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Investment inflows pave way for Turkey to rebuild FX coffers

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Foreign investors have snapped up Turkish assets in recent weeks, opening the window for the country to rebuild its stores of foreign currency that were severely depleted in an ill-fated attempt to prop up the lira.

Analysts have warned, however, that Turkey’s newly installed finance minister and central bank chief have their work cut out for them, given the scale of the rebuild needed and the damage that the pandemic is inflicting on one of the world’s biggest emerging markets.

The draining of Turkey’s FX coffers has been one of the overarching worries of foreign investors over the past two years, since reserves are considered a crucial insurance policy against the country’s large import bill and hefty foreign debt obligations.

Gross reserves, excluding gold, have hovered around a 15-year low in recent months, according to data from the Turkish central bank.

The picture is even more bleak once an adjustment is made for a contentious accounting method adopted by the central bank last year. When tens of billions of dollars borrowed through short-term swap arrangements with commercial banks are excluded from the bank’s balance sheet, net foreign assets — a proxy for net reserves — stood at a deficit of $52bn at the end of October, according to FT calculations. 

Line chart of $bn showing Turkey's foreign currency war chest is severely depleted

A key cause of the decline was an intervention aimed at halting a freefall in the lira. The central bank spent tens of billions of dollars, according to analysts, but has failed to stem a 24 per cent tumble in the currency since the end of 2019.

The scheme was the centrepiece of the turbulent tenure of Berat Albayrak, the son-in-law of president Recep Tayyip Erdogan who ran the country’s economy until his surprise resignation last month. His successor, former bureaucrat Lutfi Elvan, and a new central bank governor, Naci Agbal, have been left to pick up the pieces. 

Their task is a daunting one, but they have a chance to turn the tide, said Hakan Kara, a former Turkish central bank chief economist.

“There is an opportunity here,” he said. “With more credible people who are saying exactly what the market expects, that will attract some inflows [of foreign capital].”

Dwindling reserves contributed to downgrades by international rating agencies and alarmed foreign investors, who pulled roughly $13bn from Turkish stocks and bonds in the first 10 months of 2020, data from the central bank show.

The shake-up in the country’s economic management has lured back some foreign fund flows, with $1.9bn shifting back into Turkish assets in the three weeks after Mr Albayrak’s departure. 

Line chart of Non-resident securities transactions (rolling, $bn) showing Turkey has attracted inflows at the end of grim 2020

A decision last month to sharply raise the central bank’s main interest rate to 15 per cent, plus the lifting of other measures that had put pressure on commercial banks to lend, is expected to help slow the credit-fuelled, consumption-driven growth that was stoking a large current account deficit and contributing to the drain on reserves.

But the pandemic provides a challenging backdrop for correcting the trade imbalance. Meanwhile, Turkish companies continue to create demand for FX as they pay down foreign debts. Such factors mean it is likely to be a “relatively slow process to rebuild reserves,” said Paul Gamble, a senior director at rating agency Fitch.

If the country can attract large enough inflows of foreign money, the central bank could begin building its coffers by starting FX purchase auctions for the first time since 2011. Some analysts warn, though, that the time is not yet right.

“It’s too early,” said Haluk Burumcekci, an Istanbul-based economist and consultant, pointing to the relatively small size of recent foreign inflows and the fact that sceptical local investors have continued to buy dollars in recent weeks.

“If there is no de-dollarisation and the central bank starts buying foreign currency, the dollar will rise again [against the lira],” he said.

Line chart of Lira per US dollar showing Turkey's lira has tumbled this year despite currency intervention

Mr Kara said that further rate rises would be “very important” for creating the right environment for reserve-building. Raising the main rate to 17 per cent and keeping it there for six months would create a “virtuous circle” that he estimates could help the central bank to add $15-20bn to its war chest. The question is whether Mr Erdogan, a staunch opponent of high interest rates, is willing to tolerate further rate rises.

“That’s the biggest risk ahead,” he added.

