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UPDATE 2-Turkey's eurobond a boon amid political and market turmoil

Nick Tattersall and Asli Kandemir
Thursday, 23 Jan 2014 | 6:40 AM ET

* Eurobond completes half of Turkey's 2014 borrowing

* Central bank sells $2 bln to prop up lira, bankers say

* Turkish political risk a growing concern

ISTANBUL, Jan 23 (Reuters) - Turkey received a vote of confidence in its underlying economic health on Thursday, with foreign investors lapping up a $2.5 billion eurobond issue even as a corruption scandal swirled and the central bank intervened to prop up the lira.

The graft investigation, one of the biggest threats to Prime Minister Tayyip Erdogan's 11-year rule, has shaken Turkey in recent weeks, helping send the lira into a tailspin and heightening uncertainty ahead of elections this year.

Bankers said the central bank had sold around $2 billion in its first direct intervention in the forex market for two years, after the currency dropped to within a whisker of 2.3 to the dollar, a new record low.

The central bank confirmed it had sold dollars in a direct intervention but gave no further details.

The cost of insuring Turkish debt meanwhile rose to a new 18-month high, Markit data showed.

But bond investors looked beyond the immediate turmoil to Turkey's strong underlying public finances, with the eurobond, priced at 5.85 percent, four times oversubscribed. The country has never defaulted on its foreign debt even in past economic crises and its budget deficit and public debt as a proportion of national output remain well below European Union criteria.

"Turkey had little problem selling its debt but was forced to pay up," said Nicholas Spiro, head of Spiro Sovereign Strategy in London.

"In the current environment, the higher the yield, the more attractive the issue to yield-hungry investors - particularly if it's a dollar-denominated one in a vulnerable emerging market like Turkey."

The eurobond was a boon for Erdogan as he battles to maintain his record for strong economic management ahead of local elections in March and a presidential race in August.

The issue completes half of Turkey's planned borrowing for 2014, easing pressure on its finances ahead of a likely destabilising cut in the U.S. monetary stimulus which has flooded emerging markets like Turkey with cheap cash.

Investors from the United States bought two thirds of the 10-year issue, Turkey's first outing on a foreign market since the corruption scandal erupted with the detention of businessmen close to the government and three ministers' sons on Dec. 17.

RISK PREMIUM

Deputy Prime Minister Ali Babacan, who has responsibility for the economy, said the eurobond issue was a sign of confidence in Turkey's long-term outlook.

It was priced at 299 basis points over U.S. treasuries, almost double the spread it paid in a similar issue a year earlier, but only 15 basis points over Turkey's current yield curve.

"I think the Treasury is eager to get a big deal away to prove that despite all the concern over domestic political tensions, and the pressure on the lira, it is still able to tap international capital markets," said Timothy Ash, head of emerging markets research at Standard Bank.

Erdogan has overseen strong economic growth in Turkey since coming to power in 2002, transforming its reputation after a series of unstable coalition governments in the 1990s ran into repeated balance of payments problems and economic crises.

But its politics are an increasing concern for investors.

Erdogan's reaction to the corruption probe, purging the police of thousands of officers and seeking tighter control over the courts, has drawn sharp criticism from the EU, which Turkey has been seeking to join for decades.

Concern about creeping authoritarianism has also raised questions about the independence of the central bank, which has consistently avoided the outright rate hikes the market sees as necessary to defend the lira, bowing to what many investors see as pressure from Erdogan's government.

Erdogan and some of his ministers have repeatedly railed against what they see as an "interest rate lobby" of speculators seeking to push up rates at the expense of economic growth.

The bank again shied away from hiking rates at its latest meeting this week, but announced what effectively amounted to a rate increase by the back door, saying it would fund the interbank market at 9 percent on "additional tightening" days, when it cancels repo auctions and sells dollars at auction.