Turkish Lira: Liquidity Challenges Ahead

Declining volumes in currency trading has been an overriding theme as banks have been subject to stricter regulations on their trading activities. It is early to talk about the recent Trumpflation trade has caused any change globally, but when it comes to trading Turkish lira we still see that shrinking volume is an underlying trend.

Below we present the chart that shows total annual TRY trading volumes in form of forwards, spot trading and swaps.


Clearly 2013 was a turning point when uncertainties around emerging economies started to loom, leading stronger corporate demand for forwards to the end that hedge their FX risks. That period also marked the banks losing interest in TRY spot market. More importantly, we saw a huge drop in swap volume which is consistent with our voluntary deleveraging theory which simply based on Turkish banks’ weaker demand for foreign financing given the extremely high loans-to-deposits ratio (In Turkey banks have increased their foreign borrowings to finance the lending growth due to weakness in deposits, used swaps to hedge those positions). We believe that this credit positive, growth negative.

We note that spot trading volume of TRY declining roughly 14% y/y is worrisome that the currency is now more exposed to liquidity risk. As reported in some media outlets, global investment banks are now kind of through with TRY market. We expect TRY to remain volatile for some time come, which could partly offset by rate hike by the central bank. Our prospect is for a 2017E 10% policy rate and we recommend investors to consider 1-year xccy swaps afterwards.

Turkish Stocks: Banks v Industrials

One of the key market themes that marked this year has been the bank stocks trading with low multiples and the advancement in the industrials. Time and time again we uttered that the golden age of Turkish banking is over (see here and here) which was finally embraced by a top banker in Turkey. Given the banks capturing a dominant share of the Turkish stock market the BIST 100 index has expectedly performed poorly.


We also have seen the ratio of the Turkish banking index (BIST:XBANK) to industrials index (BIST:XUSIN) falling below 2 this year which may have seemed like an anomaly from a historical perspective. A part of analysts attributed this to the start of a bear market while the other part mentioned a changing overall market trend. Despite the fact that I have been long-term bear and clearly recommended investors to avoid from risky Turkish assets (and EM in general), I also believe the upheaval in Turkish market has begun forcing investor to be extremely selective to be able to make a winning pick.

Turkish Stocks Volume - Banks v Industrials

Turkish Stocks Valuations - Banks v Industrials

Interestingly, according to volume data the dominance of the banks are likely to continue. This may require the fund managers moving to a set of unconventional investment strategies such as smart-beta from typical index investing as hoping and holding bank stocks leave investors face a potential long-term bear market.

Profound Shift In Liquidity Risk

On Sep 15 an article appeared on Bloomberg that drew a gloomy picture for the brokerage services industry in Turkey. Some important highlights from the article are as follow:

  • About one third of brokerages posted losses in the first quarter.
  • Austria-based Erste and Kuwait-based Burgan are eliminating jobs while Moscow’s Renaissance Capital is planning to shut its Istanbul office.
  • Thirty-three analysts rate Halkbank (BIST:HALKB), one more than those who rate Goldman Sachs.
  • The Borsa Istanbul 100 Index has fallen 15 percent this year with the number of shares exchanged sinking gradually.

Istanbul stock market has witnessed falling volume year to date as banking stocks that lead the market have dipped further and are now currently traded with historically low multiples. The market risk is to remain high as long as liquidity continues to dry up but at least it is not a problem that market is overlooking anymore.

Turkey - Daily Stock Market Volume

The same goes for bonds market. Many initiatives in Turkey over the past decade have sought to encourage foreign investors to participate in domestic bond market so boost liquidity in local currency instruments. The tax reform and the implementation of a price stability-oriented monetary policy have been instrumental in this regard. However, due to the globally lower risk appetite, uncertainties around the economy and most importantly the failure in the fight against inflation led the foreign participation in Turkish bond market drop to 22% with liquidity evaporating.

Lower volume causing high volatility is one of the key themes in the debt market and is evidenced by the data which is visualized below.

Turkey - Bond Market Yield Changes, Foreign Investors and Liquidity

The reverse relationship between the changes in the total amount of Treasury securities by foreign investors and the yields has been strong in Turkish bond market. However, with the lower foreign participation yields have seemed to fluctuate more strongly even if the capital outflows have been relatively small. All aside there have been some trading days with no transaction made in the benchmark bonds. Now bonds swoon definitely points to heightened liquidity risks.

Unfortunately, it is going to be challenging for investors going forward. What the recent developments in both equity and bond market highlight I just how small changes in supply and demand can make price swings more severe. Thus any move is much more painful to the downside.