TURKISH GOVERNMENT INTEREST RATES SPIKE

C O N F I D E N T I A L SECTION 01 OF 02 ANKARA 002628 SIPDIS SENSITIVE STATE FOR E, EB/IFD/OMA, AND EUR/SE TREASURY FOR OASIA - RADKINS AND MMILLS NSC FOR BRYZA AND MCKIBBEN E.O. 12958: DECL: 05/10/2006 TAGS: EFIN ECON TU SUBJECT: TURKISH GOVERNMENT INTEREST RATES SPIKE REF: A. ANKARA 2600 ¶B. ANKARA 2599 (U) Classified by Economic Counselor Scot Marciel for reasons 1.4 (b) and (d). (U) This is an Action Reqest. See paragraph seven. ¶1. (C) Summary: Turkish markets' sell-off accelerated Monday with equities, the lira, and, especially government securities falling sharply. The increase in interest rates on government debt was very large for a single day, with rates over 30 percent for the first time in 2004. In Turkey's case, today's global sell-off in emerging markets was compounded by a worse-than-expected current account deficit announcement late Friday and local tension between the GOT and the military over legislation to ease university entrance for graduates of religious high schools. In view of the market problems, Post recommends Washington accelerate consideration of the GOT's latest proposed language for the Financial Agreement, so as to be ready should the GOT press us for an answer. End Summary. Markets Bad Mood Turns even more Sour: -------------- ¶2. (Sbu) The sour mood in the markets at the end of last week turned significantly worse today. As reported in ref b, after the markets closed Friday, the Central Bank announced a worse-than-expected current account deficit for February of $2.066 billion. This set the stage for markets to fall at the opening Monday, which they did. In addition to the current account deficit announcement, markets were hit by a global sell-off and a particularly negative mood for emerging market assets. Exacerbating the negativity was that transaction volume was relatively thin as Turkish markets awaited the outcome of this afternoon's Council of Ministers meeting (still ongoing at this writing). Central Bank Governor Serdengecti was due to brief the Council, and after the markets' close some of his (mostly critical) comments were reported by Reuters. Some Istanbul analysts had told econoff last week that they expected a Central Bank intervention if the TL/dollar rate moved (i.e. the TL depreciated) over 1.5 mm TL to the dollar. Though the lira depreciated through the 1.5 mm barrier, the Central Bank did not intervene. 
 ¶3. (Sbu) By the close the dollar was at TL 1.554 mm, vs. TL 1.502 at Friday's close, and the Euro at TL 1.820 vs. TL 1.796 mm Friday. Comparing the rates as fixed by the Central Bank, it was a 3.30 percent fall in the exchange rate. The IMKB 100 stock exchange index fell 1.145 percent from it's already low level at Friday's close, to 16.807.71. Most worrisome for the GOT, however, was the sharp increase in interest rates on government securities. In the morning, the Turkish Treasury held its reference auction. The interest rate on the reference auction is used to set interest rates paid to non-market holders of government securities, such as state-owned banks. Though the Treasury had no difficulty meeting its targeted issuance amount, the interest rates bid were higher than expected, coming in at 26.84 percent. The worse-than-expected results may have helped further drive up rates in the secondary market: by the close, the rate on the benchmark had risen to 28.76 percent, up 251 basis points in one day from Friday's closing rate of 26.25 percent, which was already over 400 basis points higher than the early-April low point. Interest rates on the benchmark for next-day settlement reached 31.28 percent. Central Bank Hesitates to Intervene: -------------- ¶4. (C) Central Bank Director General for Markets Akil Ozcay told econ specialist that he thought the markets are waiting for the GOT to announce a package of measures against the growing current account deficit (such as an increase in the tax on consumer loans) or to clarify the future role of the IMF. Comment: Post has had no indication that the GOT is close to a decision on what kind of IMF role it will request from the Fund, let alone be in a position to make a public announcement after consultation with the Fund. End comment. Ozcay admitted volatility was high, but said he doubted Central Bank intervention by itself would do much to help the exchange rate. He pointed out that it was more difficult for the Central Bank to decide to intervene now, when it would have to sell its foreign exchange reserves, than it was to buy foreign exchange as it did when the lira was appreciating. Separately, Central Bank Vice Governor Erdem Basci told Econcouns that the Central Bank was not overly concerned about the exchange rate, given the floating rate regime, but was concerned about interest rates. ¶5. (Sbu) Citigroup Treasurer Tijen Gumusdis told econoff that the Central Bank should have intervened today. She said markets expected the intervention when the TL fell sharply at the opening, with the dollar well above the TL 1.5 mm level. According to Gumusdis, foreign players are shorting lira assets, accelerating its depreciation. She explained that foreign investors, who had bought into long-dated government securities in January and February, cannot get out of these instruments because it is a thin market. Now that sentiment has turned against Turkish risk, these investors are hedging their exposure by shorting other lira assets, such as Turkish Eurobonds, or using options written by Turkish banks. Gumusdis also said it was very difficult to know how to deal with these market conditions, contrasting the situation today with earlier periods of volatility when the market direction bore some relationship with fundamentals. Today, the fundamentals are fine, but the markets are very negative. ¶6. (Sbu) Tevfik Aksoy of Deutsche Bank pointed out to Econoff that the sell-off in Turkish Eurobonds was the worst among emerging market countries today, even though it was a bad day for all emerging market debt. Aksoy noted how far the yield on Turkey's 30-year Eurobond had shot up: from 7.6 percent in early February to 9.94 percent today. In the domestic government securities market, Aksoy said foreigners were selling but that local banks were not willing to try to defend their large positions in government securities. Gumusdis said the foreign selling had triggered local selling of government securities. Aksoy attributed the local banks' unwillingness to defend their positions to their belief it was too strong a wave to try to fight. Likewise, he thought the Central Bank might not have been able to stop the fall of the lira, had it decided to intervene. Comment and Action Request: -------------- ¶7. (C) If the sell-off continues, ratcheting up pressure on the Government, the GOT may be in more of a hurry to get answer from the U.S. on its latest proposed language on the Financial Agreement. Post requests Washington accelerate its (preferably positive) consideration of the GOT proposal as much as possible. EDELMAN