Late on Friday, rating agency Moody’s cut Turkey’s sovereign credit rating to Ba1 or “junk” from Baa3, citing worries about the rule of law after an attempted coup and risks from a slowing economy, in a move that could deter billions of dollars of investment. “The drivers of the downgrade are … the increase in the risks related to the country’s sizeable external funding requirements (and) the weakening in previously supportive credit fundamentals, particularly growth and institutional strength,” Moody’s said in an e-mailed statement. “The government’s response to the unsuccessful coup attempt raises further concerns regarding the predictability and effectiveness of government policy and the rule of law.”
“The large-scale suspensions in the civil service raise doubts over the capacity of Turkey’s policy-making institutions to make meaningful further progress in both legislating and implementing the reform program,” Moody’s said.
Moody’s did however keep its rating outlook “stable,” saying Turkey’s flexible $720 billion economy and strong fiscal track record offset the balance-of-payments pressures it faces. As Reuters notes, Turkey depends on investment flows to fund its current account deficit – one of the biggest in the G20 – and service its foreign debt. Ratings downgrades could force it to pay more to borrow money in international markets.
The cut is Turkey’s second since a failed (or as some claim orchestrated) coup in July threatened to destabilize national security. Many of the world’s biggest funds require investment-grade ratings from two of the three major ratings companies to consider an asset for investment. The downgrade could drive forced selling of as much as $8.7 billion in Turkish bonds, JPMorgan Chase & Co. said in August. Turkey relies on capital inflows to finance one of the widest current-account deficits among the Group of 20 countries. Fitch is the only one left that has Turkey on investment grade, however, and it is due to review that rating at the start of 2017.
The market reaction was prompt and Turkish assets plummeted the most since the “attempted” coup in July, with the yield on Turkish 10Y bonds spiking 41bps to 9.91%, for now holding at the 40-week moving average of 10%, while the Turkish Lira tumbled, sending the USDTRY as much at 2.9868, up nearly 1% from Friday’s close. Turkish CDS widened by 12 to 260 bps.
As Bloomberg summarized, the currency was headed for the the lowest level in eight weeks in Istanbul morning trading, the Borsa Istanbul 100 Index posted the steepest decline among about 90 gauges tracked by Bloomberg globally, and the nation’s dollar debt due 2026 sank the most since July. Notably, the lira fell 0.6 percent against the dollar to 2.9868. The Borsa Istanbul 100 Index slumped 3.7%, the most since July 21, led by Akbank TAS and Turkiye Garanti Bankasi AS, both of which retreated at least 4.6 percent. The yield on the nation’s $1.5 billion debt due April 2026 rose 27 basis points to 4.55 percent, and the yield on the government’s 10-year local currency bonds advanced the most in more than two months to 9.96 percent.
The following are some of the biggest movers in Turkey’s market on Monday:
- The Borsa Istanbul Banks Sector Index sank the most since July 18
- All but two of the 100 companies on Turkey’s benchmark stock gauge fell
- The yield on Turkey’s 10-year debt soared 45 basis points, the most among emerging peers
- Five-year credit default swaps rose 15 basis points
The decline in Turkey’s assets will “be a slow burn,” said Viktor Szabo, a portfolio manager at Aberdeen Asset Management in London who owns some of the country’s bonds and is betting against the currency. The rating cut hasn’t made Turkish “credit blow up, but it will put it on a more risky path,” he said.
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In immediate response to the downgrade and in keeping with Turkey’s policy of direct confrontation, Turkey’s administration lashed out at Moody’s with Prime Minister Binali Yildirim saying the action showed Moody’s was not being impartial nor basing its rating solely on economic factors. “We don’t believe that these assessments are highly impartial. We believe they are attempting to create a certain perception of the Turkish economy,” he told reporters.
Erdogan has criticised the rating agencies for being politically motivated, and even accused S&P of siding with the coup plotters after its move in July. Investors will watch how the government responds to the Moody’s downgrade and hope for a “grown-up approach” that does not merely blame the rating agencies, wrote Timothy Ash of Nomura International.
Prior to Yildirim’s response, Deputy Prime Minister Nurettin Canikli said Moody’s had turned a blind eye to the reforms and steps the government has taken to boost growth and savings. “Despite all of the global and regional risks, the Turkish economy’s pace of growth is among the top five economies,” he added in a statement. Gross domestic product growth slowed to 3.2 percent in the second quarter. Turkey may cut its official target for 4.5 percent GDP growth this year as the impact of the coup attempt takes its toll on the economy.
Moody’s was partially right in noting some vulnerabilities in Turkey’s economy, but it was unfair to downgrade before the govt published its medium-term program to address them, Finance Minister Naci Agbal tells Cumhuriyet. “The MTP we were going to announce in a week or two included both a perspective on what we’re going to do in three years and a program with regards to structural reforms. Moody’s knew that”. He added that “what Moody’s did was the worst-case scenario. That in global economic conditions, there’s going to be a shock” adding that there’s no risk of a shock in Turkey tied to Fed tightening or the currency, and Turkey’s current-account balance has improved. While oil prices could be a point of vulnerability, medium- term expectation is that they continue to hover around $50/barrel. “The full side of the glass wasn’t seen. They kept their expectations for the future worse than the average expectation in the market.”
Considering the market’s “shocked” response today, he may have to evaluate; then again this being Turkey the most likely response is even more bellicose rhetoric aimed at the rating agencies with little in terms of actual reform of economy-frienly policies.
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