Fitch ratings agency offered Turkey an early xmas present on November 5, as it upgraded the sovereign to investment grade. However, few expect fireworks, with the markets having been rating Turkish assets at investment grade for some time already.
Fitch raised Turkey's foreign currency debt rating to BBB- (from BB+), making it the first of the three US ratings agencies to return the country to investment grade - a status it lost in 1994. The agency cited "a moderate and declining government debt burden, a sound banking system, favourable medium-term growth prospects, and a relatively wealthy and diverse economy".
Despite less encouraging comments from Moody's last week, the move from Fitch had been anticipated by the markets since it said in October that it could offer an upgrade before the end of the year.
Ankara has been complaining bitterly for months that Turkey's rating with the international agencies is unfairly low, citing its low government debt, strong banking sector, and generally constructive fiscal policies. However, the country's high current account deficit, exposing it to Eurozone banks, has been - and remains - a palpable risk, while inflation is also problematic.
The Fitch upgrade reflects the government's success in guiding a economy that was ballooning on the back of domestic demand to a "soft landing". That has seen economic growth slow from the 8.5% recorded in 2011 to a 2012 forecast of around 3%. At the same time, the current account deficit has dropped from double figures to around 7.5%, and inflation has slimmed.
Deputy Prime Minister Ali Babacan welcomed the move, calling it appropriate and overdue and pushing for S&P and Moody's to follow suit. "Turkey's achievement of this credit rating is expected to mark the start of a new era in the access of our public and private sector institutions to international capital markets," the minister insisted in a statement.
The lira jumped by 0.5% against the dollar in the wake of the announcement from Fitch, while benchmark bond yields fell by about 25bps (from 7.95% to 7.70%). Capital Economics points out that the building expectations of a cut mean that the effect is limited. "[T]hese are relatively modest moves in the grand scheme of things," they wrote, pointing out that by mid-afternoon "the equity market had barely moved on the news."
For that to happen in earnest, Turkey would need to rebalance the structure of its economy further, and achieve a full upgrade to investment status from one of the other major agencies (S&P only rates the country's local currency debt at that level currently). Moody's appears the most likely, having said last week that it could offer an upgrade should the government continue to deflate the economy.
However, analysts at RBS are wary about that prospect. "While the current account deficit has improved from 10% to ~7.5% this year, Turkey's real GDP growth will bounce back from a low this year (2012 is the trough), which will likely cause deterioration in the current account in 2013," they write. "Additionally, as growth picks up, inflation (currently high at 7.8% YoY in October) will very likely resume upward momentum."
Many institutional investors need to see investment grade from two of the three agencies. "The fact that Turkey's long- term local currency debt is also rated in the investment grade category by S&P may facilitate lira-denominated issues on international markets," suggest analysts at Erste.
However, most analysts forecast little long term impact on the markets. Erste suggests the debt market may benefit into the first quarter of 2013. "The episodes of peer countries' upgrades to investment grade suggest that the out-performance of the financial markets last for three months following the investment grade decision. We would expect the long end of the yield curve to benefit more from the lower risk premium."
Capital Economics on the other hand suggests the rally has likely been pretty much done. "[H]istory suggests that ratings changes tend to lag rather than lead moves in financial markets. This decision was generally well anticipated and follows a period in which the Turkish bond and equity markets have outperformed their EM peers," they write.
Despite their more favourable short-term view, Erste adds a warning for those with a longer horizon. "Turkey has been granted investment grade status by investors for some time and the favorable impacts of the decision on markets may be reversed over time."
That will leave the markets watching S&P and - in particular - Moody's. S&P cut its outlook for Turkey's sovereign credit rating to stable from positive in May, citing concern about external demand and terms of trade, leaving its rating two notches below investment grade looking unlikely to change in the coming months. Moody's meanwhile raised Turkey's rating to one level below investment grade on June 20, but also warned last week that it needs to see continued deflation of structural risk before committing to an upgrade.
There are select equities that should benefit to a limited extent in the short term from Fitch's move, despite the anticipatory rally in recent weeks. Analysts at Renaissance Capital are not the only ones to flag up the story of domestic-facing stocks. "We think that Fitch's upgrade reconfirmed the domestic consumer story and should continue to keep interest strong for related stocks," they write. "From a sectoral perspective, we think banks and consumers should be beneficiaries of stronger investor confidence and lower interest rates, while high leverage companies should see benefits of lower financing costs and/or FX gains from a balance sheet perspective."
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