LONDON: Be careful what you wish for. Turkey’s long-awaited restoration to investment grade has the potential to turn into a policy headache for authorities trying to prevent foreign capital from inflating the lira’s exchange rate.
The sovereign was upgraded by Fitch Ratings earlier this month after being classed as a speculative buy for 18 years. If Moody’s also elevates the country to the lower-risk ratings category as expected, its debt will be eligible for inclusion in mainstream global bond indices - setting the stage for big-money investment funds to take a slice.
New financial market inflows, estimated in the billions of dollars, will provide valuable financing for Turkey’s huge balance of payments deficit and help cut borrowing costs for companies and government.
But there is a downside. Billions of dollars of additional investment flows and a stronger lira could render Turkish exports less competitive in a slowing world economy where demand is scarce and competition fierce.
“This is a nice headache to have but it is a very big headache too,” says Murat Toprak, a currency strategist at HSBC.
“The way the central bank looks at it is: investment-grade may lead to lower borrowing costs, but the first stage is capital inflows and currency appreciation, and that will cause problems.”
Moody’s said on Tuesday it had kept Turkey’s rating at Ba1, one notch below investment grade, after an annual review, but reaffirmed its positive outlook on the country.
JP Morgan estimates foreigners have already bought almost $1 billion worth of Turkish lira bonds this month, driving two-year yields down nearly a percentage point to record lows.
Even before Fitch’s November 5 upgrade, foreign funds encouraged by central bank successes this year in taming inflation and the balance of payments gap had pumped $13.6 billion into local bonds, according to central bank data.
Equities too had drawn in almost $5 billion by end-October, making the Istanbul index one of the best performers of 2012 with dollar-based returns of almost 50 percent.
The central bank will be less pleased with a JP Morgan client survey that found fund managers have boosted their overweight positions on the lira to record highs. That reflects an implied yield of almost 5 percent on the currency over the next year, among the highest in emerging markets.
“The lira is one of the currencies you want to have longs on in a sustained manner,” says Jeremy Brewin, a fund manager at Aviva Investors who is overweight Turkish bonds and lira.
But some disappointment may lie ahead. The central bank has swung firmly away from its lira-supportive stance of early this year and is now focusing on weakening the currency by reducing its appeal to foreigners.
On Tuesday, it slashed overnight lending rates, used to supply cash to the market, for the third month running, even though inflation is well above target. It also warned it would cut the main policy rate and the borrowing rate if needed - a powerful signal to any lira bulls.
Reuters
