“Substantial Increase in the Risk of a Downside Scenario”: Moody’s
By Don Quijones, Spain, UK, & Mexico, editor at WOLF STREET.
The risks are fast multiplying in Turkey’s beleaguered economy. In a clear sign of deterioration, Turkey’s economic confidence index plunged 9% month-on-month to 83.9 points in August, its lowest since March 2009. The country’s currency, the Lira, resumed its downward spiral. And Moody’s downgraded 20 financial institutions in Turkey.
Moody’s cited a “substantial increase in the risk of a downside scenario,” for Turkey’s lenders. The banks affected include a number of foreign-owned subsidiaries such as Turkiye Garanti Bankasi A.S. (half-owned by Spain’s BBVA), Yapi ve Kredi Bankasi A.S. (part owned by Italy’s Unicredit), ING Bank A.S. and HSBC Bank A.S., as well as large state-owned banks like Ziraat Bankasi and Halk Bankasi.
Turkish banks are particularly risk-prone in the current environment due to their excessive dependence on foreign currency funding (emphasis added):
“Turkish banks are highly reliant on foreign currency funding and had market funds of around USD186 billion denominated in foreign currency as of June 2018, equivalent to 75% of their total wholesale funds. This makes the banking system particularly sensitive to potential shifts in investor sentiment, as these foreign currency liabilities must be refinanced on an ongoing basis.”
The more the lira falls against major foreign currencies such as the dollar and the euro, the more difficulties the banks will have funding their operations. According to Moody’s, a serious funding crisis could come sooner rather than later, given that in the next 12 months around $77 billion of foreign currency wholesale bonds and syndicated loans — equivalent to 41% of the total market funding — needs to be refinanced.
“In a downside scenario, where investor sentiment shifts, the risk of a prolonged closure of the wholesale market would lead most banks to materially deleverage, or to require external funding support from the government, or the Central Bank,” Moody’s warns.
Moody’s doom-laden report sparked a fresh rout of Turkish assets, including the lira, sovereign bonds and shares of Turkish banks. Over the three-day period through today, the lira plunged plunged 8.2% to 6.65 lira to the dollar. Over the past four months, the lira has plunged 40%. Seen the other way around, 1 lira is now worth 14.9 cents:
Turkey’s banking index dropped 1.2% to 100.9%, and is now down 20 points from where it was just a month ago. The country’s sovereign bonds also suffered, with the yield on 10-year bonds climbing 19 bps to 21.95%, just a whisker away from the record set earlier this month.
Big holders of Turkish debt are already beginning to feel the pain. They include Spanish banks, which have tripled their holdings of Turkish sovereign bonds in the last five years to a not-insignificant $19.2 billion. That’s still less than a quarter of the €80 billion of exposure — the equivalent of 6.5% of Spanish GDP — Spanish banks have to Turkey’s crumbling economy.
More importantly, Turkey’s mushrooming problems are also infecting investor sentiment across many other emerging markets, spurring losses of over 5% in three weeks for funds owned by giant fund managers such as BlackRock and Pimco. Out of 18 emerging markets Turkey has led losses in August with a 31% slump, followed by a 16% plunge for Argentina, an 11% decline in Russia, and a 10% fall in Brazil, according to Bloomberg Barclays indexes.
Global bondholders are understandably concerned about this trend, especially given that it coincides, and is partly the result of, rising U.S. rates and a firming U.S dollar. These bondholders’ predictable response is to beg the IMF to step in and impose some semblance of order on Turkey’s economy, whose currency crisis has already turned into a debt crisis that is now dragging some rather large European banks through the mire.
What global bondholders ultimately want is for the IMF to lend Turkey money to bail out Turkey’s bondholders so as to put an end to the turmoil and torture in emerging markets bonds, which were selling like hotcakes just eight months ago. There’s one big problem with the plan, however: for the IMF to intervene in a country’s economy, it must first be invited to do so by that country’s respective government — and it usually attaches some unpalatable strings.
There’s no sign that Turkey’s president Recep Tayyip Erdogan will take such a step, for an obvious reason: the strings that would come attached with said loan would put an instant end to the economic growth Turkey has experienced under Erdogan’s rule. The unrestrained borrowing in cheap foreign currencies — a flood mostly of euros and dollars — that has propelled Turkey’s debt levels and current account deficit to such dangerous levels would quickly fizzle out, plunging Turkey into a deep recession, if not depression. And that would significantly erode Erdogan’s popularity.
Erdogan, who now has de facto control over most of the economy’s levers, including the central bank, has also ruled out raising interest rates any further, since that too would dampen economic growth. This has left Turkey’s central bank with virtually no ammo to halt, or reverse, the downward spiral of the currency-and-debt crisis.
