Turkish stocks fell more than 4 per cent on Monday — their worst drop since a failed coup — after Moody’s cut the country’s credit rating to junk status.
The decision, which also prompted a sharp fall in the lira, followed a similar move by S&P Global Ratings and leaves Fitch as the last major rating agency to maintain an investment-grade rating for the country.
The downgrade, which came late on Friday, prompted a furious government reaction, with President Recep Tayyip Erdogan’s chief adviser, Yigit Bulut, telling state-run television he considered the decision akin to the failed coup on July 15. Prime Minister Binali Yildirim complained it was “not impartial”.
Turkey is particularly sensitive to such decisions because of its heavy reliance on foreign investment. Moody’s attributed its action to a slowing economy and concerns about the rule of law. In a worst-case scenario, it raised the possibility of Turkey facing a balance of payments crisis.
“The risk of a sudden, disruptive reversal in foreign capital flows, a more rapid fall in reserves and, in a worst-case scenario, a balance of payments crisis has increased,” Moody’s said.
Turkey needs to roll over foreign debts that total 26 per cent of its GDP — some $155bn. That debt load is the highest among its peers and nearly double what its net foreign exchange reserves are expected to be at year-end.
Such a dire outcome would require foreign inflows to dry up, a situation that the country is currently shielded from because investors are favouring emerging markets as a whole during a period of global liquidity.
The risk of a sudden, disruptive reversal in foreign capital flows, a more rapid fall in reserves and, in a worst-case scenario, a balance of payments crisis has increased
Mr Bulut predicted outflows to be under $3bn in the months ahead.
Two European fund managers predicted they would be larger, noting that most funds require countries to have at least two investment-grade ratings. The managers said they would be readjusting their portfolios of both Turkish debt and equity significantly, without giving details.
Fitch has already changed its outlook to negative, pending a decision in early 2017. For Turkish banks, which peg their borrowing to Fitch, that will be a key decision. Inflows since it first received Fitch’s investment grade ratings in November 2012 total at least $15bn, according to calculations from BNP Paribas. As much as $8.7bn of this could be at risk of a forced sale, JPMorgan Chase analysts predicted in August.
The lira weakened as much as 2.98 against the US dollar, nearing the three-per-dollar psychological threshold it has already breached several times this year. Still, Timothy Ash, an analyst at Nomura, judged the reaction fairly muted since many foreign investors had priced in the possibility of the downgrade.
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“I think the right take is that markets are taking this in their stride,” said Mr Ash. “This might be surprising to some but reflects underlying durability and stronger fundamentals than assumed by Moody’s.”
The main Turkish stock index dropped 4.4 per cent. But the increase in yields on Turkish government bonds brought out bargain hunters, with 3.5 times as many bids — the highest in 23 months — for today’s auction of 10-year bonds. “There’s money to be made in junk bonds,” said one buyer. “You can’t get these sorts of yields almost anywhere else.”
But the long-term impact on Turkey’s economy, already slowing down, might take a while to materialise. Economic growth in the country slowed to 3.2 per cent in the last quarter, its current account deficit rose to more than 4 per cent, and tourist arrivals fell by almost a third.
Turkey has consistently been able to roll over its debts, but three bankers told the FT last week that a downgrade would inflate financing costs by as much as 50 per cent.
I think the right take is that markets are taking this in their stride
– Timothy Ash, Nomura
For now, the country’s growth remains the largest positive indicator — one that Mr Erdogan has seized upon to defend Turkey from detractors. He has tried to spur consumer spending by cutting rates and making personal loans cheaper. Moody’s, in its downgrade cited the erosion of Turkey’s institutional strength, a nod to the sustained attacks by Mr Erdogan that have chipped away at the independence of the central bank, which, under a new governor, has delivered consistent rate cuts despite failing to meet its inflation targets.
Mujtaba Rahman at the Eurasia Group said the downgrade was likely to cause the government to sharpen its focus on growth. “Rather than proposing a new structural reform package, the government is likely to pursue an ad hoc and incoherent reform agenda that does little to address Turkey’s structural challenges,” he said.