Turkey has made it virtually impossible for foreign investors to sell the lira, averting a currency slide, but sending the sovereign’s cost of insuring against default soaring as traders flee the nation’s assets in the run-up to local elections this weekend.
Days before the March 31 vote that’ll determine who governs Turkey’s cities, many foreign hedge funds are trapped in lira trades they want to exit because Turkish banks are under pressure not to provide liquidity, according to four bankers with direct knowledge of the transactions.
That has stopped the lira, already the second-worst performing major currency in 2019, from sinking like it did in the weeks leading up to the vote last June that tightened President Recep Tayyip Erdogan’s grip on power.
But yesterday, other assets were flashing warning signals: credit default swaps spiked 40 basis points to the highest since September and the cost of borrowing the lira overnight in the offshore market rocketed beyond 700pc at one point.
“Turkey learned its lesson from last summer and won’t allow things to spiral out of control,” said Richard Segal, a senior emerging-markets analyst in London at Manulife Asset Management, which oversees $364bn.
Foreign investors have been trying to get out of Turkish holdings since last week, when JPMorgan Chase was among banks that urged investors to sell the lira, ending months of calm that allowed them to profit from the currency’s high interest rates.
Then the lira slid 5.1pc on a single day on Friday, catching the market off guard. Turkish authorities accused the New York-based lender of giving ‘misleading’ and ‘manipulative’ advice. Mr Erdogan warned on Sunday that bankers deemed responsible for speculating against the currency would be punished.
The threats only exacerbated the sell orders, but foreign funds can’t execute trades because they’re failing to find counterparties, according to the four bankers, who declined to be identified. Already, Turkish banks face a limit on how much they can lend to overseas counterparties of 25pc of their equity, a rule imposed after last summer’s rout to stop foreign investors from trying to flee all at once.
As an indication of how bad the liquidity crunch is, the cost of borrowing the lira overnight in the offshore market has surged more than twentyfold over the last two days to the highest since Turkey’s 2001 financial crisis.
As far as the currency is concerned, it’s working. The currency gained as much 8pc this week, reversing last week’s drop to around 5.30 per dollar late on Tuesday. Treasury and Finance Minister Berat Albayrak urged his supporters in Istanbul to check their phones for the latest prices, according to state-run Anadolu Agency – an apparent display of his pleasure about the currency’s appreciation.
Investors soured on the lira after data last week revealed that the central bank has drawn down its foreign-exchange reserves in March, leading to speculation it’s trying to prop up the lira before the elections. What’s more, Turkish households and businesses are holding record amounts of their savings into dollars an euros, usually a harbinger of waning confidence in the local currency.
A lot of the trapped investors were fans of the lira in recent months. The currency became a favourite among foreign fund managers after official interest rates in Turkey were raised to 24pc last September, leading to wagers the currency would continue to strengthen, known as long positions.