Spreads on Turkish government bonds have widened since last Friday — the day before the shock sacking of Central Bank of the Republic of Turkey (CBRT) governor Naci Ağbal, who had been in the post only five months — as a reflection of president Recep Tayyip Erdoğan frustrating emerging market investors yet again.
As of Thursday, its 2026 bond was trading at a cash price of 93, wider by 169bp than last Friday, while its June 2031 bond was 116bp wider at a cash price of 90.1.
Turkey's 10 year CDS was up to 490bp on Thursday evening from 337bp last Friday. Similarly, the lira has lost the gains it made in recent months, reaching TL7.95 on Thursday evening, from TL7.21 last Friday.
Investors say the latest move, which marks the third central bank chief sacked in two years, has led to a loss of confidence and trust in Turkey’s credit reform story.
The loss of a respected governor — who was previously the finance minister between 2015 and 2018 — after he hiked the key interest rate from 17% to 19% last week, has convinced many that Erdoğan's dogma of unorthodox monetary policy is more critical to him than tackling inflation, which currently stands at 15.6%, and enticing investors.
“Central bank independence in Turkey has been eroding pretty steadily for at least five years now,” said Ed Al-Hussainy, senior interest rates and currencies analyst at Columbia Threadneedle Investments in New York. "The problem in Turkey is the intersection of multiple bad worlds: low growth and high inflation. The government has thrown a hand grenade into the mix by chucking the CB head. Now, we will see a weaker currency, weaker growth and potentially much higher inflation."
Policy credibility, which the CBRT was trying to regain after the November appointment of Ağbal, has now been severely damaged for many Turkey-watchers.
Yields on Turkey's 10 year government bond have risen from 14.105% on last Friday's close to 18.265% as of Thursday evening.
Ağbal’s replacement with a champion of unorthodox monetary policy, Şahap Kavcıoğlu, is of concern to investors worried about inflation.
“The medium-term direction for Turkey is not positive at all,” said an EM portfolio manager in London. “The CBRT has lost credibility and there are questions about where policy is going from here. The problems are getting bigger. We are not necessarily worried about default risk, but about the general governance and economic strategy. That is going to force investors to stay underweight.
“Shocks like this are the reason we tend to stay underweight on the sovereign and prefer the multinational corporates that are not wholly dependent on domestic circumstances."
The loss of confidence has not just touched international investors, but even the characteristically optimistic Turkish market participants.
“I was more optimistic under the previous governor because it was becoming a more rational decision-making environment [with] foreseeable actions,” said a senior banker at a large Turkish bank. “This time we are yet to see that... I am generally optimistic for the country, but the ghosts of last year's policy mistakes is spooking people.”
Those 'ghosts' were features of Erdoğan's unorthodox policy — limitations on swaps, the depletion of foreign exchange reserves and encouragement of loose domestic lending by banks.
Market access
An international bond sale for Turkey is now unlikely. Of its planned $10bn of Eurobond funding for the year, the government has raised only $3.5bn in a dual-tranche trade in January. If weaker growth persists, Turkey will need more cash and faster, but international capital may be out of reach.
“Market access is cut off for now because Turkey knows it would not be able to come to market in true Turkey fashion, i.e. printing flat to the curve,” said an EM portfolio manager.
Investors, unsurprisingly, said that as long as uncertainty around the direction of the CBRT continues, it would be practically impossible for Turkey to come to market without paying a hefty premium.
“The market is always open — you just have to pay up for it,” said Al-Hussainy. “Clearly coming to market now would be a massive mis-step and would raise so many red flags. An investor buying a Turkey hard currency bond this week is buying into significant default risk.”
“Turkey has no chance of doing a bond right now, it is just not possible,” said Tim Ash, senior strategist at BlueBay Asset Management, calling the investment environment very challenging. “They would not be able to come to market right now... They have large external financing requirements and only around $92bn in gross reserves. They [central bank] want to avoid capital controls, they have some FX ammo to defend the lira in the short term to try and buy time — but they do not have time."
Although Turkey is one of the few emerging markets with a deep domestic funding market, investors are not confident about its capacity to support the government's increased funding.
"If Turkey turns around and wants to focus less on dollar funding and more on the locals, that would be a bad idea. There is only so much the locals can do," said a London-based investor.
One strategist noted that while access in primary markets for CEEMEA had opened back up again this week after sustained volatility in the US rates market, that access was “not the case for Turkish issuers”.
“These events have constrained Turkey’s growth prospects and made it more expensive for the governments and all sectors to borrow,” said Ugras Ulku, head of EM Europe research at the Institute of International Finance. "Turkey’s cost of borrowing is a function of its CDS spread, so any borrower going to the bond or syndicated loan market will see costs increase. Authorities may again provide incentives to banks in an attempt to ramp up bank lending, which would have adverse effects on inflation and external imbalances."
Test for banks
The increase in Turkey’s cost of funding comes at a particularly crucial time for its banks.
Top tier lenders are in the midst of the first biannual syndicated loan refinancing of the season. A number of banks are already in the market, including Akbank, Ziraat Bank and Yapı Kredi, according to market sources, while its sovereign wealth fund tapped lenders for a €1.25bn loan this month.
Akbank, which is in the syndicated loan market with its debut ESG loan, is looking to roll over a $603m-equivalent dual-currency loan. That loan, sources said, was meant to feature tighter pricing than its last foray into the market.
Even in the depths of Turkey’s 2018 currency crisis, its banks were able to successfully roll over syndicated loan refinancings and proved their well-known status as resilient credits.
International lenders and investors will re-evaluate Turkish credit risk, but borrowers are hoping that will not change.
“There have been no changes to pricing so far, but we are still observing,” said an Istanbul-based banking source involved in a refinancing. “We have been through more volatile days, so having to agree on a pricing that is acceptable and move on is what should be done… Indeed, last week’s change was somewhat unexpected. It has been disappointing for many people.”
Uncertain outlook
The CBRT’s next Monetary Policy Committee meeting will be held on April 15. The market, investors said, was already pricing in a potential rate cut with Kavcıoğlu at the reins of the central bank.
Investors have called a reverse of last week’s warmly welcomed hike as a “suicidal” move that would completely destroy Turkey's standing in markets, though added that with Turkey, nothing was ever off the cards.
Some suggest that investors are already bracing for the worst.
"Our baseline scenario is that the central bank will keep the current stance unchanged on April 15," said Ulku at the IIF. "Ideally we would like to see Kavcıoğlu hike rates, but that is unlikely. The market is now pricing in a rate cut from the CBRT and it will continue to send strong signals ahead of the meeting that they will not accept a reversal.
"The market was satisfied with the performance of Ağbal, so Kavcıoğlu will really need to prove to investors that the CBRT is as serious about bringing down inflation."