By Sujata Rao and Ebru Tunca
Turkey’s deteriorating finances are hurting the country’s banks whose reliance on dollar funding makes them vulnerable to the worst-case scenario: a sudden halt or reversal of foreign investment flows.
International investors are growing nervous about Turkey for a variety of reasons. But US legal action against a number of Turkish individuals over alleged Iran sanctions busting – and the risk that some of the country’s banks might be sucked into the case – lies at the heart of the latest concerns.
Since Turkey’s financial crisis in 2000, its banks have earned a reputation as being among the best-run in emerging markets, holding capital reserves far above those required by global rules.
They are still borrowing funds on international markets for lending on to domestic clients, and executives say they do not expect any significant future difficulties.
Nevertheless, borrowing costs are rising for the banks, which have accumulated dollar debt piles equal to a third of Turkey’s total foreign debt. Bank shares are down 20 per cent since mid-August, outstripping a 5 per cent fall on the broader Istanbul index in this period.
The lira has fallen more than 10 per cent against the dollar and euro in the past three months alone, clocking losses of over 50 per cent since the end of 2012.
Several factors are at work, including fears that Turkey’s credit rating might be downgraded, government resistance to higher interest rates despite double-digit inflation, and tensions between Ankara and Nato ally Washington.
Now a Turkish-Iranian gold trader has pleaded guilty in New York to conspiring to evade US sanctions against Iran and is cooperating with US prosecutors in the trial of a Turkish bank executive.
Any possibility that Turkish banks themselves might become involved, landing the kind of huge fines slapped on others for sanctions-busting, would have severe consequences for the lenders and the wider economy.
“If (fines) do materialise I would assume that all lending would stop until it becomes clear if institutions around the world can lend to Turkish banks or not,” said Alaa Bushehri, an emerging debt portfolio manager at BNP Paribas Asset Management.
Turkey’s bank regulator and government officials have denied reports in Haberturk newspaper that six unnamed Turkish banks could face fines worth billions of dollars.
But Turkish banks’ dollar bonds generally reflect investors’ nervousness, Bushehri said. On average, yields are 100 basis points above sovereign debt, whereas most big Turkish non-bank firms have lower funding costs than the government, she noted.
Turkish banks also trade with higher yields than similarly- or worse-rated banks in Russia, an emerging market peer which is directly subject to Western sanctions.
US prosecutors have charged nine people in the case, including the deputy general manager of Turkey’s Halkbank, who is on trial in New York. He has pleaded not guilty.
The gold trader, Reza Zarrab, described in a federal court in Manhattan on Wednesday how he ran a sprawling international money laundering scheme aimed at helping Iran get around US sanctions and spend its oil and gas revenues abroad.
A former Turkish economy minister is among the defendants, although he is not currently on trial and denies all charges. Ankara says the case is politically motivated, while Halkbank has said all of its transactions have fully complied with national and international regulations.
“If the trial were to end with fines on Turkish lenders, economic implications for Turkey could be highly adverse,” TD Securities said in a note to clients.
Inflation hit a nine-year high of 11.9 per cent in October, while Turkish bond yields have reached record levels above 13 per cent. Ratings agency Standard & Poor’s said on Wednesday an insufficient response by the central bank would be an immediate concern for Turkey’s sovereign debt rating.
Deputy Prime Minister Mehmet Simsek has promised the government will do whatever is necessary if its banks are hit by the US trial but Mehmet Emin Özcan, CEO of state-owned Vakifbank, expects no negative impact.
“We didn’t face any problem with borrowing from international markets and I don’t think we’ll have a problem in the future,” he said this week.
Still, investors’ fears persist. While international sanctions on Iran were eased last year, US measures remain and penalties for any infringements can be devastating – as a $9 billion fine on French bank BNP Paribas last year attests.
The potential damage of any fines on Turkish bank reserves has exaggerated the lira’s weakness, compounding the problems of the banks which have about $172bn in external debt, according to Fitch ratings agency. Of this, $96bn is due within the next year, the data showed at the end of September.
The issue is central to Turkey’s economic health and growth. As in other countries with low domestic savings, it relies on foreign borrowing, with banks acting as the conduit for a major part of the flows. Any stop in the financing could wreak havoc.