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Erdogan's policy shift on rates lures back investors

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Returns on local government bonds beat wider index

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Turkish stocks are up 45% year to date, lira stabilising

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Vanguard says Turkish CDS could be a big trade

By Karin Strohecker

LONDON, May 23 (Reuters) - International investors are

ramping up exposure to Turkey, focusing on local bonds and

Credit Default Swaps (CDS) as monetary policy normalisation is

becoming more deep rooted, investors and analysts said.

Almost a year ago, President Tayyip Erdogan - then fresh

from securing an election victory - endorsed big interest rate

hikes sought by markets to tackle runaway inflation, marking a

shift from an unorthodox policy that had deterred investors from

Turkey for nearly a decade.

The central bank has raised its policy rate by 4,150 basis

points in total since June last year. In its policy meeting on

Thursday, the bank kept the main interest rate steady at 50% as

expected, though it remained wary of inflation risks.

"Investors are getting back in quite aggressively now - the

numbers are really strong. There's been a lot of inflows," said

Nick Eisinger, co-head of Emerging Markets Active Fixed Income

at Vanguard, which has more than $7 trillion in assets under

management.

"We're long on the lira. We're long on the local bonds, but

not a lot, and then we're quite long on the credit," he said,

referring to the country's hard-currency debt.

Analysts at Citi agreed, saying the shift in policy had

stimulated interest in Turkish assets.

"We see the current moment as somewhat of a renaissance for

Turkish markets across local, external, corporate credit and

equity markets," Citi's Luis Costa wrote in a note to clients.

The rally across Turkish assets has been broad-based, with

the country's main stock index up more than 46% since the

beginning of the year, propelled by an around 80% rally in the

banking sector over the same period.

Returns on domestic government bonds are more than 4%

year-to-date, far outperforming the less than 1% on the wider

JPMorgan GBI-EM Global Diversified index.

The bonds had already enjoyed an initial wave of foreign

interest in November, after which it cooled. But interest had

been revived after a 500 basis point interest rate hike in March

and the opposition's success in local elections that followed on

March 31.

STABILISING LIRA

Turkey's hard-currency debt has returned 2.4% - broadly in

line with the wider JPMorgan EMBI Global Diversified index.

However, over the last 12 months, returns for Turkey were at

24.6% - more than double those of the wider index.

While the lira has weakened more than 8% against the dollar

year-to-date, the currency has stabilised since hitting a record

trough in mid-April.

Monetary conditions are quite tight now, said Vanguard's

Eisinger, with de-dollarization underway.

"In real terms, the currency appreciates, which is a good

thing, and they want to do that because it's a good anchor to

cut inflation," Eisinger said.

On stocks, Citi said it had turned neutral on banks

following the strong share market rally. Turkish Banks

Association Chairman Alparslan Cakar said the banking sector was

strong, with no problems in asset quality and the non-performing

loans rate low.

Looking forward, CDS - instruments used to insure exposure

to an issuer against default - could be the next big trade for

investors, said Eisinger.

Turkey's 5-year CDS stood at 264 basis points on Thursday -

less than half the 673 bps they were at 12 months ago.

"Turkey's CDS could easily be 225 if they get it right -

that's a big trade," said Eisinger. "If you put that on in size

and they get that right, that's a big deal."