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