On Wednesday the Central Bank of Turkey tried to bolster investor sentiment by announcing that it was doubling banks’ borrowing limits for overnight transactions at the interbank money market, bringing to an abrupt end the unrestricted funding it had offered since Aug. 13. But the measure was a complete flop, registering barely a blip on the Lira’s downward tumble.
“It’s yet more smoke and mirrors from the central bank,” said Nigel Rendell, an analyst at Medley Global Advisors LLC in London. “The change in banks’ overnight borrowing limits is aimed at trying to ease pressures on the banking system, rather than tackling Turkey’s underlying problem, which remains persistently high inflation.” In July inflation reached a 14-year high of 16%.
Until or unless Erdogan bites the bullet by allowing the Bank of Turkey to massively hike interest rates — by as much as 500 basis points according to some analysts — and/or requesting a bailout from the IMF, the problems for Turkey’s economy are only going to get worse as more and more spooked investors flee for the exits, while fewer enter the market. By Don Quijones.
But even if he bites the bullet… Because there’s Argentina: Unlike Turkey, it has bitten that bullet and has just jacked up its policy interest rate to 60% and has agreed to a $50-billion bailout from the IMF in June. And yet its economy is spiraling down and inflation now exceeds 30%. Just when you think Argentina’s financial crisis can’t get worse, it gets a whole lot worse.Read… The Price of Cheap Dollar-Debt: Argentina’s Peso Collapses 24% in 2 Days as Government Begs for Faster IMF Bailout
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Is it the time for the Cyprus Solution yet?
Sometimes the voters have to learn a lesson – good and hard.
The pain is going to get much worse – just look at Venezuela.
Voters have to learn what? That they should stop voting because all of the choices they are presented with are compromised puppets that are beholden to the people that fund them?
Have a look in your own front yard.
Seemed they did better when it was Constantinople.
really, how about some lesson from history.
some thing never change, looting is the oldest trade on the earth
The difference between Turkey and most other countries in debt crisis, is that the majority of loans are to public banks and not the IMF and World bank so they can default vs being sucked dry like Greece for a decade .Don’t take the IMF blood Money Turkey , screw the stupid bankers that lent you the money.
Doug Absolutely There’s no group of parasites that deserves it more than them
“Bag holders of Turkish debt are already beginning to feel the pain.”
Everything was peaches and cream not so long ago, that must’ve been the distribution phase.
“Turkey’s economic confidence…” from wolfstreet.com
“…shift in investor sentiment…” from Moody’s article
all hard and measurable “facts”. Is this a psychology class which most of
“modern” economy is about?
You’re extracting 7 words out of context and come up with a nonsense conclusion based on this? Didn’t you see the data, including a chart, percentages, and amounts in currency units? Dude, you’re not exactly coming across as brilliant with this method.
“On Wednesday the Bank of Italy tried to bolster investor sentiment by announcing that it was doubling banks’ borrowing limits for overnight transactions at the interbank money market, bringing to an abrupt end the unrestricted funding it had offered since Aug. 13. But the measure was a complete flop, registering barely a blip on the Lira’s downward tumble.”
Do you mean Bank of Turkey?
Yes. Thanks :-]
…for the moment, yes. But give it a little time.
I am just back from Germany and peering over the morning newspapers on Monday I saw a snippet of news I did not expect to read so soon: “somebody” is spreading the rumor the German government is “negotiating with European partners” for some form of debt relief for Turkey. The German government treated this like it deserved: a ridiculous fantasy. But I expect the beating of pans to become much stronger over the next few months. “Where’s my bailout?”
Starting in 2014, European banks started to really push Turkey as the next big thing, especially to retail investors. Turkey-focused funds and bonds were all the rage due to the “juicy” yields offered. I remember being pitched 10-years bonds issued by the Turkish subsidiary of an European banks in 2016: euro denominated ones yielded 4.7% while Turkish lira denominated ones yielded all of 9.1%. I would have bought the euro-denominated ones had the yield been much higher (at least 12% after fees and taxes) as a purely speculative endeavor, but there’s no way I would have bought anything Turkish-lira denominated over a 10 years timeframe.
But how many bought them? Both issues were oversubscribed so there must be plenty of people nervously checking their smartphones right now.
To have a laugh I’ve just checked some of the Turkey-focused funds I had been pitched throughout the years. It’s as bad as you think it is and it gets worse, as they all have long temporal horizons, running at least to 2022.
This is not enough to cause one of those apocalyptic crashes some commenters here seem to be pining for, but it’s enough for a lot of people to start becoming seriously worried. That’s their scrap of fixed yield, all they can get these days, going down in flames.
If Turkey, like Indonesia did after the crash of 1997, provides local firms with the legal justification to default to foreign creditors without consequences things could get really ugly for investors who traded so little yield for so many risks.
I expect excellent business for pan manufacturers over the next months as more and more EM get caught up with all the problems our cheap credit allowed them to ignore in return for some of the most miserable returns modern history has seen.