Steps by the central bank to reduce its reliance on swaps, and the lifting of measures that prevented Turkish banks from performing similar transactions with foreign counterparts, would help restore the normal functioning of Turkey’s financial markets, analysts said.


$15-20bn


Economist’s estimate of what Turkey could add to its FX reserves if it raises interest rates further.

But bankers expect the arrangement to be dismantled gradually to avoid an abrupt decline in the central bank’s reported reserves.

“I think public banks will continue to roll over swaps for a long time,” said one Istanbul banker.

The central bank nodded to a desire to increase reserves in the statement that accompanied last month’s rate rise.

Bulent Gultekin, a former Turkish central bank governor who is now a professor of finance at the Wharton School at the University of Pennsylvania, said that a comprehensive plan and good communication would be critical to “create an environment of confidence to reverse the capital flows.”

“It was never clear where they were going [with the previous policies] — that was the reason why they got into that mess,” said Prof Gultekin.



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Earnings beats: lukewarm reaction shows prices are stretched

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Investors are picking over first-quarter results for signs of economic recovery and proof that record market highs can continue. Stock markets have only been this richly valued twice before — in 1929 and 2000. Bulls hope strong corporate earnings and rising inflation can pull prices higher still. But pricing for perfection means even good results can be met with indifference.

L’Oreal illustrated this trend on Friday. The French cosmetics group stated that sales in the first quarter of the year rose 10.2 per cent. This was a better performance than expected. Yet the announcement sent shares down by around 2 per cent. Weak cosmetics sales were seen as a veiled warning that consumers emerging from lockdowns might not spend as freely as hoped.

Online white goods retailer AO World, a big winner from pandemic home upgrades, also offered a positive update this week. In the quarter that marked the end of its financial year, sales were £30m ahead of forecasts. But even upbeat commentary from boss John Roberts could not stop shares slipping 3 per cent.

Banks are not immune. Their stocks have outperformed the market by 7 per cent in Europe and 12 per cent in the US this year. But stellar Wall Street results were not enough to satisfy investors this week.

JPMorgan Chase, the biggest US bank, smashed expectations for the first quarter. Even adjusting for the release of large loan loss reserves, earnings per share beat expectations by 12 per cent because of higher investment banking revenues. Bank of America earnings also rose thanks to the release of loan loss reserves. Yet shares in both banks ended the week down. Goldman Sachs had to pull out its best quarterly performance since 2006 to hold investor interest.

On multiple metrics, stock valuations look steep. On price to book, banks are now back to the pre-crisis levels recorded at the start of 2020. Living up to the expectation implicit in such valuations is becoming increasingly hard.

Lex recommends the FT’s Due Diligence newsletter, a curated briefing on the world of mergers and acquisitions. Click here to sign up.



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Barclays criticised for underwriting US private prison deal

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Barclays has attracted criticism for underwriting a bond offering by the US company CoreCivic to fund the building of two new private prisons, in a new dispute over Wall Street’s relationship with the controversial sector.

The UK-based bank said two years ago that it would stop financing private prison companies, but the commitment did not extend to helping them obtain financing from public and private markets.

About 30 activists and investors, among them managers at AllianceBernstein and Pax World Funds, have signed a letter opposing the $840m fundraising for two new prisons in Alabama, which was due to be priced on Thursday.

The signatories said the bond sale brings financial and reputational risk to those involved and urged “banks and investors to refuse to purchase securities . . . whose purpose is to perpetuate mass incarceration”.

Activists and investors who pay attention to environmental, social and governance issues have sought to cut off companies that profit from a US criminal justice system that disproportionately incarcerates people of colour. As well as raising ethical issues, many also say such financing may be a bad investment because legislators are increasingly calling for an end to the use of private players in the prison system.

While Barclays is not lending to CoreCivic, activists and investors attacked its decision to underwrite the deal, which is split between private placements and public issuance of taxable municipal bonds. The arrangement is “in direct conflict with statements made two years ago” when the bank announced it would no longer finance private prison operators, according to the letter.

