In emerging Europe, Turkey is the investors favorite


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(By EM) Turkey is investors’ favorite in emerging Europe as it was recently upgraded to investment grade, but some analysts warn about the tide turning

With its upgrade to investment grade, easing monetary policy and improving growth outlook, Turkey is the favorite macro story in EEMEA, Bank of America Merrill Lynch analysts Turker Hamzaoglu, Raffaella Tenconi and Arko Sen wrote in a market note.

“Turkey received by far the most interest in our meetings with fixed income investors,” they said. “Even though the investment grade is largely discounted, since it came from Fitch, there’s a general acceptance that the global backdrop and the macro story on the back of lower rates puts Turkey in a sweet spot.”

Turkish assets “would remain supported” until Moody’s – considered the most conservative of the big three rating agencies – deliver their upgrade, expected to raise turkey to investment grade by the third quarter next year at the latest, the Bank of America Merrill Lynch analysts said.

“Also note that the relatively more troubled outlook for EEMEA either because of country-specific problems (eg. South Africa, Hungary) or the eurozone recession helps Turkey win the beauty contest,” they added.

Bonds denominated in Turkish lira are the most popular, with investors liking both the short and the long-end of the nominal bond yield curve, they said. On external debt, investors maintained their position in Turkish Eurobonds after the upgrade.

Local currency is usually the best performing asset class before and after an upgrade but, the Bank of America Merrill Lynch analysts said, this might not be the case for the Turkish lira (TRY) as Central Bank Governor Erdem Basci warned last week that the currency had become almost overvalued.

The central bank (CBRT) will take action if the real effective exchange rate (REER) exceeds 120.

“The CBRT has unambiguously warned the market that they are itching to intervene to weaken the TRY. Our calculations show that we are now perilously close to this level – you have been warned!,” strategists at HSBC said.


They estimated the current value of the REER at 119.24, implying that a policy response may be closer than markets anticipate.

“Position for range-trading in the Turkish lira,” Benoit Anne, foreign exchange strategist at Societe Generale, also said.

“The CBRT has made it very clear that it would counter any appreciation of the currency outside of its comfort zone. We recommend a strategic positioning in anticipation of the CBRT counter-appreciation actions.”
But Turkey also seems to be among the most vulnerable countries from one point of view. Many emerging markets still have big current account deficits, with some, like Turkey, posting wider gaps than during the years before the financial crisis, William Jackson, an emerging markets economist at Capital Economics, said.

He pointed out that a deficit that is funded by foreign direct investment is more sustainable, because FDI flows are relatively stable and coming in for the long term; portfolio inflows, by contrast, tend to be sensitive to swings in appetite for risk at a global level and are easier to pull out.

“Turkey appears to be the most vulnerable economy on account of the composition of net capital inflows,” said Jackson. About 75% of Turkey’s total inflows are made up of portfolio and other inflows, typically loans from foreign banks.

“Accordingly, it looks like Turkey’s current account deficit makes it one of the most exposed emerging market economies in the event of a deterioration in the external funding environment,” he also said.

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