Turkey’s credit rating was cut further into junk by Moody’s Investors Service on March 7 with the ratings agency citing an erosion of institutional strength and added risk of external shocks.
Moody’s lowered the rating on the Turkish government’s long-term issuer and senior unsecured debt ratings to two levels below investment grade, taking it to ‘Ba2’ from ‘Ba1’. The rating on the senior unsecured shelf rating was reduced to ‘(P)Ba2’ from ‘(P)Ba1’. The rating outlook was changed to stable from negative.
Kristin Lindow, a Moody’s analyst, said the Turkish government seems focused on short-term measures, undermining effective monetary policy and economic reform. That’s become a concern to an increasing number of analysts in recent months, who ask how much longer Turkey can maintain economic stability in these circumstances. Persistent double-digit inflation and political factors, such as the prolonged state of emergency still in effect after its introduction following the attempted coup in July 2016, have weighed down on the country, Lindow wrote. Debt and rollover needs have worsened, she added.
"The potential triggers of a re-evaluation of Turkish country risk by foreign investors continue to multiply with the continuing deterioration of Turkey’s geopolitical situation," Lindow wrote. "Turkey’s sovereign rating would likely be downgraded if there is a material increase in the probability and proximity of a balance of payments crisis."
Moody’s also downgraded the long-term senior unsecured debt of a Turkish special purpose vehicle used to to issue sukuk lease certificates, Hazine Mustesarligi Varlik Kiralama.
The downgrade to two notches below investment grade puts Turkey on par with Brazil, Croatia and Costa Rica.
After the downgrade issued late on March 7, the Turkish lira (TRY) fell by 0.4% to 3.8093 per US dollar. On March 8, at around 10:30 a.m. Istanbul time, it was trading at 3.8162.
Moody's cut Turkey's credit rating to junk status in 2016. It cut its outlook to negative from stable in March last year. The outlook was changed to stable in the latest downgrade.
‘Explicit tolerance of high inflation’
Further detailing its latest downgrade, Lindow wrote: “Faltering institutional strength is reflected in a broad range of adverse outcomes on the economic, financial and political front despite strong near-term growth rates and healthy public finances. Inflation has stayed stubbornly in the double digits—the highest inflation rates seen in nine years. It is unlikely to fall to single digits on a sustained basis until 2020 at the earliest. Both the 2018-20 Medium Term Program as well as the 11th 5-year National Development Plan, which will start next year, assume average inflation consistently above the central bank's medium-term inflation target of 5%. The explicit tolerance of high inflation in these plans demonstrates the priority accorded to short-term growth regardless, it appears, of the medium-term consequences.”
Lindow also referred to the continuing erosion of Turkey's executive institutions with the government's ongoing activities to remove suspected sympathisers with the Gulen movement blamed for 2016's coup attempt and the ongoing state of emergency. “The undermining of the authority of the judiciary is illustrated by the government's refusal to honor a Constitutional Court ruling to release certain political prisoners, and a lower court later sentenced the prisoners to life terms in prison. Deep divisions in Turkish society were evident in the campaign before the referendum on the constitutional amendments last April and the vote itself. Those amendments—which will eliminate the office of the prime minister and very significantly expand the authority of the president when they become effective next year, with limited checks and balances—are likely to undermine the predictability and therefore the effectiveness of policymaking.”
Set against the negative institutional backdrop, Turkey's external position, debt and rollover needs have continued to worsen, Moody’s observed. Although the government's own external borrowing needs are relatively low, the country as a whole has very large external financing needs given sizeable current account deficits, maturing long-term debt and high levels of short-term debt. “This external exposure has continued to grow over the past year and is expected to continue to do so,” said Lindow. “The country's foreign exchange buffers are very low compared to these needs; the country's External Vulnerability Indicator is expected to rise to well over 200%, which is extremely high in comparison to Turkey's rating peers, and signals an ever-rising exposure to changes in international investor sentiment.”
The potential triggers of a re-evaluation of Turkish country risk by foreign investors continue to multiply, Moody’s concluded, with the continuing deterioration of Turkey's geopolitical situation, its already strained domestic politics and the prospects of monetary policy tightening in the more developed economies. “Amplifying its vulnerability to external shock are Turkey's political risks, with the convergence of risks from the geopolitical arena and domestic politics. On the domestic front, as described above, the government's legal crackdown since the failed coup in July 2016 has taken a negative toll on the investment climate and relations between Turkey and the US and EU,” Lindow added.