(Bloomberg) -- Foreign investors will steer clear of Turkish lira bonds until inflation reverses course and decelerates, according to Europe’s biggest asset manager, a distant prospect that suggests inflows likely won’t materialize until mid-year at best.

“My sense is that for international investors to go into the domestic bond market, I would ideally like to see inflation really ticking down,” Sergei Strigo, co-head of emerging-market debt at Amundi SA, said in an interview. “And we are yet to see that. That for me would be the main trigger point.”

A longer wait will frustrate officials like central bank Governor Hafize Gaye Erkan, who said last month the time for foreigners to invest in lira-denominated government bonds “should be now” after she quintupled interest rates since being appointed in June. But inflows into local debt have been limited relative to their historical highs, with inflation expected to reach up to 75% around May and borrowing costs deeply negative when adjusted for prices. 

Once a huge draw for foreigners, local debt has for years been off the international investor radar as authorities leaned on ultra-loose monetary policy to juice up growth. Non-resident holdings are now below $3 billion, the most since early 2022 but still a fraction of their peak at more than $70 billion over a decade earlier. 

The disinterest contrasts with the appeal of Turkey’s foreign-currency bonds, which have been a top performer in emerging markets after a makeover of economic policies following President Recep Tayyip Erdogan’s reelection in May.

Amundi has already put some of its $2 trillion under management into hard-currency debt issued by Turkish companies and the government, according to Strigo, who’s also more upbeat on the lira’s prospects than now priced in by the market.

Although the currency is set to continue to weaken gradually in nominal terms, forward contracts imply “too much depreciation,” he said, describing Amundi as having a “neutral exposure” to the lira. One-year forwards are trading around 43 per dollar, nearly 30% weaker than the spot level.

‘Positive Returns’

A crucial part of the currency’s appeal comes from its “carry component,” Strigo said. “In absolute terms, the Turkish lira potentially can generate positive returns for 2024 at current levels.”

For much of last year, the lira yielded some of the worst returns globally for traders who borrow where rates are low to invest where they are high. But with its depreciation to record-low levels contained within a narrow range, it’s offered one the world’s most profitable carry trades in the past three months, according to data compiled by Bloomberg.

For Amundi, risks to the investment case in Turkey will crystallize around municipal elections in March. 

The likelihood that the central bank will raise its key rate this week to 45% from 42.5% — and “some expectations for a little bit more to be done” — could help shift sentiment in favor of local debt, especially if policy continuity is intact, Strigo said.

“As soon as we start seeing inflation numbers behaving a little bit better compared to what they’re today, there’s definitely potential for portfolio inflows,” he said. 

--With assistance from Tugce Ozsoy.

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