Cablegate: Market Correction Despite Continued Positive Macro

This record is a partial extract of the original cable. The full text of the original cable is not available.





E.O. 12958: N/A


1. (Sbu) Summary: On April 8, Turkish financial markets
experienced one of the few significant corrections in recent
months, with interest rates blipping back up over 22 percent,
the lira falling to TL 1.334 million to the dollar and the
stock market falling 3.10 percent. A confluence of negative
factors are blamed for the correction: an increase in Central
Bank TL auctions, negative comments on Turkey's EU accession
bid by the French Foreign Minister, anti-Annan Plan
announcements by both Greek and Turkish Cypriot leaders, the
increased fighting in Iraq, and the upcoming Easter weekend
for Western investors. The announcement of
better-than-expected numbers for the first quarter primary
surplus and February Industrial Production failed to buoy the
market. The correction comes after a sustained period of
gradually improving markets, including successful moves by
the Turkish Treasury in March to issue some slightly
longer-dated lira-denominated bonds. End Summary.

Markets Dip April 8:

2. (U) Equity, fixed income and foreign exchange markets all
fell sharply April 8. The IMKB 100 stock exchange index fell
3.10 percent on the day to 19,419, perhaps because the stock
market had benefited the most from the recent spate of market
bullishness: analysts, bankers and hedge fund managers have
all told econoffs that the best "Turkey play" is equities,
since there is more upside than in fixed income assets, which
are constrained from falling too far by inflation, and bank
funding costs. Government securities prices and the lira
exchange rate also fell sharply (see below).

Government Debt Market Developments:

3. (Sbu) Interest rates on the benchmark bond rose back over
22 percent to 22.40 at the close April 8, with an unusually
high trading volume of TL 2.2 Quadrillion on the benchmark
bond. Interest rates had slowly trended lower in recent
weeks, with the benchmark getting below 23 percent only on
March 19--following the Central Bank's 200 basis point rate
cut March 17. The benchmark gradually inched downwards,
getting below 22 percent March 30, and hitting a low of 21.41
April 2, before coming back over 22 percent on April 8.
Despite the Central Bank rate cut, both Istanbul analysts and
Treasury officials say rates could not fall further,
especially short-term rates, because bank funding costs
(which key off of the Central Bank's overnight rate,
currently 24.60 percent on a compound basis) are still higher
than government securities rates. The gently downward
sloping (i.e. inverted) yield curve means that banks are
betting on further rate cuts in the future. Without further
cuts, banks would have a "negative carry" on their government
securities portfolios. These contacts explain that
banks--the dominant players in the government securities
market--lack access to medium- or long-term funding, and even
their portfolios of bonds with maturities of 12 to 18 months
represent a maturity mismatch: they are funding medium-term
government bonds with short-term deposits.

4. (Sbu) Both Treasury domestic debt manager Volkan Taskin,
and Istanbul market analysts say that it is for this
reason--the absence of domestic buyers of longer-dated paper
due to buyers' short-term funding--rather than a Treasury bet
on lower interest rates, that has prevented more issuance of
long-dated TL-denominated paper to the market. For this
reason the average maturity of TL-denominated debt
outstanding in the market--not including FX-linked paper or
TL paper placed with non-market investors such as the state
banks and other public institutions--stayed more or less
constant in late 2003 and early 2004 at about 12 months.
Since the beginning of March, however, Treasury has issued
several bonds with maturities exceeding twelve months, such
as the issuance of an additional $1.54 billion of TL
benchmark bonds, maturing August 24, 2005 on April 6.

5. (Sbu) Taskin, some Istanbul bankers, and Central Bank
markets department head Akil Ozcay separately said Treasury
did a good job of exploiting favorable market conditions
during the first quarter of 2004 to front-load debt issuance
for the 2004 borrowing program. During the first three months
of 2004, Treasury's rollover rate has been 94 percent, well
above the targeted average for 2004 of 87 percent. Treasury's
heavy issuance early on will place its domestic TL debt
managers in a stronger position for the remainder of the
year, only needing to rollover an estimated 84 percent of its
debt, on average. Repeating an ongoing concern of Central
Bank officials, however, Ozcay said Treasury's focus on
lowering its rollover rate means the Central Bank has to do
more to mop up excess liquidity in the market for monetary
policy reasons.

