International Bank of Reconstruction and Development denominated in Turkish Lira yielding 5.9% maturing in 18 months
Investors should consider foreign denominated debt for the following reasons:
* Instability of US fiscal and monetary policy
* Diversification can reduce overall portfolio risk and volatility
* Higher interest rates may be found in foreign markets
* US economy may be entering a stagnant growth period
* Globalization has added a risk/reward profile on sovereign debt
At Durig Capital, we have seen a large demand for foreign debt due to some of the above bullet points. We have been working hard to find issues that offer clients higher cash flow, high credit ratings and short term maturities. These criteria are hard to find individually let alone concurrently.
Investing in foreign bonds is not for everyone. These bonds are exchanged on global markets and the traders/market makers dictate what amounts they are willing to buy and sell. Currency volatility, political stability, and foreign fiscal and monetary policy, to name a few, can and will cause large swings in principal value. Many of Durig Capital’s clients were asking for much smaller allotments in single foreign currency positions and we have found a way with hard work and excellent industry relationships. While working with multiple traders at different institutions, we have filled orders of $10,000 US dollars.
One of the first items that we sought was finding issues denominated in foreign currency that are highly rated. We have review and placed Australian Government bonds that are AAA rated but emerging markets government debt has lower ratings, such as Brazil which is BBB. Thinking outside the box, the World Bank issues debt in numerous different currencies and they are AAA rated. After finding a solution to the credit worthiness dilemma, we became more optimistic that we could meet our clients needs.
After reviewing all the offerings of the World Bank, one country really stood out in a part of the world that our clients have little exposure to yet is geographically located between Europe and Western Asia. Turkish debt backed by the International Bank of Reconstruction and Development met our needs and it appears Turkey is positioned to enjoy economic growth in the future as it is one of the few top twenty economies in the world with robust growth.
About the World Bank
The specific issue noted above is for International Bank of Reconstruction and Development denominated in Turkish Lira. This is a subsidiary of the World Bank which is a multinational non governmental organization (NGO) that provides financing to developing and underdeveloped nations.
Originally the World Bank was organized in 1945 to fund reconstruction of Europe and Japan after World War II. The World Bank is funded and supported by 187 member nations. The top six supporters are the United States, Japan, China, Germany, top United Kingdom and France and represent about 40% of the overall voting power.
The World Bank currently has notes issued in over 50 different currencies. As of September 2010, they had approximately $130 billion in loan outstanding and approximately $190 billion in pledges (callable capital) and deposits from member nations. This means that the World Bank has $60 billion surplus if all loans were to go into default. In the lending limits by laws do not let them lend more than countries have pledged. They have never had to call for capital to repay a defaulted loan. Due to their fiscally conservative policies, they have received the highest rating of AAA from Moody’s and S&P respectively.
Different Types of Exposure
One should assess the risks between the sovereign debt and the foreign debt. Clients wanted to reduce the credit risk while obtaining currency exposure. The World Bank (IBRD) offers notes that address this very issue since they are AAA rated and offer notes denominated in Lira.
Issuer Yield Term Coupon Currency Rating
IBRD 5.9% 08/2012 12% Turkish Lira AAA/AAA
IBRD 7.915% 05/2017 13.25% Turkish Lira AAA/AAA
Turkey has issued debt in US Dollars. These issues pay interests and principal in US Dollars thus removing the currency risk but including credit risk. Debt issued with the removal of currency risk may be appealing to some as Turkey takes on the currency risk and cannot simply print more Liras to pay debt holders. As one may conjure, these yields with credit risk (note ratings of Ba2/BB) and without currency risk (denominated in US Dollars) have
Issuer Yield Term Coupon Currency Rating
Rep of Turkey 2.626% 03/15/2015 7.25% US Dollar Ba2/BB
Rep of Turkey 3.917% 07/14/2014 7.5% US Dollar Ba2/BB
Rep of Turkey 4.864% 02/05/2025 7.375% US Dollar Ba2/BB
Rep of Turkey 5.539% 02/14/2034 8% US Dollar Ba2/BB
A second type of exposure can be found by purchasing debt from the Turkish government denominated in Lira. This exposes the investor to both credit and currency risks.
Issuer Yield Term Coupon Currency Rating
Rep of Turkey 8.1% 11/2012 Turkish Lira Ba2/BB
Rep of Turkey 9.6% 01/2016 Turkish Lira Ba2/BB
Moody’s and Standard & Poor’s have each upgraded Turkey’s sovereign debt rating since 2005 and have established positive to stable outlooks. They currently have Ba2 and BB+ ratings respectively. Although these ratings are below the industry standard of investment grade, we like to see the positive outlook and the recent historical upgrading. In the last few years, few sovereign debt issuers have been upgraded while many have been downgraded.
Modern Turkey was established in 1923 and has had different forms of government including authoritarian, military, and its current Democratic Republic. Located on two continents, Turkey’s geographic location is an important as it is an avenue between Europe, the Middle East and inner Eurasia. Turkey literally means “Land of the Turks” as about 70% percent of the 73 million people are ethnic Turks.
In the early 2000, political and economic instability wreacked havoc in the financial markets of Turkey bringing the economy to its knees. Leadership turnover did not help the problem as they had six Prime Ministers in as many years. The Lira, Turkey currency, suffered from elevated levels of inflation. Foreign investors were spooked with the lack of political stability and inflation that eroded the real value. The government owed $23.5 billion to the International Monetary Fund alone. The financial sector in Turkey was on the brink of collapse. These are a few reasons why Turkey suffered greatly economically in the late 90’s and into the beginning of the 21st century.
