What's Troubling The Turkey ETF

The iShares MSCI Turkey ETF TUR jumped 5.46 percent Tuesday on volume that was more than double the daily average. Even with that gain, the lone Turkey exchange traded fund is down more than 21 percent year-to-date.

One of the primary culprits behind TUR's recent swoon is the plunging lira. Last week, Turkey's central bank raised its benchmark lending rate to 8 percent in an effort to prop up the flailing currency. Turkey's interest rates are now among the highest among investable emerging economies.

What Happened

The interest rate hike, while needed, flies against recent comments from President Tayyip Erdogan. Erdogan voiced displeasure with higher interest rates, indicating he wants more control over Turkey's monetary policy. A weak lira is problematic for TUR because the ETF has no currency hedging mechanism and several of the fund's largest sector weights, including financials and the consumer sectors, tilt toward Turkey's domestic economy.

The weak currency is also concerning because Turkey is a profligate borrower. Turkish companies that borrowed in foreign currencies, such as dollars, could be pressured to repay debt that is close to maturity if the lira remains weak.

Why It's Important

“Turkish companies make widespread use of foreign currency borrowing, which is often not effectively hedged or balanced by foreign-currency revenues,” said Fitch Ratings. “As the lira deteriorates they find themselves having to service inflated foreign-currency denominated debt with local-currency revenues. Risks can be exacerbated when this debt is short term, as companies are more likely to find themselves having to physically repay debt with foreign currency using cash or accommodative financing.”

The VanEck Vectors Emerging Markets High Yield Bond ETF HYEM, which holds high-yield corporate bonds, allocates 9.13 percent of its weight to Turkish bonds, the ETF's third-largest country exposure.

On the bright side, non-sovereign emerging markets junk bonds typically have lower default rates than U.S. equivalents.

What's Next

Turkish corporate issuers are hoping the interest rate hike has the intended effect of damping inflation and steadying the lira.

“A sharp currency depreciation just before this debt becomes payable can rapidly increase the reported outstanding debt, potentially affecting companies' liquidity positions,” said Fitch.

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