IFR Turkey Special Report May 2013
9 min read

The bellwether economy for emerging Europe has set its usual brisk pace in the international bond markets, but diversification is the watchword as it seeks to reduce its dollar dependency.

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Turkey continues to revel in its status as the poster child in Central and Eastern Europe and the Middle East for sovereign bond investors, and as such always favours a January foray to the dollar market.

This year it has surpassed itself by starting its 2013 borrowing programme in December, when it printed a 4.352% US$1bn 30-year dollar bond to pre-finance its 2013 borrowing plan. That deal reduced its original international funding target for 2013 to US$5.5bn, and it whittled that down further in January with another dollar issue; this time, raising a US$1.5bn 10-year offering that printed with an all-time low yield of 3.473%. This was followed up with a Samurai private placement as part of the sovereign’s growing ambition to tap the cash-rich but risk-averse yen market.

With a sizeable dollar trade already under its belt, Turkey is well on the way to addressing its funding needs for 2013. Nick Darrant, head of debt syndicate CEEMEA at BNP Paribas, said: “Turkey tapped the market with a classic year opener, hitting the 10-year sweet spot to access the deepest pool of liquidity.”

Grab for yield

Demand for Turkish bonds is symbolic of the broader grab for yield by investors looking to emerging markets, but the main draw has long been the country’s own improving economy. Inflation has slowed to 6.2% and the current account deficit narrowed to 6.5% of GDP as part of the Central Bank’s unorthodox plan to cool the economy by doubling interest rates. Darrant said: “The sovereign has been such a success story that it is now firmly considered to be low beta.”

This progress was rewarded last year when Fitch upgraded the sovereign to investment-grade status. Many expected Moody’s to follow suit by the middle of the year, which will provide a big boost to its borrowing power on the international capital markets. For the time being, however, Moody’s appeared to be lukewarm on the country’s immediate prospects. In March it said it would “consider upgrading Turkey’s rating” only if the government made “further progress in reducing its external vulnerabilities by reducing its current account deficit, increasing foreign exchange reserves or reducing the private sector’s external borrowing”.

This followed an announcement at the start of the year by Standard & Poor’s that it was converting its issuer credit and issue ratings on Turkey to “unsolicited”, as the agency no longer has a ratings agreement with the sovereign.

S&P said it would continue to rate the sovereign on an unsolicited basis “because we believe that we have access to sufficient public information of reliable quality to support our analysis and ongoing surveillance, and because we believe there is a significant market interest in this unsolicited rating”.

Indeed the agency upgraded the sovereign’s long-term foreign currency rating to BB+ despite the falling out.

Market muscle

A second investment-grade upgrade would unlock billions of dollars in institutional funds, and with Turkey having an SEC registration, that would put it on a par with Brazil and Mexico in terms of US bond market clout. It would also help the sovereign in its quest to diversify its sources of international funding across the curve.

“Turkey wants to diversify its borrowing as a sovereign entity,” said Haluk Bilgic, a partner at law firm Ozdirekcan Bilgic Dundar, the correspondent law firm of Gide Loyrette Nouel in Istanbul. “But it is still dependent on funding in US dollars.”

But coveted investment-grade status is not the be-all and end-all for a credit that has been on an upwards trajectory for over a decade. Darrant said: “Gaining full investment-grade status would broaden Turkey’s access to other currencies but it is not absolutely essential. Turkey is already a strong credit.”

“Turkey wants to diversify its borrowing as a sovereign entity. But it is still dependent on funding in US dollars”

An official at the Treasury said: “Turkey deserves a higher credit rating given its macroeconomic fundamentals and the significant improvement in its debt dynamics. Moreover, the fact that Turkey’s market performance is much better than some of those countries with higher credit ratings is also an indication of how market perceives the Turkish credit.“

While favouring dollars for its depth of liquidity and investor reach Turkey is bringing an element of diversification to its international funding strategy with debut Samurai and sukuk issues. Last March, Turkey printed a new ¥90bn 10-year deal with a 1.47% coupon and a spread of 40bp over yen offer-side swaps plus.

The official said: “Diversification of markets and currencies is a key element of our debt management strategy. Several new funding opportunities have appeared for Turkey in addition to our conventional markets such as lease certificates [sukuk] and yen-denominated bonds in Samurai market. We will use a combination of these markets depending on the market conditions. We expect the proportion of US dollar-denominated funding to continue to be higher than other currencies this year.“

The JBIC programme provides guarantees to enable new issuers to tap the risk-averse yen bond market in return for the payment of a guarantee. Sovereign borrowers under the programme are expected to issue on a standalone basis after two or three transactions and in February Turkey showed the progress it had made by printing its longest ever dated yen issue in a rare privately placed Samurai offering.

The sovereign issued a nominal ¥18.4bn (US$203m) 20-year yen-denominated bond maturing on February 7 2033 at 2.68% via Daiwa Securities.

“Turkey’s desire to establish a sukuk curve is part of its plan to set a roadmap for the country’s corporate borrowers to follow. It’s part of its plan to become less dollar-dependent”

This followed the sovereign’s debut sukuk market in September, when it printed a landmark US$1.5bn 2.803% 5.5-year note which attracted around US$7.5bn in orders from global investors. Turkey’s Islamic finance ambitions have been talked about for a long time, but tax changes that put corporate sukuk issues on a par with conventional bonds enabled the issuance of Treasury sukuk al ijara to turn into a reality.

“Turkey’s desire to establish a sukuk curve is part of its plan to set a roadmap for the country’s corporate borrowers to follow,” said Bilgic. “It’s part of its plan to become less dollar-dependent.”

The sovereign achieved its goals of executing a benchmark-sized deal and diversifying its investor base after Islamic accounts in the Middle East and Asia took 70% of the paper. Local and US investors, which typically dominate Turkey’s conventional transactions, were much less influential, despite the trade being a rare example of a 144a/Reg S sukuk issue.

Sukuk overlap

There is overlap between the dollar sukuk and conventional dollar investor base but the move is seen as a statement of intent, as well as a tactical move. “The sukuk market is one where there is sometimes a pricing advantage and sometimes not, so it’s more of an opportunistic market for an issuer like Turkey,” said Fabianna del Canto, a director in the London syndicate team at Barclays.

The Treasury official said the sovereign would continue to issue in sukuk internationally and domestically: “In line with our domestic borrowing strategy, TL1.5bn worth of lease certificates [sukuk] was issued in February. Depending on the market conditions, we will issue sukuk in international markets.“

Its flourish of diversification raises the question about whether it plans to return to the euro market, which it last tapped in 2010. The Treasury said it was closely monitoring the euro market along with others markets as it looks to extend maturities.

“Turkey’s strategic preference is to increase the maturity of the funding, bearing in mind its cost. Given its number of investors, size and the depth, US dollar is the best currency to issue a long maturity bond. Generally [the] euro market is operating with shorter maturities,” said the official.

While the sovereign’s go-to international currency will continue to be dollars, Turkey is clearly open to greater diversification, as long as it meets with its long-maturity profile. The lure of Swiss francs, for example, which has provided a deep source of funding for CEMEA borrowers, may also be an option. Darrant said: “In terms of diversifying into new currencies, for an issuer of Turkey’s stature and credibility I would rule nothing out.”

The New Galata bridge over the Golden Horn
Turkey is busy strengthening its ties...