Citi: Currency risk premium on TL bonds hits one of the highest levels in 16 years

In a report prepared by Citi Research economists İlker Domaç and Gültekin Işıklar, the currency risk premium was evaluated based on the spread between two-year Turkish Lira-denominated government bonds and dollar-denominated Eurobond yields.

According to the report, the currency risk premium, which has risen again alongside the normalization process in monetary policy, reached 12.6 percent as of June 2026. Citi pointed out that this level is one of the highest values seen since 2010.

The analysis stated that the premium in question, which hovered around 1 percent on average during the 2010-2017 period, turned negative during the low-interest-rate policy period between 2021 and 2023. The report noted that even during the 2018 currency shock, the premium only approached about half of its current level, around 7 percent.

CONTROLLED EXCHANGE RATE POLICY AND THE 'PESO PROBLEM'

The Citi report also highlighted the "peso problem" created by the controlled exchange rate policy. Accordingly, while the short-term exchange rate path may appear predictable, the factor investors are primarily pricing in is not daily volatility, but the durability of the current monetary policy regime and the risk of a potential sudden correction.

The report assessed that the gradual postponement of a real exchange rate correction increases the demand for additional yield against the possibility of a sudden break for investors, which keeps the currency risk premium high. It was emphasized that a credible strategy for disinflation to take hold and for exiting the controlled exchange rate regime is required for a permanent narrowing of the premium.

According to Citi's calculations, for the two-year TL bond to underperform Turkey's dollar-denominated Eurobond performance, the lira would need to depreciate by an average of approximately 33 percent annually. In this scenario, it was stated that the dollar/TL exchange rate would need to reach approximately 82 by mid-2028.

The report recalled that the current annual depreciation expectation is 17.8 percent, while the actual loss over the past year was 17 percent, noting that the market offers currency protection at nearly double the expected loss.

Analysts stated that this wide buffer creates an advantage for investors, but noted that past experiences show no yield spread provides full protection against a sudden change in policy regime.

The report also conveyed that the partial retreat seen from the peaks in the spring of 2025 is evaluated as a sign of normalization rather than deterioration. According to Citi, the source of the decline in the risk premium in the coming period will be decisive: if the narrowing comes from a decline in bond yields, it will mean healthy normalization; if it stems from a rise in exchange rate expectations, it will mean a weakening of the protection offered to investors.