Barclays said its commitment to not finance private prisons “remains in place”, adding it had worked alongside representatives from the state of Alabama to finance prisons “that will be leased and operated by the Alabama Department of Corrections for the entire term of the financing”.

CoreCivic said the Alabama facilities will be “managed and operated by the state — not CoreCivic. These are not private prisons. Frankly, we believe it is reckless and irresponsible that activists who claim to represent the interests of incarcerated people are in effect advocating for outdated facilities, less rehabilitation space, and potentially dangerous conditions for correctional staff and inmates alike.”

Barclays’ 2019 commitment to limit its work with private prison companies came as other banks, including Wells Fargo, JPMorgan Chase and Bank of America, also said they would stop financing the sector.

Critics said they were not sure why Barclays is differentiating between lending and underwriting.

“You’ve already taken the stance, the right stance, that private prisons and profiting from a legacy of slavery is bad,” said Renee Morgan, a social justice strategist with asset manager Adasina Social Capital, one of the signatories of the letter. “But then you’re finding this odd loophole in which to give a platform to a company to continue to do business.”



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Hedge funds post best start to year since before financial crisis

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Hedge funds have navigated the GameStop short squeeze and the collapse of family office Archegos Capital to post their best first quarter of performance since before the global financial crisis.

Funds generated returns of just under 1 per cent last month to take gains in the first three months of the year to 4.8 per cent, the best first quarter since 2006, according to data group Eurekahedge. Recent data from HFR, meanwhile, show funds made 6.1 per cent in the first three months of the year, the strongest first-quarter gain since 2000.

Hedge fund managers, who often bet on rising and falling prices of individual securities rather than following broader indices, have profited this year from a rebound in the cheap, beaten-down so-called “value” stocks and areas of the credit market that many of them favour. Some have also been able to profit from bouts of volatility, such as the surge in GameStop shares, which turbocharged some of their holdings and provided opportunities to bet against overpriced stocks.

“We’re going into a market environment that is going to be more fertile for most active trading strategies, whereas for most of the past decade buying and holding the index was the best thing to do,” said Aaron Smith, founder of hedge fund Pecora Capital, whose Liquid Equity Alpha strategy has gained around 10.8 per cent this year.

The gains are a marked contrast to the first three months of 2020, when funds slumped by around 11.6 per cent as the onset of the pandemic sent equity and other risky markets tumbling. However, funds later recovered strongly to post their best year of returns since 2009.

This year, managers have been helped by a tailwind in stocks and, despite high-profile losses at Melvin Capital and family office Archegos Capital, have largely survived short bursts of market volatility.

It’s a “good market for active management”, said Pictet Wealth Management chief investment officer César Perez Ruiz, pointing to a fall in correlations between stocks. When stocks move in tandem, it makes it more difficult for money managers to pick winners and losers.

Among some of the biggest winners is technology specialist Lee Ainslie’s Maverick Capital, which late last year switched into value stocks. Maverick has also profited from a longstanding holding in SoftBank-backed ecommerce firm Coupang, which floated last month, and a timely position in GameStop. It has gained around 36 per cent. New York-based Senvest, which began buying GameStop shares in September, has gained 67 per cent.

Also profiting is Crispin Odey’s Odey European fund, which rose nearly 60 per cent, having lost around 30 per cent last year, according to numbers sent to investors.

Odey’s James Hanbury has gained 7.3 per cent in his LF Brook Absolute Return fund, helped by positions in stocks such as pub group JD Wetherspoon and Wagamama owner The Restaurant Group. Such stocks have been helped by the UK’s progress on the rollout of the coronavirus vaccine, which has raised hopes of an economic rebound.

“We continue to believe that growth and inflation will come through higher than expectations,” wrote Hanbury, whose fund is betting on value and cyclical stocks, in a letter to investors seen by the Financial Times.

Additional reporting by Katie Martin

laurence.fletcher@ft.com



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