Turkey’s default increases security costs as Erdoğan moves ahead of presidential vote

The cost of buying insurance against default on Turkish bonds has risen to its highest level since November as investors braced themselves for further market stress on signs the country may win the presidential election.

The “spread” on the five-year credit default swap widened over 100 basis points to 607bp on Monday morning, the biggest single-day movement since March 2021. Loan against default for five years.

But investors caution about bigger volatility to come. “So far everyone is in a wait-and-see position, nobody really knows how the market will react,” said Cagri Kutman, Turkey market specialist at KNG Securities.

“If Erdogan stays in power, most likely we will see CDS trade at 750bp or more,” he said.

Leading up to the vote, Turkish markets had rallied as his main rival Kemal Kilikdaroglu was leading in the polls and vowed to undertake sweeping reforms to lure back foreign capital.

But as Turkish markets opened on Monday, Erdogan was well ahead, and is now seen as the clear favorite, with the two main candidates likely to be sent to a second round of voting on May 28.

Meanwhile, the yield on Turkey’s benchmark 10-year dollar-denominated bond jumped to 9.25 percent on Monday, a sharp rise of 0.97 percentage points from Friday, to its highest level since March. Yields rise when prices fall.

Currency movements were more muted after Turkish state banks sold the dollar to support it ahead of election results. The lira was down 0.2 percent at TL19.66 against the dollar.

Timothy Ash of Bluebay Asset Management, a veteran tracking Turkey, said the government would fight to keep the lira stable for another round but would struggle to do so for much longer.

“The battlefield will be Lira,” he said. If Erdoğan wins the second round, “we will be back to the perennial balance of payments crisis and we know the story there – Erdoğan does not want to raise interest rates, Turkey has a huge demand for the dollar and they have lots of reserves” .

Turkey’s large current account deficit and lack of reserves have left importers struggling to get dollars. Citizens trying to buy foreign currency as a hedge against depreciation and inflation put downward pressure on the lira.

Ash said that if Kılıçdaroğlu had won the presidency, the lira would still have fallen to around TL25 against the dollar due to unmet demand. With Erdogan’s victory, he expected it to quickly fall between TL25 and TL30 to the dollar after the second round.

UBS analysts said assuming the government continues to boost the lira after the election, Turkey’s central bank may be forced to raise rates in the second half of the year to prevent “major deposit dollarization”. Could

Turkey’s Bist 100 stock index – which ended 2022 at a record high but has since fallen 15 percent – initially fell 6.4 percent before trading 3.1 percent lower as of local time. The financial sector was the worst performing stock, with the sector declining by 8.3 per cent.

Real estate and construction groups shot higher: Kilar Holding ranked tenth while Pacific GYO and Kyzylbuk GYO added 9.8 percent and 8.7 percent, respectively.

Kutman said the recent rally in stocks, like the dollar, was driven by local investors seeking protection against inflation and would limit downside. Investors will now look for signs of a change in economic policy from the next Erdogan administration, but as the president gave no indication of it on the election campaign, any shift towards economic conservatism was unlikely.

“Clearly the keyword now is uncertainty,” Kutman said. “There are big question marks over what might come next.”