Global Investing

Japanese mom-and-pop investors’ penchant for seeking high-yield investments overseas is well known. Mrs Watanabe (as the canny player of currency and exchange rate arbitrage has come to be known) invests billions of yen overseas every year via  so-called uridashi bonds, debt denominated in currencies with high yields.  Data shows the lira has suddenly become the red-hot favourite with uridashi investors this year.

In a note entitled Welcome Mrs Watanabe, Barclays analysts estimate $2 billion in lira-based uridashi issuance this year, ahead of old favourite, the  Australian dollar.

So far, Japan’s exposure to Turkey is negligible at just 1.2 percent of their emerging market portfolio investments (Brazil is 4 percent, Korea 3 percent and Mexico 2 percent).  But Turkey’s high yields (almost 8 percent on one-year bonds) and the lira’s resilience mean the figure could rise to $5-$6 billion a year. That is almost half of total portfolio flows to Turkey in 2011, Barclays says.

Its analysts note that Brazil has fallen from favour with Mrs Watanabe as the central bank there has cut rates sharply, taxed foreign inflows and pushed the real down almost 10 percent to the dollar. In contrast,  the Turkish lira is up 5 percent this year.  The central bank has signalled it will not countenance a weaker lira and kept monetary policy tight.  It has also not stood in the way of flows to local bond markets which have received almost $8 billion this year from foreigners. Barclays write:

Turkey and some other high-yielding EM countries such as Russia may find themselves beneficiaries of investor interest previously directed at Brazil and the real….If Turkey succeeds in attracting more and more of these flows, the lira exchange rate is likely to benefit, as well as the Turkish bond market where these flows could end up.

How do you cut interest rates without actually loosening monetary policy? Turkey’s central bank effectively did that today.

I wrote this morning that the bank and its boss Erdem Basci were gearing for rate cuts, thanks to the lira’s steady rise (see the graphic)  that should help tame inflation later this year (provided the global investment feel remains positive). But I also said a rate cut was unlikely to happen today. I was wrong — and right too. The central bank cut its overnight lending rate by 100 basis points to 11.5 percent while keeping the one-week repo rate  — the main policy rate — steady at 5.75 percent.

So why is this not a real cut? Note that the former overnight rate hasn’t been used for over a month. Instead the central bank has been using the “corridor” between the lending and borrowing rates to adjust policy on an almost daily basis. The upper end of the corridor is in fact used more to tighten policy when there is a need to defend the lira, analysts point out. And most importantly, the central bank has already been providing funds at the cheaper 5.75 percent rate.

Could the Turkish central bank surprise markets again today?

Given its track record, few will dare to place firm bets on the outcome of today’s meeting but the general reckoning for now is that the bank will keep borrowing and lending rates steady and signal no immediate change to its weekly repo rate of 5.75 percent. With year-on-year inflation in the double digits, logic would dictate there is no scope for an easier monetary policy.

But there are reasons to believe the Turkish central bank, whose mindset is essentially dovish, is letting its thoughts stray towards rate cuts. Consider the following:

a) Governor Erdem Basci has already said he does not see the need for further policy tightening  b)The lira has strengthened  9 percent this year against the dollar and is back at levels last seen in early September, thanks to almost one billion dollars in foreign flows to the Turkish stock market and well-subscribed bond issues. And crucially c) Global factors are supportive (developed central banks are continuing to pump liquidity and a bailout  has finally been agreed for Greece) .

Doomsayers have been prophesying Turkey’s economic boom to deflate into bust for many months now. The recent revival in positive investor sentiment worldwide ar has helped silence some voices. Others say it is a matter of time. 

Data on Friday showed annual inflation accelerated from last year’s 3-year highs to 10.6 percent in January. It is likely to remain elevated at least until May, analysts predict. And trade data released this week indicate Turkey will likely have finished last year with a current account gap of around 10 percent of GDP last year — the biggest of any major developing economy. All this appears to indicate that the central bank will have to keep monetary policy tight and might even have to even raise rates, should the current resurgence in risk appetite fade. But rather optimistically, the government is still forecasting 4 percent growth this year. The IMF says 0.4 percent is more likely. A report today by Capital Economics, entitled “Turkish boom hits the buffers”, says recession is a cinch.

Neil Shearing, the report’s author, notes that imports of both consumer and capital goods have fallen by around $1 billion over a 12-month rolling period. That indicates a contraction in private consumption and fixed investment, he writes. Some of this could of course be down to the lira’s weakness last year, that aided some import substitution, Shearing acknowleges. But he says that all signs are that: