Moody's hands Turkey another precious investment grade

By bne IntelliNews May 17, 2013

bne -

Cementing the optimism that has been bubbling in Istanbul for the last few months, Moody's Investors Service moved late on May 16 to hand the Turkish sovereign its second investment grade rating, as it upgraded the government's bonds by one notch to 'Baa3', with a stable outlook.

While the move from the rating agency has long been mooted by the market, Moody's has been busy dampening expectation of an upgrade. Still, sentiment has been bubbling since Fitch Ratings gave the country its first investment grade in close to 20 years in October, and the mood has approached "euphoria" in Istanbul, helping to boost Turkish debt and equities markets to records.

That mood has only grown in recent weeks on a series of major news breakthroughs that help promote stability and energy security for Turkey. May has seen the start of the withdrawal of militants from the Kurdistan Workers Party (PKK) from the country after a three-decade war.

Meanwhile, Tim Ash at Standard Bank suggests "the warming of relations with northern Iraq and potential therein for greater energy security" could be another factor - despite the problems that sparks off with Baghdad and the US. Still, Washington has to play gently when it comes to Turkey due to its strategic role in the unstable region, and President Obama even pushed Israel into normalizing relations recently.

The key for the ratings agencies is the current account deficit however, which raced to double digits as the economy expanded at over 8% in 2011 and domestic demand ballooned. That heavily exposes the country to the shaky Eurozone banking sector, which is the ultimate source of funding for the bulk of Turkish debt. Ankara spent 2012 deflating the economy, and pushed that deficit to below 7%.

Moody's has spent months watching that process, but has moved as the central bank is becoming more and more tied in knots as it tries to stimulate the economy without provoking accelerating consumer credit.

The ratings agency said in its statement that the key drivers of the move are "[r]ecent and expected future improvements in key economic and public finance metrics," as well as "[p]rogress on structural and institutional reforms that Moody's expects will reduce existing vulnerabilities to shocks to international capital flows over time."

"I think the factors encouraging Moody's to move over the rubicon... were the weak growth performance evident over the past few months, which suggests that a lid will be kept on the current account deficit," suggests Ash.

A second investment grade makes all the difference. The criteria of many of the globe's largest funds demand investment grade from at least two major ratings agencies before they will invest. "This should bring a whole new investor base to Turkey," Ash predicts, "and help the long queue of Turkish banks and [corporations] looking to tap international capital markets to fund some of the government's big ticket investment projects."

Economy Minister Zafer Caglayan welcomed the upgrade, saying it will cut foreign borrowing costs for Turkey and boost financing options for the nation's companies, according to Bloomberg. However, he also notes that Turkey should prepare for appreciation in the lira, a trend that the central bank is working hard to deter due to hot money inflows pushing the currency higher. That only helps encourage imports and puts the vicious circle surrounding the current account deficit into motion once more.

However, while the lira mounted a recovery on the news, it finished the day little changed, illustrating that the market has been trading on the assumption of an upgrade for some time, despite Moody's discouraging that speculation.

"I guess the market has been positioning for this for some months," writes Ash. "Further upside might be limited in the short term - maybe a case of buy the rumour, sell the fact."

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