In May 2013, Turkey became an investment grade country for the first time in 19 years. The recent rating cut by Moody’s was followed by some fluctuations in the lira and the stock market, but a sharp development that can be considered a “collapse” hasn’t taken place. This owes mostly to the fact that the rating cut had already been reflected in prices and also to the relative strength of Turkey’s macroeconomic structure. With the rate cut, Turkey now has a non-investment grade. But why did Moody’s take this decision and what does it entail? The rating agency highlighted the increase in the risks related to the country’s sizeable external funding requirements explaining its decision. In the period ahead, Moody’s will be following closely any structural improvement to alleviate Turkey’s external funding requirement. Economists say specifically real sector dependance on external funding and the high level of foreign currency position deficit are at the core of this issue. Another area the agency will be watching will be Turkey’s own institutional structure and whether there will be any improvement in the competition framework.
‘Investors worried about SoE practices’
Experts say that the credit rating cut is relevant given the post-coup developments in Turkey. HSBC Bank Turkey treasury director Fatih Keresteci said in a note to investors released after the rate cut “We had been hearing some very vocal concerns from foreign investors especially about the State of Emergency (SoE) regulations and how the process is being handled.” Analysts also say that in what way political risk perceptions, shaped both by geopolitical developments and by the domestic political environment, will evolve in the period ahead will be decisive Moody’s has said in its statement that if there is an improvement in this area, the country’s credit rating will not be changed unless the other two factors also improve.
Let’s not lose our confidence
As has been mentioned earlier, this decision didn’t come as a surprise to many investors. However, its timing was a bit of a surprise for everyone, as the rate cut was expected to occur in October. Additionally, a statement from Moody’s two days before its the downgrade indicating that the Turkish economy has overcome the shock of the failed coup had lessened the expectation of a junk grade. Although there were fluctuations in the markets following the decision’s announcement, experts say that the Moody’s decision is not the end of the world and a severe fallout from the rate cut is unlikely. Experts also say that if Turkey makes progress in terms of structural reforms and political normalization, pricing geared towards an investment grade might start soon enough. The experts however say this relies on a single condition: Turkey needs to focus on structural reforms and swiftly achieve political normalization. If not, the adverse atmosphere might continue.
What do foreigners say?
Foreign banks’ comments also confirm that it would be wrong to conclude that the rate downgrade will have an extremely negative consequence. Goldman Sachs said in an email note about the downgrade that the authorities already had already accepted the risk of a credit downgrade, as the government’s priorities such as making extensive revisions in government agencies were not compatible with the efforts to stop Moody’s from downgrading Turkey’s rating. The note said: “Given the weakening growth and in our view monetary policy being less effective at stabilising growth, we believe fiscal and quasi-fiscal policy will become more important in stabilising the economy at the expense of potentially worsening the credit fundamentals further”.
Nomura Emerging Markets Chief Economist Timothy Ash tweeted following Moody’s decision: “Turkey has a long track record of paying, and no real deterioration in key ratios since upgrade to IG? Very subjective decision by Moody’s.” In another tweet, he said: “Turkey – important now how the govt responds to rating move. They need to be grown up and focus on reform rather than bashing ratings agency.”
An auction of new government 10-year notes that took place after junk downgrade received the most bids in almost two years. Yields at the sale rose 22 basis points from an offer last month, to 9.94 percent. According to a Bloomberg analysis, “Turkey’s most successful local bond sale since 2014 is a signal that many are calling the bottom of a selloff that’s outpaced all emerging-market peers this quarter.Turkey’s most successful local bond sale since 2014 is a signal that many are calling the bottom of a selloff that’s outpaced all emerging-market peers this quarter. While domestic banks and investors account for the biggest holders of lira debt, foreign money managers, including Aberdeen Asset Management and Union Investment Privatfonds GmbH, say prices may have fallen far enough to herald a rebound.”
Is credit rating downgrade end of the world?
