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DUBAI: Turkey sold $3 billion in Islamic bonds on Wednesday, in its first U.S. dollar-denominated debt sale since September, before unorthodox rate-cutting despite high inflation sent the lira into a tailspin.

Turkey's economy fell into turmoil late last year as the central bank cut its policy rate by 500 basis points to 14% since September, causing the lira to end the year down 44% against the dollar, its worst performance during President Tayyip Erdogan's nearly two decades in power. The depreciation sent inflation to nearly 49% in January, its highest in 20 years.

The lira has largely stabilised this year after Erdogan announced a new scheme to protect lira deposits, costly government interventions in the currency market and a local currencies swap deal with the United Arab Emirates.

Turkey sold the Islamic bonds at 7.25%, tighter than initial guidance of between 7.5% and 7.625% after orders topped $10.75 billion, the document from one of the banks on the deal showed.

"We continue to remain underweight Turkey due to the elevated uncertainty," said Doug Bitcon, head of credit strategies at Rasmala Investment Bank.

"However, the pricing of the new 5-year issue is cheap relative to the sukuk curve and broadly in line with the conventional curve. The order book is strong and we expect the issue to trade well at the break."

Turkish central bank's net FX reserves rise to $10.53bn

Investors in the UAE piled into the Islamic bonds, three sources said. Relations between the two countries have pivoted to economic partnership following a charm offensive by Turkey last year, with Erdogan visiting the UAE this week after the UAE's de facto ruler took a trip to Turkey in November.

One of the sources, a fund manager in Dubai, said higher demand from the UAE due to cosier ties may partly explain the large order book despite a risk-averse market.

Demand for sukuk has long outstripped supply, and sales of high-yielding bonds have been scarce as investors fret over an imminent tightening cycle, with many analysts expecting as many as seven rate hikes by the U.S. Federal Reserve this year.

"Investors are wary about a Fed that's too hawkish and are averse to longer tenors - Turkey's tapping into that demand for shorter bonds," a fixed income analyst in Dubai said.

Fitch Ratings last week downgraded Turkey's sovereign debt rating to "B+" from "BB-" saying the government's policies have increased risks from high inflation and weak foreign currency liquidity.

FX reserves stood at $16.33 billion as of Feb. 4, rising $5.8 billion in a week, likely in part due to the $4.7 billion swap deal with the UAE. Net FX reserves had reached a two-decade low of $7.55 billion last month.

Citi, Dubai Islamic Bank, HSBC and KFH Capital arranged the sukuk sale.

Turkey has roughly $18.5 billion in bonds maturing this year, with $7.6 billion denominated in dollars and the rest in lira, according to Refinitiv data.

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