Analysis-After Turkey's giant rate hike, foreign investors mull return

© Reuters. FILE PHOTO: Turkey's Central Bank headquarters is seen in Ankara, Turkey in this January 24, 2014 file photo. REUTERS/Umit Bektas/File Photo

By Nevzat Devranoglu and Karin Strohecker

ANKARA/LONDON (Reuters) - Turkey's latest massive interest rate hike has caught the attention of long-sceptical foreign investors who say they could return to Turkish assets if authorities continue to demonstrate that a return to orthodox monetary policy is underway.

The lira rallied as much as 7% on Thursday after the central bank shocked the market by lifting its key rate by 750 basis points to 25% - three times the size of the expected move.

Turkey's top officials say that they plan to take two more vital steps to reverse a years-long exodus of foreign investment as well: they will publish a comprehensive economic programme next month that will reduce uncertainties; and they will begin holding meetings with investors abroad.

Finance Minister Mehmet Simsek will kick off the investor roadshow on Sept. 19 at Goldman Sachs headquarters in New York, Reuters reported on Friday.

Though the tide may be shifting, persuading investors will not be easy: Foreigners had all but abandoned Turkey over the last five years of President Tayyip Erdogan's unorthodox and often erratic policies, which included slashing interest rates in the face of soaring inflation.

Yet five foreign investors told Reuters that this week's rate hike signalled a new independence among policymakers who are serious about addressing unrelenting pressure on the currency and reining in inflation expectations.

"It feels like they are correcting the mistakes they made with their first rate hike decisions," said Viktor Szabo, portfolio manager at abrdn in London. "And it is a sign that the pressure continued on the currency."

Ola El-Shawarby, deputy portfolio manager for Emerging Markets Equity Strategy at Van Eck, said: "We have some exposure and we are getting more comfortable with the overall picture so we are getting more constructive."

    "The more proof we get of the return to orthodoxy the more likely we are to revisit these investments," she said.

ERDOGAN QUESTION

Faced with badly depleted FX reserves and other economic strains, Erdogan, fresh from winning re-election in May, appointed Simsek and picked as central bank governor former Wall Street banker Hafize Gaye Erkan - the first woman to run the central bank - to turn things around.

Vice President Cevdet Yilmaz told bankers that next month's "medium-term programme" will detail a transition to increased economic and financial predictability and include three-year macro forecasts. The investor roadshow will also accelerate, he added.

Simsek has stressed his team has political support for its plan, which should see inflation begin to cool around May of next year.

Erdogan, who has fired four central bank chiefs in four years, has said little about the rate hikes.

"They will have to raise policy rates further in this cycle to have a lasting effect on international investors," said Blaise Antin, head of EM sovereign research at asset manager TCW in Los Angeles.

"The question is whether they have Erdogan's green light to keep going."

The central bank said on Thursday it will hike rates more as needed and JPMorgan (NYSE:JPM) predicted they will hit 35% by year-end.

TENTATIVE STEPS

With inflation seen rising to near 60% by the end of the year from almost 48% last month, the rate hikes partly narrow the gap.

Though Turkey's international bonds are widely held and form part of key indexes, the country has struggled to lure foreign investors back into its domestic bond markets after a series of lira crises and de facto capital controls.

Foreigners hold less than 1% of Turkish bonds, down from 10% in 2019 and 20% in 2015, official data shows. Over the last three months, bonds saw only $110.5 million in cumulative foreign inflows, while stocks saw a rush of $1.7 billion.

Turkish stock, Eurobond and CDS markets are more attractive targets this year and next, especially after the rate hike, investors and officials say. New investments from Gulf states have helped to buy time and refresh FX reserves.

"Ultimately for investors the end rate matters - but it is more that the central bank is ready to act when needed," said Kaan Nazli, portfolio manager at asset manager Neuberger Berman in London. "But seeing that change is a positive thing."

Aside from the combined 1,650 basis points in monetary tightening since June, there are other signs of lasting change. Authorities have raised taxes to limit budget deficits, cooled domestic demand, begun rolling back a costly depreciation-protected deposit scheme, and raised FX reserves by $20 billion to head off any possible current account deficit crisis.

In an interview with newspaper Yeni Safak, Simsek said Turkey held huge promise for foreign investors as long as "we follow rules-based policies in line with world norms."

After meetings in New York and at the United Nations - which Erdogan is also expected to attend - Simsek listed plans for trips to London and an International Monetary Fund event in Morocco, as well as other meetings in Japan, Singapore and Hong Kong by the end of the year.