Playing chicken with Turkey

Playing chicken with Turkey macro flash notes.JPG
86 days ago (17 Apr 2020)  |  

Playing chicken with Turkey?

In this Macro Flash Note, GianLuigi Mandruzzato looks at the reasons behind the increased tensions on Turkish financial assets.

The risks to financial stability in Turkey have risen in the last few weeks. The main reason for concern is the drawdown of foreign currency reserves following the central bank’s attempt to support the Turkish lira amid high global uncertainty.

Turkish lira (TRY) exchange rate and Purchasing Power Parity

Source: Refinitiv and EFGAM calculations as at 16 April 2020.

At the beginning of April, total foreign reserves, including gold, fell to USD89bn, USD17bn less than at the end of 2019. However, focusing only on currency reserves and taking into account banks’ required reserves, net currency reserves are only about USD20bn.

These resources compare poorly with short-term maturing debt. At the end of January, the Central Bank of the Republic of Turkey (CBRT) estimated that total outstanding short-term debt was USD123.6bn and total debt due over the next 12 months on a remaining maturity basis was USD172.3bn. The net coverage of maturing obligations guaranteed by net FX reserves is therefore currently only 12%.

Turkish short-term debt and FX reserves

Next 12-month maturing debt coverage

Source: CBRT and EFGAM calculations as at 16 April 2020.

To make matters worse, the recent rise in Covid19 cases in the country threatens to destroy the holiday season. This would not only hit GDP growth given the importance of the tourism sector but it would also drastically reduce the inflow of foreign currency. Tourism revenues are mainly concentrated in the July-October period and foreign travellers contribute more than 85% to the total.

Tourism revenue shares

Turkey CA balance by quarter, 5-y avg.

Source: CBRT, Refinitiv and IMF as at 16 April 2020.

Tourism activity also usually mitigates the weakness of Turkey’s external accounts, contributing about 15% to total exports. Last year Turkey experienced its first current account surplus (1% of GDP) since 2001. There is a high risk the current account will return to deficit this year.

Investors are understandably concerned about Turkish financial stability. Despite a low government debt-to-GDP ratio, the 5-year CDS (credit debt swap) on Turkish debt has risen higher than for most emerging markets. This increases the cost of refinancing maturing debt for both the sovereign and private sector borrowers.

5-year CDS

General government finances (% of GDP)

Source: Refinitiv and IMF as at 16 April 2020.

In its latest report, Moody’s concluded that the “central bank's foreign exchange reserve position has declined considerably, while external refinancing requirements remain high and costly. In spite of the decline in oil prices, the risk of a balance-of-payments crisis remains material, and has been exacerbated by increased capital outflows.” The agency maintains a negative outlook on Turkey’s B1 sovereign rating and the risk of a further downgrade is evident.

Last week, rumours circulated that Turkey was in talks with the Federal Reserve and the IMF to secure extraordinary US dollar funding. While the latter option was dismissed by Turkish government representatives – President Erdogan has previously been critical of the fund – securing funding from the Fed is a logical strategy to tackle a potential liquidity crisis. Yet this may be hard to achieve given the strained relationship with the US administration, despite Turkey’s NATO membership.

To conclude, pressure will probably remain high on Turkish asset prices. While not our central scenario, a balance-of-payment crisis cannot be excluded, particularly if Covid19 repercussions dampen the usual inflow of foreign currency during the summer season. The risk/reward profile of Turkish bonds does not look compelling despite the high yield they now offer.

Important source information: The sources for data used in this publication are EFG Research and Bloomberg, as at publication date, unless otherwise stated.

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Playing chicken with Turkey macro flash notes.JPG