Cablegate: Continued Sell-Off in Turkish Markets

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

071736Z May 04





E.O. 12958: N/A

B. ANKARA 2359

1. (Sbu) Summary: The sell-off continued in Turkish markets
this week, with bursts of nervous selling Thursday and Friday
driving the lira to new lows for the year. A bad week for
global emerging markets was exacerbated in the Turkish case
by increased tension between the Government and the military
over legislation to make it easier for students from
religious schools to enter university. Though interest rates
continue to rise, they remain manageable for the Turkish
Treasury. After the markets closed Friday, the Central Bank
announced a worse-than-expected February Current Account
deficit of $2.066 billion. End Summary.

2. (Sbu) Turkish Financial markets had another bad, but not
disastrous, week. The market volatility that began with the
April 24 Cyprus referendum and the moved-up expectations of a
U.S. interest rate hike continued this week, and was helped
along both by global market and local developments.
According to analysts and the Central Bank Governor, the main
global market trend depressing Turkish markets was the
negativity in the global market in emerging market bonds,
driven by the drumbeat of information out of the U.S. raising
fears of a Fed rate hike sooner rather than later: the Fed
statement earlier this week followed by lower than expected
applications for unemployment compensation on Thursday and
higher than expected non-farm payrolls on Friday.

3. (Sbu) Local developments hardly helped the markets' mood.
Even though the inflation data for April announced Monday,
showed that 12-month CPI was already, at 10.18 percent, below
the year-end target of 12 percent, Citigroup Istanbul's
economist Olgay Bukkayali told econoff that markets seemed to
focus more on the surprisingly sharp month-on-month jump in
agricultural prices and in the Wholesale Price Index. The
month-on-month WPI jump was worse than expected at 2.65
percent, although the 12 month change in the WPI was still
only 8.91 percent. Consequently, Monday was a bad day in the
markets, with the Lira weakening from TL 1.420 at Friday's
close to TL 1.458 at the close.

4. (Sbu) On Wednesday, Prime Minister Erdogan publicly
floated the idea of reducing Turkey's crucial primary surplus
target of 6.5 percent of GDP in 2005. Though certainly a
negative for markets, the markets did not react sharply,
perhaps because Central Bank Governor Serdengecti had earlier
in the day implied Turkey needed a continued IMF role next
year. Markets were also focused on the U.S. unemployment
application and non-farm payroll data on Thursday and Friday,

5. (Sbu) Most rattling of all, however, was the sudden uptick
in tension between the GOT and the military over the GOT's
moving ahead on legislation that would make it easier for
graduates of Imam Hatip high schools, which focus on
religious education, to enter university. Though the
political dimension of these developments is being reported
septel, the military's issuance of a strong warning statement
late Thursday clearly unsettled the markets. A worried
Central Bank Governor Sureyya Serdengecti told Econcouns
Thursday evening that he had taken the unusual step of urging
GOT ministers to withdraw the legislation to avoid market
problems. He feared that Friday would be a bad day if
tensions were not defused. Sure enough, in early morning
trading Friday the equity market fell sharply and the TL fell
from 1.463 mm to the USD at Thursday's close to TL 1.480
before stabilizing somewhat. Near the end of the day, the
sell-off again took on a head of steam such that the TL ended
the day breaking the TL 1.5 barrier, reaching TL 1.51 mm per
USD in after-hours trading. The IMKB 100 stock index ended
the day 3.5 percent down, at 17,001.97. Today's sell-off
happened in a context of very low transaction volumes,
suggesting that most investors are still on the sidelines,
even though those that are in the market are selling rather
than buying.

6. (Sbu) The government securities market was not immune to
the sell-off: The benchmark May 10, 2005 bond ended the week
yielding 26.25 percent compared to 24.46 at the close last
Friday. As these numbers suggest, the sell-off in government
securities was not as dramatic as in the thinner and more
volatile equity and foreign exchange markets. The tendency
of Turkish banks, who dominate the government securities
market, to buy to support the value of their portfolios,
combined with reports that foreign holders of longer-dated TL
assets are still holding on to them, may explain this more
limited impact on fixed income markets.
7. (Sbu) In all three markets, however, the difference a
month has brought is quite striking. One month ago, the TL
was at 1.335 mm to the dollar and 1.615 mm to the Euro (vs
1.796 mm at the close May 7), the benchmark interest rate was
only 21.91 percent and the stock market was around 20,000.
Much as the market was in one of Turkey's "virtuous circles"
for much of the past year, in the last month it has returned
to a "vicious circle" pattern. During the virtuous circle
period, the appreciation of the currency helps reduce
inflation, causing interest rates to fall, and investors to
keep betting on the currency rising and interest rates
falling. During the vicious circle period, the momentum is in
reverse. Not only, as several Istanbul analysts have
explained to econoff, do investors "stop-loss" positions
exacerbate the fall as they are forced to unwind their
positions when the lira hits certain levels, but the fall in
Turkish Eurobond prices generates margin calls on Turkish
banks' external borrowings collateralized by Eurobonds.
Huseyin Kelezoglu of HC Istanbul, who explained the latter
phenomenon to econoff, said the fall in Turkish Eurobond
prices also exacerbates Turkish banks' already significant
open foreign exchange positions, i.e. the banks
FX-deonominated liabilities exceed their FX-denominated
assets. When the Eurobonds, which are FX-denominated assets
fall in price, the banks have to sell more TL and buy FX to
avoid going over exposure limits monitored by the bank
regulators. This adds to the market pressure on the lira,
exacerbating its fall.

8. (Sbu) If all this were not enough, after the markets
closed Friday, the Central Bank announced a
worse-than-expected Current Account Deficit for February of
$2.066 billion. (Markets were expecting $1.532 billion).
The Current Account
Deficit announcement, and the unresolved Imam Hatip
situation, set the stage for difficult market conditions on
Monday. Some analysts, including Kelezoglu, believe the
Central Bank could intervene to prevent excess volatility in
the foreign exchange market. Unlike the Central Bank's
several interventions to break the speed of the Lira's
appreciation over the past year, intervening to support a
falling lira will decrease rather than increase the Central
Bank's foreign exchange reserves.

9. (Sbu) Despite the continued sell-off, it is important to
note that the markets are nowhere near a crisis. The Turkish
Treasury is not expected to have any difficulty rolling over
its debt in the coming months. Because of the substantial
fall in inflation and interest rates in the first quarter of
2004, current interest rate levels are already well below the
projected average interest rate for the year of 29 percent,
on which the Treasury's borrowing program and the GOT's
budget are based. Moreover, the Treasury borrowed heavily
from the domestic market in the first three months of the
year, when conditions were favorable, given it some room for
maneuver for the remainder of the year.


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