The chronic weakness of the Turkish lira (TRY) is credit negative for Turkey’s sovereign debt rating and poses difficulties for its economy, Moody's Investors Service said in a credit outlook report released on April 16.
In the report, Moody's said the TRY was vulnerable to renewed pressure if authorities delay in combatting lira weakness with interest rate hikes. Analysts will watch to see how the report goes down in Turkey where President Recep Tayyip Erdogan is pushing for lower interest rates designed to drive growth despite the weight of conventional opinion against him and worries that the Turkish economy—which grew at the “warp speed” of 7.4% last year—is overheating. It is also notable that Erdogan was scathing of Moody’s and the international credit rating agencies in general after on March 8 it cut Turkey’s sovereign credit rating further into junk, two notches below investment grade. He claimed that they were preoccupied with trying to drive Turkey into a corner and that the financial markets should not take them seriously.
“The government appears determined to keep the economy growing rapidly ahead of national elections scheduled for November 2019, regardless of the costs,” Moody’s said in its note. The weakness in the lira—which hit an all-time low-point against the dollar of 4.1944 on April 11 but at around 16:45 on April 16 stood at 4.1118—was “credit negative” for Turkey’s sovereign debt rating, it added.
“This tense situation is an important test of the delicate balance between Turkey’s fundamental strength from its dynamic economy and very strong fiscal metrics—and its high and rising external vulnerability,” Moody’s said.
The rating agency also noted that on April 11 Turkey’s current account deficit for February came in 60% larger than a year ago, “the result of an economy growing significantly above potential going into a second year”.
It stated: “Ongoing lira weakness is especially problematic for Turkey’s economy because of its high degree of external vulnerability and low foreign-exchange reserves, a credit negative for the sovereign. In 2017, the current account deficit widened to 5.6% of GDP from 3.8% in 2016, reflecting higher oil prices and strong import demand. The growth in imports more than offset a double-digit increase in exports of goods and services, which was driven by increased demand from trading partners and a recovery in tourism. But because Turkey’s exports have an unusually high import content, a weaker lira is a double-edged sword for the current account.”
In a separate report also released on April 16, Moody’s said Turkey’s banks were now more exposed to problem loans because of the weakened lira, raising the probability that the availability of foreign funding will fall.
The TRY’s decline is also partly responsible for the steep rise in inflation to persistent double-digit levels over the past year. Inflation stood at 10.1% as of March. Turkey was now experiencing “a vicious cycle of additional lira weakness and more inflation”, said Moody’s. “As was the case last year, the quality of the financing for the current account deficit continues to deteriorate, with more debt-creating portfolio inflows carrying shorter maturities and less foreign direct investment. External debt rose to $453bn by year-end 2017, equivalent to 53.3% of GDP, from 47.4% the year before. Our indicator of external vulnerability, which compares the redemptions due on maturing long-term debt plus rollover requirements for short-term debt (including non-resident bank deposits) with official foreign-exchange reserves, is above 200% and climbing.”
At the same time, Turkey’s central bank has less than $90bn in foreign-currency reserves, which only covers half of the debt that is maturing or needs to be rolled over, the rating agency observed, adding: “Our sovereign benchmark is 100% or lower for emerging markets because they are subject to market volatility and sudden stops of external financing, especially when, like Turkey, domestic and geopolitical risks are high.”
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