Assuming banks were pushing “Turkey as the next big thing, especially to retail investors” means big/smart money wanted out, do you see this happening today and if so, what are they pushing? Great post–Thanks
First of all, I live in Europe. I haven’t dealt with US banks since I definetely left the US several years ago so I have no idea what it’s hot and what not right now among US investors.
Second, do not think banks were merely getting rid of bad investments by dumping them on the unsuspecting public. As is usual the reality is far more nuanced than this.
As Wolf often repeats, investors or even simple savers across Europe and Japan have been driven to insanity by financial repression: fixed yield has been eviscerated and trampled underfoot. Yet banks need to keep customers from openly rioting and moving their money elsewhere, hence they started to offer all these EM-markets-based products, usually both bonds and funds with long maturities (over 5 years).
And that’s just retail. Institutional investors such as pension funds (which are big everywhere but huge in both Germany and Switzerland), insurance companies and the like have been particularly enthusiastic buyers of EM-markets-based products, especially securities. Again: they didn’t do this because they were misled by Hell Banks. They did this because they desperately need fixed yield and that’s the only fixed yield left, since even junk bonds in Europe yield next to nothing.
As I said before, there’s absolutely nothing wrong by buying EM bonds. I’ve held a lot in my life, especially from Brazil, Malaysia and South Africa. But they need to carry a yield proportionate to the risks you are taking, which are not just those normally associated with buying securities, but also need to take into account currency risks.
As a rule of thumb, bond issuers will always try to lock investors into long maturities (7+ years), meaning bondholders are guaranteed to face a currency crisis if they want/need to hold to maturity. Again, you have to be a fool not to demand to be compensated for such a risk, but the last decade has not been gentle to fixed yield, once the most important component of any portfolio.
Now for the saveurs du jour which are… spectacularly underperforming funds with long maturities (2023 or more) and some of the craziest derivatives I’ve seen in a decade. By “craziest” I mean they are built around FTSEMIB breaking the 25,000 barrier or decomposing Austrian banks becoming the new AAPL. You cannot make this stuff up even if you could, so I am basically shopping around for a little banking sanity. Hard to come by these days.
So where does the finger point?
Should the poor retail investors pay the banks for keeping their savings, or get 4.7% for euro denominated bonds, or lever up to buy a cottage on the seaside? Difficult questions.
Someone should own up to yet another debacle.
bank of Italy ref. above should read bank of turkey… but yes its a sound article, thank you.
“Because there’s Argentina: Unlike Turkey, it has bitten that bullet and has jacked up its policy interest rate to 45% and has agreed to a $50-billion bailout from the IMF in June. And yet its economy is spiraling down and inflation now exceeds 30%.”
Interesting that the real rate of return in Argentina is 15%! If that’s true, I suppose nobody had any confidence that the interest will be paid at all.
It’s so interesting to see so many countries, the US included, running their finances worse than individual people do. We must be reaching peak insanity soon though.
This debt is in pesos. So you take US$1,000 and convert them into pesos. With those 40,000 pesos, you buy 30-day securities issued by the government that carry 45% annual interest (about 3.75% a month). A month later, the securities mature, and you get 40,000 pesos back, plus interest of 3.75% (=1,500 pesos), for a total of 41,500 pesos. Then you convert those pesos back to USD and learn that during that 30-day period, the peso dropped 30% against the USD (it dropped 24% in just two days!), so you get about $800 for your pesos. You lost $200, or about 20%, in 30 days because the peso crashed.
If the peso doesn’t crash during the 30-day period but stays flat, you come out ahead with 3.75% return in 30 days, which is pretty good. But as you can see, there are probably better things to bet on.
What Erdogan should do is: let the banks suffocate, and advise people to hold their lira in CASH, under the mattress or, better yet, in gold.
But telling the truth just won’t fly, will it, politically…
Are these the tremors before the earthquake or a little bit of local settlement?
Earthquakes are local events: they can completely devastate a city while being barely registered only by extremely advanced seismographs 500 miles away.
Rickety buildings and lack of desaster preparedness will add to the devastation.
Earthquakes also happen in “swarms”, so you should expect more than one in the same general area.
A perfect metaphor for what EM’s have been doing for decades.
Just don’t stand near the epicenter of this one and you should be fine.
The solution requires taking a hatchet to the USD but rates seem ready to resume the move higher. The Fed could reverse itself. At the margin shaky EMs have no control over their destiny. What the IMF might do is set up an emergency EM fund but that would rattle markets, however the word “emergency” is always a signal to investors to BTD. And there is a lot of hot nervous money out there.
If any large European banks fail it could still place a threat to US banks who trade derivatives as that paper provides the interconnectivity.
There is $200 trillion of US dollar-denominated debt out there in the world…. and the US has only $20 trillion of it.
As the dollar rises… they all go bust… one by one.