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Turkey Returns to International Market with US$2.5bn Sukuk Al Ijarah as IMF Latest Article IV Consultation Commends “Exceptional” Turkish Economic Recovery Albeit Several Vulnerabilities Remain

The Turkish Ministry of Treasury & Finance continues to raise funds from the international markets through Sukuk issuances as part of its active but diversified public funding and debt strategy. On June 15, 2021, the Ministry of Treasury and Finance issued a US$2.5 billion Sukuk Al-Ijarah in the international capital markets with a tenor of 5 years, maturiting on 22 June 2026.

A day earlier, the Ministry of Treasury and Finance mandated Dubai Islamic Bank, Emirates NBD Capital, HSBC and Standard Chartered Bank to arrange a series of investor meetings in the UK, Europe, Asia and with Offshore US accounts for a US dollar denominated lease certificate issuance in the international capital markets. The Turkish Treasury is a proactive issuer of lease certificates (Sukuk Al-Ijarah) as part of a wider universe of government fund-raising instruments which include international and domestic bonds and Sukuk – leasing certificates/bonds, FX denominated issuances and gold-backed certificates/bonds.

On 11 June 2021, the IMF Executive Board concluded its latest Article IV Consultation with Turkey. The IMF Executive Directors noted that, as in other countries, the COVID-19 pandemic has taken a severe toll on the country. “But while the initial collapse in economic activity was similar to other countries, the recovery has been exceptional,” they stressed.

This recovery, said the Fund, was driven by “large interest rate cuts, rapid credit provision by state-owned banks, administrative and regulatory credit incentives, and extensive liquidity support.” This meant that Turkey was “among the few countries to experience positive economic growth in 2020 at 1.8%.” Real GDP growth is projected to increase to 5.8% in 2021 and stabilising at 3.3% per year for the next four years.

Employment has partially recovered along with the rebound in economic activity, although labour market conditions remain challenging, particularly among women and younger people. Public debt remains contained, at around 40% of GDP, as direct fiscal support – including to workers and vulnerable households – has been relatively modest, with the central government deficit widening only marginally in 2020.

However, while these policies helped the strong recovery, they also fuelled inflation and external imbalances, and exacerbated pre-pandemic vulnerabilities notably low reserves, large external financing needs, and dollarization. Inflation has steadily increased from the pre-COVID level of 11.8% to 14.6% in 2020 and is projected to increase further to16.5% this year before stabilising downwards to 14% next year and 12.5% over the next three years thereafter.

The Directors stressed the need to adopt policies “to reduce vulnerabilities, mitigate scarring, and improve prospects for durable growth, while also responding to pandemic-related needs in the short term.”

In the financial sector, the IMF Directors called for further reining in and refocusing state-owned bank credit growth, as well as carefully monitoring bank foreign exchange liabilities. They encouraged gradually reversing regulatory flexibility and loan deferrals as the pandemic recedes. Most Directors agreed that, once the pandemic fades, a third-party asset quality review would help in better understanding underlying bank health. Additional reforms to strengthen regulatory, resolution, and AML/CFT frameworks would also help financial stability.

It was this better-than-expected economic recovery that influenced the price of this latest US$2.5 billion Sukuk Al Ijarah offering. The initial price guidance was set at around a lease rate of 5.5%, but by the time of transaction close on 22 June the pricing narrowed to a lease rate of and yield to investor of 5.125%, with a spread of Mid Swaps + 426.7 basis points (bps).

According to the Turkish Treasury, the offering attracted an order book of US$9.3 billion, approximately 4 times the actual issue size, from over 200 accounts. Some 54% of the certificates were sold to investors in the Middle East, 15% in Turkey, 14% in the UK, 8% in other European countries, 6% to US offshore accounts, and 3% in Asia. The proceeds of the issuance, said the Finance Ministry, were transferred to the Treasury accounts on 22 June 2021.

With this transaction, the amount of US dollar-denominated funds that have been raised from the international capital markets in the first half of 2021 reached a total of US$6 billion. In January this year, the Turkish Ministry of Treasury & Finance also held two conventional bond auctions, raising US$3.5 billion in two transactions totalling US$1.75 billion each.

Turkey is a proactive issuer of Sukuk Al Ijarah primarily in the domestic Turkish Lira market but also regular raises funds from the international market through US dollar and Euro denominated Sukuk issuances.

The most recent international issue before this latest offering saw the Turkish Ministry of Treasury & Finance issue a 3-year US$2 billion Sukuk Ijarah in February 2019. That issuance matures on 21 February 2022. The transaction was priced at a lease rental rate of 5.80 per cent (Mid Swaps + 318.4 basis points).

The Treasury also raises funds in the US dollar and Euro markets on an ad hoc basis through transactions conducted by the Central Bank of Turkey via its Auction System under the Central Bank Payment Systems. In July 2020, the Treasury issued a benchmark US$500 million Sukuk Al-Ijarah with a tenor of 1,092 days maturing on 26 July 2023 and priced at a Periodic Rental Rate (6 Months) of 1.50%. Similarly, the Debt Office of the Turkish Treasury and Finance Ministry raised €365.548 million through a FX (EURO) Denominated Lease Certificate issuance (Sukuk Al Ijarah) via a direct sale auction in May 2021.

This auction was also conducted by the Central Bank of Turkey via AS (Auction System under Central Bank Payment Systems). The issuance has a tenor of 1,092 days maturing on 24 May 2024 and was priced at a fixed rental rate of 1.50% payable over a 6-month rental payment period.

Turkish banks (both participation and conventional) may also increase their holdings of government securities going forward for reasons other than the reserve and liquidity management purposes, as the requirement for them to maintain an asset ratio of at least 100% from 1 May 2020 set in.

According to Fitch Ratings, the move introduced by the Banking Regulation & Supervision Authority to stimulate lending to support the economy amid the COVID-19 pandemic has forced some banks to increase lending at a time when the operating environment has weakened, with heightened risks to borrowers’ repayment capacity and therefore to banks’ credit profiles. Banks failing to meet the target are faced with a fine based on their ratio shortfall.

The encouraging sign is that demand for Turkish government papers, despite the potential volatility of the Turkish lira, the economic and health impact of the COVID pandemic and other internal economic vulnerabilities, international investors especially from the GCC, UK and Europe continue to be comfortable with Turkish sovereign and credit risk.

The lease certificates were issued by Hazine Mustesarligi Varlik Kiralama A.S., a locally-incorporated special purpose vehicle on behalf of the Ministry of Treasury and Finance, the obligor.

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