Investors left shocked after Erdogan upends Turkey’s markets


Emerging-market investors are well accustomed to unpleasant surprises from Turkey. But the latest — a late-night weekend firing of a respected central bank governor who had been in the job for just four months — has left them reeling.

The ousting of Naci Agbal, just 36 hours after he slapped an extra 2 percentage points on the country’s benchmark interest rate, sent Turkey’s currency, stocks and bonds into freefall when markets opened on Monday. For overseas fund managers, that is bad enough.

But Turkey’s money markets also seized up, sharpening the blow. Investors say it has made it more difficult to pull their money out or hedge their exposure to the lira, in an incident that could leave lasting damage to investors’ trust.

“It’s really a feeling of exasperation,” said Yerlan Syzdykov, the London-based global head of emerging markets at Amundi, Europe’s largest asset manager. “We were just getting to the point where Turkey was rebuilding credibility.”

Syzdykov had been running positive bets on Turkish debt, both corporate and sovereign, and a long position on the lira, when the shock of Agbal’s firing in the early hours of March 20 hit. In chaotic markets after the dismissal, he was unable to reverse course.

“It has been a difficult couple of days,” a deflated Syzdykov said. “We have been trying to reduce our exposure. We have been able to bring it down to neutral, but we were overweight. The [market] conditions are very difficult. Liquidity has evaporated. Foreign investors are quite frustrated.”

Line chart of Turkish lira per US dollar showing Agbal: Turkey's only recent central bank governor to revive the lira

Analysts and fellow fund managers say this sense of being stranded in a soured bet will make it much harder, and more expensive, for Turkey to secure the foreign funding it needs in future.

“Markets took Agbal’s appointment as a fundamental change. Hedge funds and other investors put their money in. But I knew the president would never change,” said one former Turkish official. “This tells you that there are no rules. This is not how you treat people who finance your current account deficit.”

President Recep Tayyip Erdogan has long had a fractious relationship with foreign fund managers. An opponent of high interest rates, which he has previously labelled the “mother and father of all evil”, he has spent several years railing against measures that mainstream economists agree help to depress harmful inflation. During the lira crisis of 2018, he referred to a shadowy “interest rate lobby” of western financiers seeking to undermine his paternalistic rule.

But orthodoxy prevailed late last year. Agbal was appointed to run the central bank — an economic shake-up in which Berat Albayrak, the finance minister and Erdogan’s son-in-law, who did not command the respect of external observers, was pushed out.

Agbal set about a series of substantial interest rate rises — 8.75 percentage points by the time Erdogan fired him. That lifted the lira by 18 per cent in just four months, making him the first head of the central bank to preside over a strengthening lira since the 2008 financial crisis — a big step towards controlling inflation, which is still running around 15 per cent a year.

Line chart of One-month % change showing Istanbul's stock market tumbles

Central bank data suggest that about $16bn entered Turkey to chase juicy lira interest rates through currency swaps between Agbal’s appointment on November 7 and March 19, the most recent data point. Another $4bn entered the country to buy lira government bonds, while net flows to equities were about $700m in that period, having peaked at about $1.8bn in February. Additional flows to sovereign bonds denominated in foreign currency, corporate bonds and loans added another $4bn, according to the Institute of International Finance.

But it appears Agbal’s final rise in rates, which was twice the size of economists’ forecasts, was too much for Erdogan to stomach. Some investors say such a large rise, while welcome, was unnecessary. A smaller bump would likely have been enough to prop up the lira in the face of rising US government bond yields.

People familiar with the matter say Agbal, who could not be reached for this article, knew the scale of the rise would irk the president. He had been isolated from Erdogan for several weeks and knew that a further large rise in March would not have his blessing, they say.

Turkish press loyal to the president had been stepping up criticism of his role. Yeni Safak, a pro-government newspaper where Agbal’s replacement Sahap Kavcioglu wrote a column, fired a warning shot the day after the latest rate rise. The daily accused him of primarily serving “London-based owners of hot money”.

Kerim Rota, a former banker who is now deputy chair of the conservative Future party, said criticism of Agbal intensified at a news conference in late January, when a high-profile columnist at a mass-circulation newspaper run by the brother of former finance minister Albayrak said the business community was complaining about high rates.

Line chart of Offshore overnight swap rate (annualised %) showing Turkish money markets seize up

“When Naci Agbal was prevented from changing the central bank’s senior personnel in his first 100 days, people saw this as a vulnerability and began to target him,” Rota said. “I knew that his tenure would not be long . . . though I would have never guessed it would be this short.”

International money managers, however, did not pick up on signs that Agbal’s position was in immediate peril, dismissing the disquiet as noise.

The firing of Agbal ripped through markets, leaving the lira down 11 per cent this week and knocking the Borsa Istanbul 100 stock index 9.6 per cent over the period. Of the $16bn that had flowed into currency swaps during Agbal’s tenure, more than $6.5bn left in two days. Investors who bought local currency government bonds were hit hard: 10-year bonds lost a fifth of their value in five days. The rush to the exits was fraught.

“What we are seeing now is backdoor capital controls,” the former Turkish official said.

Line chart of Yield on dollar bond maturing in June 2031 (%) showing Turkey's borrowing costs jump

Analysts and investors say that when markets opened on Monday, local Turkish banks made it hard for foreign investors to get out of their positions in currency swaps. To exit a swaps contract before it expires, as many have tried to do this week, they need to borrow lira.

But the interest rates Turkish banks charge for lira loans quickly rose to as much as an annualised 1,400 per cent on Tuesday in the rush of demand. Supply, too, was restricted, as Turkish banks are limited by regulators in the amount they may lend. One Turkish investor at a foreign fund manager that got trapped this week said the constrained liquidity echoed previous bouts of volatility. In 2019, for example, “there was verbal communication [from the central bank] that every lira lent to a foreign counterparty required approval,” he said.

“We had never got into domestic bonds, which was a huge relief this week,” said Kieran Curtis, head of emerging market local-currency debt at Aberdeen Standard Investments. “But we completely cut our lira positions in swaps. It was not easy. It was expensive and there was not a lot of liquidity or transparency in pricing. The traders certainly earned their money getting us out.”

Naci Agbal in his office in February 2021, and his successor, Sahap Kavcioglu, less than two months later © Reuters

Kavcioglu remains an unknown quantity, albeit with clear sympathies for Erdogan’s unorthodox views on monetary policy. He could yet find a way to placate concerns at this delicate juncture where a US economic recovery could pull down the lira further against the dollar. He is expected to speak to international bankers and fund managers in the coming days, and has already said he intends to control inflation in his new role. The central bank could not be reached for further comment.

Investors say a rate cut, especially before the next scheduled meeting in April, would give an alarming sign of Kavcioglu’s intentions. They also agree that this latest shock means they would demand high borrowing costs to smooth out the risk of any further disruptions.

“It’s too early to say if we will go back in,” said Curtis at Aberdeen Standard. “You never say never. I’m an emerging markets bond fund manager and there is not an unlimited menu of countries you get to choose from, especially where there is the potential for very high returns. But it’s a much riskier place than a week ago.”

The shock also risks dealing a blow to businesses in Turkey. “The net result has been a massive tightening of monetary conditions,” said Murat Gulkan, CEO of OMG Capital Advisors in Istanbul. In a cruel irony, that could make it harder for businesses to borrow for investment, putting a brake on the growth that Erdogan seems so desperate to deliver.

Line chart of Five year CDS spread (basis points) showing Cost to protect against Turkish debt default abruptly jumps

Additional reporting by Eva Szalay.

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