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Turkey's attempt to stem lira rout may come back to haunt it

The lira fell on Friday as prospects of further US sanctions and downgrades by S&P and Moody's spurred uneasiness before Turkish markets closed for a week-long public holiday.


WHILE Turkish authorities may have stopped the lira from haemorrhaging, their measures may cost the country's debt and equity markets.

By squeezing liquidity out of the offshore currency swap market, the banking regulator forced speculators betting against the lira to close their positions. That also made it much harder for foreign investors in local bonds and stocks to hedge their currency risk. Now, it looks like they're bailing.

The yield on five-year local currency bonds jumped more than 250 basis points last week to a fresh record and the benchmark stock index led global losses. That's a sign that stop-gap actions to stem the currency slide had unintended consequences, even as the battered lira staged an impressive recovery.

"The risk is you're throwing the baby out with the bathwater," said Anders Faergemann, a fund manager at PineBridge Investments in London. "If you hold Turkish assets you're now unable to hedge the currency. We saw that in Malaysia last year and it creates uncertainty. If you can, you're probably going to sell your local bonds. We're seeing the same thing in the stock market."

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Foreign investors exchange their dollars and euros with Turkish liras held by local banks through forward agreements to take directional bets on the currency, as well as to hedge their exposure to the country. So when the Banking Regulation and Supervision Agency, or BDDK, capped local lenders' swap and swap-like transactions to just 25 per cent of shareholder equity on Wednesday, liquidity began to dry up, rates surged and many investors had little option but to offload their holdings.

On Friday, the banking regulator expanded its limits on currency swaps to non-swap derivatives. Turkish banks' purchases of lira forwards, options and other non-swap derivatives cannot exceed 25 per cent of banks' legal shareholder equity, BDDK said on its website.

The Turkish lira has effectively become "untradeable", David Riley, chief investment strategist at BlueBay Asset Management LLP, told Bloom-berg Television.

The currency fell on Friday as the prospects of further US sanctions and downgrades by S&P Global Ratings and Moody's Investors Service spurred uneasiness before Turkish markets closed for a week-long public holiday. As things stand, the fear is that there's little investors can do to protect themselves from the turbulence.

"Offshore investors with lira assets will be faced with a difficult question," said Erkin Isik, a strategist at Turk Ekonomi Bankasi AS in Istanbul. "Either to close their lira position, convert to dollars and exit, or to continue bearing lira risk. In the absence of an improvement in US-Turkey relations or a credible economic programme, we think the outflows will accelerate." BLOOMBERG

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