After a period of sustained demand for domestic government bonds, the market is vulnerable to any shift in sentiment that might 0undermine EM currencies. March trading showed local markets as well as lower-rated Eurobonds retreating smartly as carry trades were unwound.
Raphael Kassin, head of EM fixed-income at ABN AMRO Asset Management, stressed that timing here is crucial. "Basically you will make money out of Turkey until (and if) things go wrong. There has been something of a gold rush since interest rates began to tumble, justifiably so given the yields on offer and a stable/strong currency. But there is always potential for volatility in every country, and in Turkey that would happen if the EU membership goal unravels," he said.
Foreign investors are keen to extend duration, and were the main buyers of the first five-year Turkish lira government bond issue in February 2005. However, Commerzbank's Turkey economist Greg Kronsten does not anticipate a further extension in maturity for the time being, as domestic investors like to match their liabilities, which are primarily short term, and so will resist maturities beyond January 2011
There have been other issues to contend with. Since January 1 2006, capital gains derived from securities, redemption income and interest income from securities have been subject to a withholding tax of 15% that affects both foreigners and domestic investors. But this has had little impact on net foreign demand, for though overseas players have shied away from this year's five-year FRN auctions, they remain active traders in the pre-tax, five-year benchmark. The tax is reflected in higher yields for anything issued this year (such as the January 2011s) compared with bonds sold before, such as the February 2010s.
Memduh Aslan Akcay, the Treasury's director general of foreign economic relations, stresses that the imposition of the withholding tax has served to unify the Turkish tax system and investor treatment regardless of an investor's origins.
"Naturally, there has been some confusion during the early stages of implementation, but we do not expect that the new tax regime will constitute major impediments for the local market access of foreigners," he said.
Away from the government, borrowing domestically is becoming feasible for the first time in years. Falling rates have provided a big boost, with Turkish yields tumbling to 13%–14% (for 18-month notes) from over 50% just three years ago. As domestic inflation is now around 8%, this is no longer a hugely expensive source of funding – and for local issuers it comes without currency risk. Koc Consumer Finance, a subsidiary of the large Koc group, is thought be looking to award a mandate for a domestic bond.
Bankers are not happy about the current regulations. For example, regulatory approval is capped at a certain deal size, which is in turn a function of specified financial ratios, and there are hopes that these rules will be made more flexible. In addition, because of the fixed costs involved in issuance, tenors under three years are not currently economic.
But there is a real sense that a new market is about to open. Moody's introduced a new national Scale Rating for Turkey (on March 1) that provides a ranking of relative creditworthiness, including relevant external support. While there are no current plans to open a local office in Istanbul, the ratings agency says it is constantly monitoring the situation.
And Is Bank's head of treasury, Erdal Aral, is confident that an opportunity is finally appearing for Turkish corporates and banks to tap the domestic bond market.
"A door could open up if the Treasury buys back outstanding bonds. Or the Treasury could increase the average maturity of its debt, which would open up space for corporates at a sensible spread and at tenors up to five years," he said.
Locals seem confident that such issuance will find ready buyers. Conventional mutual funds in Turkey now have TL30bn under management (approximately US$23bn) from roughly 3m investors, with the overwhelming bulk of this money still invested in fixed-income funds. Until now, debt mutual funds have been limited in their holdings to government domestic debt, but in 2006 the fare on offer should be expanded to include lira-denominated corporate debt, mortgage bonds (see separate article on securitisation) and covered bonds.
"The offer of a spread pick-up over government debt should be enough to ensure buyers for these instruments," said Gurman Tevfik, general manager of Is Asset Management, the fund management subsidiary of leading local institution Is Bank.