GLOBAL RISK REDUCTION HITS TURKISH MARKETS

UNCLAS SECTION 01 OF 02 ANKARA 000450 SIPDIS TREASURY FOR INT'L AFFAIRS - JROSE SENSITIVE SIPDIS E.O. 12958: N/A TAGS: EFIN TU SUBJECT: GLOBAL RISK REDUCTION HITS TURKISH MARKETS This is a joint Ankara-Istanbul cable. 1.(SBU) Summary: As expected, the global market sell-off hit Turkey harder than most other Emerging Markets, particularly in the equity and foreign exchange markets. There was no Turkey-specific news flow to exacerbate the global sell-off, but market-watchers uniformly tell us Turkey is viewed as having a higher risk profile because of its current account deficit, high inflation and upcoming elections. Turkey is also vulnerable to unwinding of "carry trades" when the yen strengthens. Despite the sharp correction, neither Central Bank nor Turkish Treasury officials expressed concern and some market players tell us the situation in the markets this year should help moderate the severity of any decline. End Summary. -------------- Turkish Markets Fall More than Most -------------- ¶2. (SBU) Following a now-familiar pattern, as global investors reduced their risk profile on February 27 and 28, Turkish markets fell more than most other Emerging Markets. On February 27, for example, the Istanbul stock exchange (IMKB) fell 4.49% versus 4.44% in Argentina, 3.62% in Brazil, 3.17% in South Africa, and 3.28% in Russia. Another illustration of the potential for global nervousness about EM's to hit Turkey came on Wednesday, when South Africa's announcement of weak trade figures caused a wave of lira sales. ¶3. (SBU) The correction hit the equity and foreign exchange markets harder than the domestic bond market. Despite the partial rebound in China overnight, on Wednesday, the IMKB fell another 3% at the opening but clawed its way back to a mere 0.8% decline on the day. The lira, which was trading at 1.383 to the dollar on Monday, touched 1.43 in morning trading Wednesday before strengthening back to 1.4198 at the close Wednesday, a 1.47% loss on the day. Though the yield on the benchmark bond in the secondary market had risen to 19.92% by Wednesday's close, the move over the past two days was not as dramatic as in the foreign exchange and equity markets. It was at 19.40% at Monday's close. ¶4. (SBU) Unlike some of the down days during last year's May-June sell-off, there was almost nothing Turkey-specific about the news flow that sparked the sell-off. A market consensus has long held, however, that Turkey's outsized current account deficit, high inflation, and upcoming elections give it a higher risk profile than other EM's. Some market contacts also pointed to concerns last year's strong flows of Foreign Direct Investment, which financed the current account deficit, may not be sustained, particularly with delays in large privatizations. Turkish markets have also been turning in a strong performance since the beginning of the year, leaving them vulnerable to a change in sentiment. -------------- Strong Yen Threatens Carry Trade -------------- ¶5. (SBU) Turkish markets, like other high-yielding markets, were also hit by concerns that a strengthening yen could hurt "carry trade" investments here. Investors note that much of the money invested in Turkish instruments is the result of the carry trade, whereby investors borrow in low-interest yen and invest in high-yielding markets, like Turkey. This is particularly true of hedge fund investors and Istanbul market-watchers told us today that much of the selling was from hedge funds. Istanbul market analysts warned that a continued strengthening of the yen could send shock waves through Turkish markets as carry trades are unwound. -------------- Turkish Officials Unperturbed -------------- ¶6. (SBU) Neither the Central Bank nor Turkish Treasury officials we spoke with seemed concerned about the sell-off. The Central Bank estimated the outflow from Turkish markets at $500 million on Tuesday. The Turkish Treasury official responsible for external finance pointed out that Treasury had front-loaded its Eurobond issuances such that it has already issued more than $2 billion and has nine months in which to issue the remainder of its $5 billion 2007 targeted external market borrowing. At a policy-making level, the market correction may serve as a reminder to the risks of excessive complacency. This reminder can only be helpful to the IMF Mission arriving in Turkey March 1 to begin discussions on the Sixth Review and Article IV consultations. -------------- Differences from Last Year -------------- ¶7. (SBU) Whether or not the sell-off is short-lived, investors and analysts tell us there are some key differences with last year's sell-off that should help cushion the extent of any sharp drops this year. Turks have bought approximately $15 billion in foreign exchange-denominated assets in recent months, while foreign investors have been pouring into lira-denominated assets. The availability of foreign exchange held by locals is expected to moderate the severity of any fall in the exchange rate as Turks take advantage of buying opportunities on the dips. Traders from HSBC also told us that the technical positioning in the market was healthier than last year. They told us that many of the very short-term, risk-taking investors who were in the market last year have not returned having been burned in the May-June sell-off. Wilson