Cablegate: Eu Decision Prompts Market Rally and Interest Rate

Published: Tue 21 Dec 2004 03:53 PM
This record is a partial extract of the original cable. The full text of the original cable is not available.
E.O. 12958: N/A
B. ANKARA 6947
C. ANKARA 6700
1. (SBU) Summary: The EU decision to give Turkey a date for
accession negotiations, underpinned by the news earlier in
the week of a new IMF program, sparked a rally in Turkish
financial markets. Though the markets ended up on Friday,
confusion over what was really happening in Brussels created
uncertainty, and the big rally for the lira and government
securities, came Monday. The Central Bank accommodated and
encouraged the market with a 2 percentage point cut in
short-term rates early Monday and announced it would resume
its foreign exchange purchase auctions this week, without
waiting for the new year. The Central Bank also publicly
confirmed that it would move to formal inflation targeting as
of January 1, 2006, as agreed in the IMF program. The
confluence of good news leaves the market in a bullish mood
heading into 2005. End Summary.
Market confusion over EU decision Friday:
2. (SBU) After hesitating earlier in the week over the
confusing EU news flow, markets moved up Thursday and Friday,
betting on a positive outcome in Brussels. On Friday, markets
had a rough time figuring out what was really happening in
Brussels. Markets opened lower on fears the discussions were
going badly, then worked their way back up to close up on
increasingly positive hints--but no confirmation by the
close--that Turkey had reached an understanding with the EU
Council. The uncertainty during the day, and the importance
of the decision, resulted in a huge (TL 2.1 Quadrillion or
$1.5 billion) trading volume. In the end, the IMKB 100 stock
price index hit a new record, at 24,503. The increase from
Thursday's close was only 0.58% increase, following the 1.78%
surge on Thursday. The lira, despite falling at the opening
Friday ended up pretty much where it started at 1.403 million
to the dollar and 1.891 to the Euro. Though Thursday's
optimism had caused the interest rate on the benchmark July
5, 2006 bond to come down 91 basis points, from 23.27% to
22.36%, Friday's uncertainty caused the bond to give up half
of this gain, as the rate rose 44 basis points to 22.80%.
EU decision and Interest Rate Cut Cause a Rally in Lira and
Bonds Monday:
3. (SBU) Having digested the confirmation of the EU decision,
the markets opened with a bang Monday. They were quickly
given an assist by Central Bank Governor Serdengecti, who
announced an interest rate cut early in the trading day (see
below). The lira broke out of what had been its trading
range, strengthening on the day against both dollar and euro,
ending up at 1.386 million to the dollar and 1.855 million to
the euro. The Central Bank interest cut helped the benchmark
bond interest rate to fall 150 basis points on the day.
Though this was less than the 200 basis point cut on the
Central Bank's overnight rate, it represents a 206 basis
point fall since the close on December 14. Though the rate
cut is for the shortest maturities, it tends to bring down
the entire yield curve, as banks fund their purchases of
longer-dated paper with short-term deposits (ref a). The
stock market, on the other hand, though it started to move up
in the morning, ended the day Monday almost flat with a loss
of 0.08% at 24,341.
4. (SBU) The rally was both accommodated and given impetus by
a Central Bank announcement early Monday that it was cutting
its simple overnight borrowing rate from 20% to 18%. For
months analysts had been predicting a further rate cut by
yearend, ranging between 100 and 200 basis points. The
Central Bank, however, has a track record of waiting until
positive reform-linked events are confirmed (such as IMF
reviews, or the EU decision) before cutting rates as a way of
maintaining pressure on the GOT to stay on the reform track.
True to form, the Bank waited for the IMF and EU
announcements before moving to cut rates. The markets wait
was rewarded both by the cut being at the top of the expected
range. By one analyst's calculation, ex ante real interest
rates are now only 10.3%, the lowest level since the
introduction of implicit inflation targeting after the 2001
financial crisis.
Resumption of Foreign Exchange Purchase Auctions:
--------------------------------------------- ---
5. (SBU) The market was also pleased with the Central Bank's
announcements about resuming foreign exchange purchases.
Taking advantage of favorable market conditions (i.e. strong
inflows of foreign exchange), the Central Bank announced it
would resume its foreign exchange purchase auctions on
Wednesday, December 22. The Bank had agreed with the IMF on
the desirability of resuming these auctions, which will allow
the Central Bank to build up reserves in anticipation of
large external debt payments coming in 2005. But it only
made a public announcement on Monday, and moved up the start
date to this week because of the rally. The Central Bank and
IMF have worked out a change in approach, in the hope of
avoiding of the problem the Bank ran into in April, when the
unlucky timing of a change in the amount purchased left
market participants angry at the Central Bank for
exacerbating a sell-off.
6. (SBU) The new plan is to make smaller but more frequent
purchase, that will be known in advance to the market. The
Central Bank announced it would buy $15 million of foreign
exchange each trading day, with the Bank having the option of
buying up to $30 million more from the winner of the auction.
Analysts considered the auction resumption to be
market-positive--some thought it was even more important than
the rate cut--because it will inject needed liquidity into
the lira market. Some analysts attributed the relatively
slow fall in interest rates to the recent decline in lira
liquidity. As it has before, the Bank stressed that its goal
was to build up reserves rather than to try to influence the
exchange rate. The IMF and the Bank hope that announcing in
advance a modest sum of daily purchases, the Central Bank's
needed reserve build-up will have less of a market-distorting
Formal Inflation Targeting in 2006:
7. (SBU) The Bank also publicly announced its decision to
move to formal inflation targeting (as opposed to informal,
or implicit inflation targeting) as of January 1, 2006, and
to institutionalize the monetary policy decision-making
process and make it more transparent. Whereas the volatility
of money supply in Turkey's volatile, high-inflation,
environment had made it difficult for the Bank to set formal
inflation targets, it will begin to do so on January 1, 2006.
The IMF had long been urging the Central Bank to move to
formal inflation-targeting, but, as he had told us privately,
Central Bank Governor Serdengecti worried that the Bank
needed to be very cautious before making this move. If it
went badly, he argued, the Bank had no other policy options
8. (SBU) The moves to a more transparent and
institutionalized decision-making process bring Turkish
monetary policy in line with international practice. The
Bank announced that, beginning in 2005, it will make monetary
policy decisions at a monetary policy committee meeting to be
held the eighth of each month. The monetary policy commmittee
will continue to be merely advisory in 2005, with the
Governor making the decisions. In 2006, however, the
committee will gain formal decision-making powers.
Bullish Mood Heading into 2005:
9. (SBU) Comment: The markets perceive the EU decision as a
huge positive, as it it is viewed as ensuring greater
stability and continuity of economic reform. Indeed, the
size of the rally understates the importance to market
participants, since they had priced in a high probability of
a successful outcome. Coupled with the IMF announcement and
encouraging macro data releases in recent weeks, the markets
end 2004 on a very positive note.
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