Lira Falls out of Trading Range...

6. (Sbu) In a departure from recent years' exchange rate
volatility, for the past few months the lira has been trading
in a relatively narrow range, typically just above 1.3
million lira to the dollar. The stability of the lira has
been maintained, in part by the Central Bank's policy of
fine-tuning its auctions of foreign exchange. The Central
Bank fine-tuning has depended on the level of TL liquidity,
arising in part from inflows of foreign portfolio investors'
money and partly from continued reverse currency substitution
(i.e. people keeping more of their holdings in TL than in the
past). Though the Central Bank denies that it is trying to
influence the level of the lira, it has claimed it is merely
trying to dampen exchange rate volatility. Privately, Ozcay
explained that the Central Bank also adjusts its foreign
exchange auction as a monetary policy tool, to sterilize
inflows of foreign portfolio investment that would otherwise
work against the Bank's monetary tightening.

7. (Sbu) Having increased its FX purchase auctions (TL sales)
from $80 million to $100 million a few weeks ago, the Central
Bank upped them to $140 million late in the day on April 7.
Earlier the same day, Ozcay told econoffs the Central Bank
was considering intervening, but later settled on the milder
action of increasing the auctions. In retrospect, the
Central Bank may have gone too far. The following day,
helped by French Foreign Minister Michel Barnier's negative
statements on Turkey's EU accession prospects, calls by both
Greek Cypriot leader Pappadopoulos and Turkish Cypriot leader
Denktash for voters to oppose the Annan plan, and increased
fighting in Iraq, the lira tumbled from 1.314 to the dollar
and 1.603 to the Euro at the close on the 7th to 1.335 and
1.615 at the close on the 8th. The approach of the Easter
weekend for Western investors may have also played a role, as
some foreign investors did not want to hold Turkish exposure
over the long weekend (long in Western Europe and America,
that is). Economist Baturalp Candemir of HC Istanbul
privately grumbled to econoff that the main culprit in the
sell-off was the Central Bank, since the markets understood
that Barnier's comments mainly reflected domestic political
posturing and that Denktas' and Pappadopoulos' statements
were expected. Other analysts, such as Deutsche Bank's
Tevfik Aksoy, attributed the sell-off to multiple factors,
but with the Central Bank's action the single most important.
On the other hand, Central Bank officials privately
downplayed the impact of their auctions. putting more weight
on the geopolitical developments. Candemir said many of his
firm's clients had lost money on April 8, and would not
quickly return to Turkish markets. Comment: Given the almost
uninterrupted bull market in recent months, the slap on "hot
money" investors' wrists is probably healthy. End Comment.

...Despite Favorable Macroeconomic Data:

8. (Sbu) Ironically, on the day of the sell-off additional
positive macroeconomic numbers were released, building on
some favorable news in recent weeks. In the afternoon of
April 8, Finance Minister Unakitan announced a
better-than-expected primary surplus of TL 7.21 Quadrillion
($5.52 billion) for the first quarter of 2004. This means
that not only is the GOT's fiscal situation being helped by
lower-than-expected interest costs but that the broader
fiscal situation--excluding interest payments--did well in
the first quarter. On the same day, the State Statistical
Institute announced better-than-expected industrial
production numbers for February: a 15.6 percent rise over
February 2003. Though the number was encouraging, coming in
well above the consensus estimate of 10 percent, economists
point out that the increase industrial production was boosted
by the base effect arising from very weak production early in
2003. Economists therefore remain of mixed views on how
optimisitic to be about full-year 2004 GNP growth.

Markets Ease Back up on April 9:

9. (Sbu) On April 9, helped by the good news on fundamentals,
the markets recovered, but only very slightly. At the close,
the lira had come back a hair to 1.332 to the dollar and
1.612 to the Euro, while the benchmark interest rate eased to
22.06 and the IMKB 100 stock market index was up 0.44 percent
to 19.505.

© Scoop Media

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