Mehmet Simsek’s pitch is simple: “rational” policies are back in Turkey after an era of economic adventurism and crises. And that should make the country’s lira debt a sound bet for the world’s money managers.
It’s taken almost a year and some of the world’s most aggressive interest-rate hikes for the finance minister, a former Merrill Lynch bond strategist, to get that message to sink in with investors. Turkey still has a way to go — the inflation rate is almost 70% and expected to rise this month.
Yet most foreign investors are now confident that price rises will decelerate rapidly by the end of 2024. Locals are also more positive, many of them moving their money from dollar to lira accounts and helping the Turkish currency pare some of this year’s losses.
“We’ve been overwhelmed with the inflows,” Simsek, 57, said in an interview in Ankara.
The bond market had been all but abandoned by outsiders as President Recep Tayyip Erdogan’s push for lower interest rates resulted in runaway inflation. But the Turkish leader’s reelection a year ago and his subsequent appointment of Simsek marked a turnaround in policies and the inflow of foreign capital recently hit a record pace.
Turkey has seized on the influx by buying dollars to replenish its depleted coffers. The central bank’s underlying foreign-exchange position has risen by $49 billion since March, the sharpest increase ever, according to Goldman Sachs Group Inc.
By channeling the windfall into reserves, Turkey is avoiding what Simsek has called excessive appreciation of the lira. It’s down around 8% this year but the finance minister is keen to avoid it going up too much from now, something that would hurt Turkish exporters.
“A combination of sound policies and structural transformation is a good narrative that enables us to regain investor confidence,” Simsek said. “And that helps portfolio preferences in favor of Turkish assets, which translates into inflows, which enables us to help steady the real exchange rate.”
Banks such as BNP Paribas recommend investors buy short-term lira bonds, which have yields of around 40%. Simsek isn’t averse to so-called hot money flows — which Erdogan blamed for years for destabilizing what’s now a $1.1 trillion economy — but believes a shift into longer duration securities is only a matter of time.
“Our program does not rely on hot money,” he said. “I would be very surprised if investors don’t take duration risk,” he added, referring to longer-term bonds.
Portfolio inflows into Turkish assets have exceeded $25 billion since the end of March, nearly triple the amount in the preceding five months, according to QNB Finansbank.
With foreign purchases on the rise, about a fifth of the total flowed into domestic debt, of which most went into “short-term, repo-like bond products,” the Turkish lender said in a report. It estimates that the rest of the money funded carry-trade investments in the higher-yielding Turkish lira.
The Turkish carry trade has been one of the best for emerging-market investors this year. Those borrowing in dollars and investing in liras have earned more than 11%, according to data compiled by Bloomberg. That’s because the high yields on Turkish local bonds have more than made up for the lira’s depreciation.
Still, a truce with portfolio investors won’t be complete until inflation starts slowing and Turkey eases restrictions on offshore currency swaps, which are needed to hedge exposure to the lira. Those restrictions were used to steady the lira.
The regulations date back to 2018, when Turkey lowered the amount of liras commercial banks were allowed to lend to international counterparts following a currency crisis that year.
Simsek said Turkey is exploring ways to loosen the arrangements for offshore markets and could start with longer-term swaps. “We know what needs to be done, but the timing of it, the sequencing of it and the dose of it have not been decided,” he said.
‘Renaissance Moment’
The momentum of domestic reform will remain in the spotlight for investors, even as Wall Street banks like Citigroup Inc. proclaim the turnaround in market sentiment around Turkey has brought it “on the verge of a renaissance moment.”
Even following an aggressive cycle of interest-rate hikes, inflation is among the fastest in the world and will likely peak around 75% this month before a slowdown sets in this summer.
Beyond an inflation rate that remains among the highest globally, investors are watching to see if Turkey will rein in spending, or at least do away with big annual hikes that were a feature of recent years. Fitch Ratings says the country’s fiscal stance is still “clearly expansionary” despite cutbacks on some public spending announced by Simsek in May.
Yet a stretch of four years without major elections is an opportunity for officials like Simsek to cool the economy without immediately paying a price at the ballot box.
“We are still at the early stages of delivery,” he said, referring to efforts to broaden the tax base, and combat the shadow economy. “I’m not saying that we have addressed all the challenges, but we have made decent progress.”
–With assistance from Tugce Ozsoy.
