Market Bets U.S. Won't Let Turkey Default on Its Debt
3/7/03
By CRAIG KARMIN Staff Reporter of THE WALL STREET JOURNAL
In the middle of Russia's financial crisis five years ago, gutsy investors went on a bond-buying spree. The U.S., they reasoned, would never allow such a strategic ally to default. When Russia did just that, these same investors suffered huge losses, forcing several big funds out of business.
Now, the same bet is being made on Turkey.
Even as the Turkish stock market has tumbled on war uncertainty, investors and brokerage trading desks have been buying Turkish debt, gambling that the U.S. and institutions like the International Monetary Fund will bail Turkey out before any government default. They figure the U.S. can't risk allowing a Turkish economic meltdown at a time when America is touting Turkey as the model of a democratic, secular Muslim state -- and when it desperately needs access to Turkish military bases for a war in Iraq.
Analysts call situations like this a "moral hazard" because if lenders believe there is an implicit U.S. promise of credit they are likely to make riskier loans than they otherwise would. The lending risk doesn't go away, of course, but it is transferred from the lenders to the U.S. and other wealthy nations that would pay out the emergency aid.
But as Russia demonstrated, trying to predict how a government or the IMF will respond to any financial crisis carries risks of its own for investors.
"These aren't explicit government guarantees; they are at best implicit," says Brian Gendreau, an emerging-markets strategist for Heckman Global Advisors LLC, a New York-based research firm. "Investors are gaming the government," he says.
So far, a Russian-style economic meltdown in Turkey hasn't materialized, and Western exposure to Turkish bonds is a sliver of what it was in Russia. Despite one-year interest rates of 58%, Turkey hasn't yet missed any debt payments. In fact, bond prices have stayed relatively steady even as stocks in Istanbul have stumbled, including a 12.5% plunge Monday following Parliament's refusal to allow U.S. troops in Turkey.
Even after that Parliament vote -- which put in jeopardy $30 billion in much-needed U.S. aid -- the bonds have held up in part because of a perceived Washington safety net. Reports of a possible second parliamentary vote to approve U.S. troops only helps debt prices.
But without a perceived government guarantee, some analysts say, Turkey's financial situation would clearly be worse. For one thing, that country's bonds would be forced to offer much higher yields, further stretching the nation's coffers. Turkey has a credit rating on par with Brazil and Uruguay. But while those countries' bonds yield a range of 15% to 19%, Turkey's yield only about 11.5%. In part, that reflects Ankara's unique stance in the world: While most emerging-markets bonds fell as war in Iraq looked increasingly likely, Turkish bonds often gained in price as investors felt ever more certain that a war meant Washington's committed financial and political support.
"No question that the moral-hazard element is an important part of the reason investors are paying attention to Turkey," says Eric Fine, head of emerging-market research at Morgan Stanley.
Talk of as much as $30 billion in U.S. aid in exchange for troop deployment seemed only to bolster the case. Such a payout would vastly improve Ankara's hard-currency reserves, give the economy considerably more financial flexibility, strengthen the currency, and clear a path for interest rates to come down more quickly.
When the Turkish parliament put that aid package in doubt last weekend by failing to approve U.S. troop stationing, the 30-year bonds fell Monday in dollar price to 100.5 from 106. By comparison, the stock market's 12.5% plunge that day, which was a 25% slide in dollar terms, underscored how the perceived U.S. bailout would feed directly to bondholders, not equity owners.
The too-big-to-fail investment idea goes back at least to America's savings-and-loan crisis in the 1980s, Mr. Gendreau says, when thrifts that were suffering from poor lending decisions were bailed out by Washington rather than being allowed to fail and taking the life savings of many people with them.
The principle moved to the international arena in 1995, shortly after Mexico's bungled currency devaluation aggravated its ability to pay back its debt. The Clinton administration -- fearing economic instability in its southern neighbor would be felt in the U.S. -- sidestepped congressional objections and gave Mexico a $50 billion aid package.
Mexico paid back the loan, with interest, but the White House's actions weren't lost on global investors. So when the Russian economy began to stumble, and that country began to draw money from the IMF, the case for implicit government backing of the debt seemed even more compelling.
Russia's failure as a capitalist economy would set a terrible precedent. Even more convincing, the U.S. couldn't risk anything happening to Moscow's nuclear arsenal in the event of economic crisis. Investors noticed that every time Russia failed to meet IMF policy demands, its debt was rolled over anyhow, further implying that investors in Russia would be protected.
Even Russia's default, however, didn't mark the end of the moral-hazard idea. When Argentina moved methodically toward default in 2001, some investors still assumed that an IMF bailout would come to the rescue because international bankers feared a repeat of the emerging-markets crisis. In a move criticized by the U.S. Treasury, the IMF did lend Buenos Aires an additional $8 billion in August 2001. But by then most investors were anticipating a default and had been selling Argentine debt. That government declared a default that December.
Some maintain that the implicit safety net in Turkey remains. "Turkey's still seen as too big to fail," says Beklan Oztoprak, head of securities trading of Citigroup Inc.'s Citibank in Istanbul.
But others are rethinking the situation. David Halpert, head of Price Street Capital, a New York hedge fund, says he's still bullish on the country but has sold his Turkish bonds at a profit and transferred the proceeds to Turkish stocks, where he sees greater potential. "There was more risk in the bond market than previously realized," he says.
-- Guy Chazan contributed to this article.