Markets skeptical about AKP’s proposal for Turkish debt swap

ISTANBUL – The party that may win Turkey’s elections touts a voluntary debt swap as a way to ease a crippling domestic debt burden, but will find precious few banks volunteering unless they are offered costly sweeteners. The Justice and Development Party (AKP), an untried party now leading opinion polls, uttered the unthinkable several weeks ago when its leader suggested a debt swap. Its economic managers rushed to reassure markets any such deal would be voluntary. But the domestic debt stock has already been thoroughly massaged. Whether it’s the debt held by private banks or the 55 percent of the load that the state owes to itself, both were swapped and changed and honed throughout 2001 and 2002. Banks have no need to extend maturities on their portfolios any further until interest rates fall and their clients and debt markets regain the confidence to borrow or save over terms longer than six months, analysts say. «There will be a general reluctance to move to longer-term paper but it could happen if sweeteners are offered,» said Farid Khan, banking analyst at Morgan Stanley in London. «It would not suit banks.» Tax breaks, assurances of buyers for long-term paper no one trades or a deal to take non-performing loans off bank books might be possible ways forward, he suggested. «The AK Party has been talking about it. Even if they are right, the timing is wrong,» said Mehmet Simsek, economist for Merrill Lynch in London. High rates, short terms The domestic debt stock in NATO member and EU membership candidate Turkey has swollen to around $84 billion since a 2001 crisis forced the government to come clean about huge losses lurking at state and private banks. At around half of the country’s projected 2002 gross national product, that debt load – and the painfully high rates the treasury pays to maintain it – will dominate the agenda of whatever government emerges from the November 3 elections. The AKP says its priority is to build the confidence needed to bring borrowing rates down from around an annual 65 percent. With inflation falling to an IMF end-2002 target of 35 percent, real interest rates on debt would cripple the treasury unless the market can be persuaded to lend more cheaply. The AKP makes the right noises. It says it will continue a $16-billion IMF loan deal, will encourage foreign investment and says it would be open to any proposals from private banks for a debt swap to extend maturities. One problem is that no one trades in lira paper on terms longer than a year, so low is confidence in the treasury. If banks take on longer paper, they may never be able to sell it. «Having (long-term paper) on their books exposes banks to the risk of mismatch and to liquidity risk,» said Khan. The private banks that survived the cull following the 2001 crisis have already carried out one debt swap. In mid-June 2001 the treasury swapped around $8 billion in debt at private banks, issuing longer-term foreign exchange linked paper in return for shorter-term lira-denominated debt. That deal helped banks to cover their foreign currency risks, but the way forward is limited because many observers already warn that the proportion of forex-linked debt has reached worrying proportions. Treasury statistics say that at the end of September 2002, 32 percent of the domestic debt was either linked to hard currency or in hard currency. As many Turkish firms with hard currency debt found out in a 2001 lira collapse, that poses risks. «A sudden real depreciation of the currency would add further strain to the debt’s sustainability,» the Organization for Economic Cooperation and Development (OECD) warned last week. Turkey always points to the high proportion of debt held by state institutes as its secret weapon in its battle with debt. The government that inherits Turkey’s massive domestic debt load after the elections will rapidly realize that the state owes more than half of the roughly $84 billion to itself. Treasury statistics show that of the 140,291 trillion lira in domestic debt at the end of September, 55.2 percent was held by institutions ranging from state banks to the state fund that quarantines the country’s failed private banks. That state debt lives in a different world to the heated debt market in Istanbul, partly because of a string of maturity-extending swap operations the treasury carried out over the last two years. The treasury hardly dares auction maturities of more than a year to the jittery market for fear of rejection. Meanwhile, the average maturity on «non-cash» bond sales – a codeword for sales to public bodies – was 63.5 months in September. If the treasury can announce that the average maturity on its entire domestic debt stock is 35.4 months, then it has its pliant state creditors to thank. Those lenders are also obliged to be flexible when it comes to rolling over their loans. «It’s very important. It impacts on the rollover issue,» says Tolga Ediz of Lehman Brothers. «The principle can be extended indefinitely.» But with much of that debt held by state banks that Turkey has promised the IMF it will privatize, problems loom there too. «The problem comes when they want to privatize these (state) banks,» says Ediz. No purchaser would want to take on a portfolio that bears so little relation to the maturity of the savings accounts of the bank clients, he says. If the lagging sale of the state banks is ever to take place, the treasury would have to find another place to store its long-term debt.