Elections were held in 2003 which resulted in one party winning two thirds of Parliament’s seats. With the new coalition government, Recep Tayyip Erdoğan was elected Prime Minister and stability slowly started to returned and economic, monetary and fiscal policy standards were reestablished. In 2002 the Turkish Central Bank had $26.5 billion in foreign currency. At the end of 2010, it has been reported that foreign reserves were above $80 billion. This helps illustrate that the reforms may be working.
The Turkish economy has developed greatly since the 1980’s. Actions taken have included privatizing corporations, adapting a flexible exchange rate, increasing exports while relaxing import regulation, deregulating financial markets and lowering the levels of corruption. These steps have assisted in Turkey being recognized by the US Department of Commerce as one of the top ten promising economies of the global emerging countries. Although there is still room to improve, these are very positive signals for a nation considered as emerging.
Turkey’s GDP, as measured in Purchasing Power Parody, is the 16th largest in the world just behind Canada and slightly larger than Australia. The Turkish economy produced an estimated $1 trillion US Dollars in 2009. Since 2002, GDP has grown at an average rate of 4.5%. The government is currently estimating that it will continue to grow at a rate of 6.8%, 4.5%, 5%, and 5.5% for 2010 through 2013. For comparative purposes, the US Central Bank revised its growth projection downward to under 3% per year until 2013 for the US economy.
With a favorable age demographic, 92% of the population under the age of 60, the young large work force is ideal for continued economic growth. The government expects the population figures to grow to 77 million by 2015. Since 2002, unemployment figures have hovered between 10% and 11%. Over the last two years, Unemployment has inched up to 13%. The recent rise may be attributed to the global financial crisis, however if these unemployment rates could be reduced, growth prospects may be even better than current outlooks. Having a young growing working class is important to economic growth theories.
One ratio we like to assess when looking at foreign government debt is the general government debt to GDP ratio. Below one will find these numbers as reported by the Turkish Undersecretariat of Treasury. Since 2004, this ratio has trended downward—-a good sign. It is important to note that it did increase in 2009 due to the global financial crisis. It is expected to remain constant for 2011. Current levels are still well below the 2004 reported ratio even after global credit lending froze and are currently better than many of the “Big Boys” in the European Union.
Deregulation of Banking System
One of the reasons why Turkey has experienced such exponential growth in recent years is due to the modernization and deregulation. These developments have In the recent news, Western European nations such as Greece and more recently Ireland have needed foreign assistance to stay solvent. Ireland recently asked the IMF and European Union for an estimated $110 million dollar loan. These loans are needed due to the Irish government backing of the fragile banking system. The Turkish banking sector, on the other hand, seems to be in a healthy state due partially to the deregulation that has been occurring since 2002. Without going into to much detail regarding private banking debt, Turkey seems have superior capital coverage similar to the Brazilian financial markets. From an outsider’s perspective, it seems like fate of the Irish and Turkish banking systems are not the same.
One of the criteria we review is the Heritage Foundations World Economic Freedom Rankings as we did with our review of Hungary. Turkey ranked 67th in world which his above average. Although the ranking is not as high as Hungary’s, more importantly we focus on looking for countries with improving levels of freedom. Over the last three years, the score has move up from 61.6 to 63.8 to 64.2. We like to see a rising trend as we believe economic freedoms are a key part of economic development.
Social unrest is an example of an additional risk one must assess before purchasing foreign denominated debt. Just in the last week, Egyptians have taken to the streets demanding political change. This unrest has almost completely shut down the economy. One can see how regional unrest, Egyptians may have been inspired by Tunisians, could cause a ripple effect that involves the supra regional powers such as Turkey. Turkey has held elections and has had peaceful transitions of power in recent history. Egypt has held elections however they are seen as ceremonial and Hosni Mubarak has held power since the early 1980’s. Social unrest will cause values to fluctuate relative to the US Dollar or other currencies.
One of the larger risks associated with this issue is currency risk. The value of the Turkish Lira compared to the US Dollar is in continual change. Currencies trade on numerous global markets on a continual basis. The 5.9% yield mentioned above represent a yield to maturity if currency levels were to stay the same. Should either the currency appreciate relative to the other realized returns will be affected.
There are other risks to consider and each investor situation should be assessed individually regarding suitability. For additional suitability requirement please contact an advisor.
The currency and political issues could and most likely will, affect future returns. The United States government is experiencing massive growth with debt levels and showing a lack of control or realistic solutions. This can be seen with America again approaching it debt ceilling level established by congress of $14.3 trillion. It grew a projected $105.8 billion in January 2011 alone. Turkish policies have been able to reduce their debt load in recent years. If you have followed our methodology over the weeks, it is easy to understand why we like issuers, corporate or government, with smaller amounts of debt and brighter prospects and this is one of the reasons we like Turkey.
As numerous academic studies have illustrated, diversifying ones portfolio will help reduce systematic risk. This is just another way for the investor to diversify away a portfolio heavily weighted in US Dollar denominated debt. While being able to reduce the overall risk, a yield in the range of 5.9% for a year and a half is pretty good considering the current interest rate environment. Turkey’s dynamic economic growth, geopolitical position between Westernized nations and Arab nations and their fiscal and monetary policy management gives the Lira a bright outlook. Washington’s policy of weakening the US dollar in an effort to repay US debt may continue to deteriorate the real value of the US Dollar.
Durig Capital’s clients currently own Turkish debt issued by the World Bank.
To know more about this World Bank bond call our fixed income specialist at 971-327-8847
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