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Moody’s cuts Turkey’s rating to ‘junk’

Moody’s cuts Turkey’s rating to ‘junk’ article image

Ratings agency Moody’s has lowered its rating on Turkey's debt one notch to Ba1 with a “stable” outlook – stripping it of investment-grade status.

The downgrading follows the completion of a review it initiated after Turkey’s unsuccessful coup attempt on July 15.

The agency cited rising risks related to Turkey’s external financing needs and a weakening in its credit fundamentals as economic growth slows.

The decision left Fitch Ratings as the only major ratings company to keep Turkey at investment grade. Moody’s said stable outlook balances downside risks arising from the erosion in Turkey's economic resilience and increasing balance of payments pressures against credit-positive considerations arising from its large and flexible economy which continues to register positive growth and the government's strong fiscal track record.

Turkey lacks domestic savings necessary to finance its economy. It is therefore dependent on foreign funding. Despite lower energy prices, the current account deficit remains elevated.

Coface, a global leader in credit insurance and risk management, estimated the deficit to GDP at 4.5% this year and 4.9% next year.

Tourist revenues down

Coface notes that domestic security problems and sanctions imposed by Russia had a negative impact on the tourism sector which accounts around 4.3% of GDP in 2015. In the first half of this year, tourist arrivals and revenues were down 27.9% and 28.2% from a year ago. 

Also, Turkey’s external indebtedness has risen. According to Coface’s estimates, Moody’s calculates that Turkish corporate, banking and government sectors need to repay nearly $155.8 billion in external liabilities this year. Short-term external debt of the private sector except banks stands at $35.7 billion.

This external funding need makes the country vulnerable to sudden shifts in investor confidence and global risk perception. 

According to Moody’s, there is an erosion in Turkey’s institutional strength which has been exacerbated after the failed coup attempt. Moody’s says this situation may restrain the implementation of structural changes needed in the economy as it raises concerns regarding the predictability and effectiveness of government policy and the rule of law.

Slow progress

Moody’s expects real GDP growth to slow at an average of 2.7% over the 2016-19 period, which is significantly lower than the average growth of 5.5% over 2010-14. This slowdown in growth performance would make more difficult for Turkey to reduce the debt accumulation problem. 

Coface saysalthough the government has made some progress on its reform agenda, the switch of the economy into a more production-and domestic saving-driven growth model remains slow.

Coupled with the Federal Reserve’s rate hiking process, the loose of investment grade status would limit further Turkey’s growth potential. In fact, some international pension funds are allowed to invest on in countries having investment grade status from two of the top three ratings agencies. This would limit quantity of foreign money coming into Turkey that is needed to finance investments.

Insurance costs

Also, the cost of insuring exposure to Turkish government debt jumped to its highest level since the days following the failed coup attempt on July 15 after Moody's decision.

Five-year Turkish credit default swaps (CDS) jumped by as much as 30 basis points to 276 bps from last week’s close of 246 bps. This would increase the cost of borrowing for Turkey from international markets as well, pushing up corporates’ borrowing costs. 

After weakening as low as to 3 against the US dollar, the lira has returned back to its levels prior to Moody’s decision, hovering around 2.96. But the loss of investment grade may cause an increase in volatility in the money market.

Such a situation may deteriorate increase costs and deteriorate cash flow management especially in sectors having high dependence on input imports such as metals, chemicals, textile and electronics, says Coface.

Currency exposure risk

In general, the Turkish manufacturing sector as a whole remains highly dependent on imports, estimated about 60% according to many analysts.

This situation increases currency exposure risk on the corporate sector.

According to Turkey’s Central Bank data, Turkish non-financial companies’ net foreign exchange position recorded a deficit of $199.9 billion as of June 2016. However, short-term net foreign exchange position was in the positive territory, $632 million, indicating companies’ short term assets are higher than their short term liabilities. 

Coface has a GDP forecast for Turkey of 3% this year and for 2017 and a country risk assessment: B.

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