
But Turkey’s time in the sun was not to last. Problems, from inside and outside the country, began to rear their heads early in 2018.
Drunk on cheap capital, Turkey’s economy was beginning to overheat. Recovering from a failed coup attempt in 2016, the country swiftly returned to a remarkable growth rate. Gross domestic product swelled by 7% in 2017, outstripping emerging market peers.
The growth was fuelled by cheap debt and fiscal stimulus. The government had cut VAT and supported bank lending, keeping interest rates as low as possible.
By early in 2018, the strain on the economy was beginning to show. Inflation was soaring and the current account deficit was becoming worrying. The IMF, rating agencies and investors began to sound warnings, highlighting the risk of an overheated economy.
Turkish president Recep Tayyip Erdogan remained determined to stay the course. He brought forward the 2019 election to mid-2018 and campaigned on a promise to keep interest rates low and foster economic growth.
Nevertheless, the Turkish central bank raised rates by 500bp in April, to 13%. A further 300bp hike followed in May, and another 175bp in June.
But with Erdogan hitting the campaign trail ahead of the election on June 24, promising low rates and more fiscal stimulus, investors were sceptical that the nation’s tightening trajectory would stick.
Sure enough, the central bank, perhaps bowing to political pressure from Erdogan fresh from his election victory, elected to keep the interest rate steady at 17.75% in July, despite inflation of over 15%.
The market hated the news and the lira plummeted from TL4.7 to the dollar to TL6.9 in only a couple of weeks. “Not hiking in July, when investors were primed to expect it, was a serious policy mistake,” says Paul Greer, senior portfolio manager at Fidelity in London.
The move left Turkey cut off from international financial markets and at the mercy of a punishing burden of external debt.
Political pot-stirring
Erdogan’s stubbornness on monetary policy slashed the value of the currency and destroyed the country’s credibility in financial markets, leading Moody’s and Standard & Poor’s to downgrade it from Ba2/BB- to Ba3/B+ in August.
But there were other issues dragging on Turkey’s reputation. A US citizen, pastor Andrew Brunson, who had lived in Turkey for almost 20 years, had been arrested after the failed coup in 2016.
Brunson was held by the Turkish government on suspicion of espionage and for associating with the banned Kurdistan Workers’ Party. After he had been held in prison for 20 months, a judge heard his case in May. Brunson’s witnesses for the defence were not heard.
US vice-president Mike Pence demanded Brunson’s release on July 26. When Turkey refused, the US Treasury imposed sanctions on the Turkish ministers for justice and the interior.
It is difficult to isolate the effect of the sanctions from those of Erdogan’s disastrous monetary policy. “The theme heading into the elections was the excessive looseness of monetary policy and the overheating economy,” says Greer. “But the Brunson affair certainly wasn’t helping. The sanctions made matters worse.”
The head of sovereign, supranational and agency debt capital markets at an investment bank agrees. “Turkey has had an immensely troubled year,” the banker says. “We knew about the economic risks and could evaluate their impact, but the geopolitical events of 2018 have been so unpredictable, and have had such wide-ranging impact, that it’s been hard to know where Turkey is going next.”
Disaster averted
But just as the situation looked at its bleakest, Turkey began to turn itself round .
To a degree, some of its problems were self-limiting. The collapse of the lira caused the Turkish economy to slow down and bank lending dropped off drastically — a “painful but necessary development”, according to Greer.
“We’ve seen collapses in the value of the lira before, but what’s encouraging about this one is that exports have picked up 15%-20%,” says Charles Robertson, global chief economist at Renaissance Capital in London.
Robertson adds: “Turkey has to fundamentally shift its model of growth from debt-financed expansion to exports and trade.” The growth in exports has started to dent Turkey’s current account deficit.
With inflation still out of control, the Turkish central bank reasserted its autonomy, making up for the missing July rate rise and delivering (or perhaps over-delivering) a 625bp boost to the central rate in September.
“The central bank knew it was behind the curve, and it had to catch up,” says Greer. “It really surprised with the magnitude of the hike, but it brought Turkey’s monetary policy into more realistic territory.”
Banks have still got it
Accordingly, the lira began to strengthen, allowing the Turkish banks to shrug off the country’s troubles and embark upon a successful, if expensive, refinancing season.
All of Turkey’s larger banks regularly borrow in the international syndicated loan market twice a year, for terms of one year or, in recent years, two or three years. This means there is a regular twice-yearly season of loan refinancings at which the loan market reassesses its view of Turkish bank risk.
By late November, almost all the top tier banks had rolled over their autumn-maturing loans, with the last remaining major deal, for Garanti Bank, expected to be closed imminently.
As is traditional, Akbank led the way. It managed to refinance in late September and attracted 4% more commitments from banks than the amount it had sought.
The deal is perhaps best viewed as a qualified success. Earlier in the year, Akbank had expected to roll over its 367 day loan at 160bp over Libor and its two year at 245bp.
A few months later, it ended up combining the tranches into a single 367 day loan at 275bp over Libor, all in. Nevertheless, an emerging markets strategist called the deal “a huge relief all round”.
The other Turkish banks all managed to roll over their debt at the same spread as Akbank.
Much higher spreads notwithstanding, they had passed the test and shown that international banks were still happy to lend to Turkey.
The good news for Turkey continued in October. At last, the government bowed to international pressure and held a new hearing for pastor Brunson. He was convicted, but was sentenced only to time served and was returned to the US a few days later. The US sanctions on Turkish politicians were swiftly removed.
Then, the government stepped in to stand behind its banks, injecting capital in the form of subordinated debt purchases.
The head of SSA DCM says: “Once the sanctions were out of the way and the central bank had got its house in order, the mood on Turkey changed. The direction of travel was much better.”
Loans specialists are similarly optimistic. “People are now buying and trading more of the Turkish financial institution loans in the secondary market,” says a senior EM loans banker in London. “Some investors have even returned to the market to buy back their trades. Slowly, both the bond and loan markets are returning to normal.”
Return of the prodigal
To capitalise on the improved sentiment, the Turkish sovereign returned to the bond market, not once but twice, raising $2bn of five year cash in October and returning three weeks later for a €1.5bn seven year.
Both trades were well subscribed in primary , but met with mixed reviews from bankers and investors regarding the wisdom of locking in historically high debt costs.
A second SSA DCM head at one of the leads on Turkey’s euro bond said: “The Turkish market dried up entirely this year, including for bank and corporate debt. When the mood improved, it’s only natural to see the sovereign come back to re-open the market.”
Reality still real
But Turkey’s problems have not disappeared with its return to the capital markets. The US Federal Reserve is still tightening monetary conditions and the dollar, according to Greer, remains undervalued.
“Turkey has made a huge comeback,” says Greer. “But the problems are still there. Inflation is stubbornly high, banks are suffering from the depletion of their capital ratios, and the vibrancy of the US economy is still a worry.”
Robertson agrees: “The hike in Turkish rates combined with the slowdown in the economy means that Turkey could soon be facing a terrible problem of non-performing loans.”
The economic flaws themselves are nothing new, but sliding towards recession has left Turkey more exposed to their impact than before. Nevertheless, investors have shown their willingness to buy Turkish debt, even if they require exorbitant yields.
But a swift return to 5%-6% growth and a reliance on debt would merely compound Turkey’s problems, according to Robertson. “A shift to exports and a more sluggish and restrained growth trajectory is a much healthier solution.” GC