Doubts cast about future of Turkish bond prices as uncertainty reigns before start of accession talks

LONDON – The rise in Turkey’s external debt prices ahead of its likely start to European Union accession talks may have run its course, with some strategists questioning if they have the momentum to rally further. Turkey’s bonds have benefited from increased investor confidence as Ankara, over the course of 40 years, has edged closer to the EU by instituting economic and political reforms. The Oct. 3 start date for talks is still not certain given lingering objections from Austria over what kind of membership Turkey should have. The bonds have lagged their peers in the emerging sovereign debt market’s recent rally, which has seen risk premiums cut to historic lows as yield spreads over benchmark US Treasuries have narrowed. Still, one of the few points of certainty among investors is that the bonds have grown expensive in the lead up to Oct. 3. What is less certain is where they go now. «I think at this point it is getting close to being fully priced in. That would not worry me so much except I think it is unlikely that talks are really going to go anywhere,» said Mike Buchanan, co-director of global macro and markets research at Goldman Sachs International in London. Buchanan believes not only will the start of talks be anti-climactic, but voices rising against full membership from within EU members Austria, France, and Germany will likely scuttle substantive talks, allowing rot to set into the process. «If talks go absolutely nowhere, and you get a very negative message from Germany that no matter what you do you (Turkey) are not going to join, it is just that much harder to use it as a carrot. And that is what worries me more,» he said. Carrots But that carrot of EU membership, which has driven Ankara down the path of reform is now starting to pay big dividends, says the other side of the argument. Dividend enough to keep the momentum in Turkey’s favor. On Tuesday, Turkey said it expects privatization deals concluded in 2005 to be worth a total of $20 billion, far higher than previous estimates. When that money hits the Treasury’s bottom line is an open question. Lehman Brothers estimates about $8 billion in hard-currency revenue will come in next year from a combination of privatizations and cash recovered by the state from bad loans. “Turkey’s spreads will tighten over the long term, especially with the privatization money coming through,» said Tolga Ediz, director of emerging markets research at Lehman. «With this cash coming in the government can use it to pay down external debt further. External public debt stock could fall to 14 percent by the end of 2006,» he said. Ediz estimates Turkey’s external public debt stock is 19 percent of gross national product (GNP), down from 23 percent at the start of the year and 27 percent at the start of 2004. Most analysts, however, agree that as long as the emerging debt market holds up, Turkey won’t suffer. What the EU does in the talks might not either. «Obviously if they stopped talks, we would have a sell-off,» said Ediz, adding that «from a Turkish perspective the EU carrot is already becoming very moldy. However, the reform process will still go on because Turkey’s track is not going to change.» Value? As government debt falls and privatization receipts cut financing needs, existing bonds should become more precious. But the value in Turkey’s bonds may have already been squeezed out. One way to measure the relative value of Turkey is to compare its bonds against Ukraine’s and how each trades against benchmark 10-year US Treasuries. Both countries are similarly rated, «B1» by Moody’s Investors Service and «BB-» by Standard & Poor’s and Fitch Ratings. In the last four weeks, the yield spread of Turkey’s 2014 bond has compressed spreads by roughly 40 basis points relative to Ukraine’s 2013 bond. It now trades 22.6 basis points wider. «I don’t think Turkey will be trading ever through Ukraine. I don’t see another 25 basis points of tightening,» said Luis Costa, emerging market debt strategist at ING. Costa says Turkey will continue to benefit from positive surprises but investors would be wise to wait. «Wait for October 3 if you are not in there now. The avenue for talks and joining will be more understandable and how fast this process might develop. If you are there now, hold. Definitely not a time to sell,» Costa said. A second way to look at the value of Turkey’s benchmark sovereign bond due in 2030 is its failure to break below a yield of 7.60 percent. «This has been a strong resistance point for the past two years,» said Peter Botoucharov, investment strategist at Convivo Capital Management in London. «The issue here is, do we have enough positive developments in the political or economic outlook to push Turkey even tighter? At this point we don’t know if we have enough.»