When it rains, it pours for Turkey, which already saw its currency slump earlier in the day when its foreign minister, Murat Cavuosglu, said that Ankara is ready to retaliate to any US sanctions imposed upon the NATO member state by the US over Turkey’s purchase of a Russian S-400 missile system. And then, with markets set to close for the day and today’s pounding of the Turkish lira put in the history book, Warren Buffett’s favorite rating agency, Moody’s, delivered what tomorrow will surely be called an act of aggression and prompt Erdogan to expel any Moody’s employees from Turkey and confiscate any office they may have in the country, namely a downgrade of Turkey deeper into junk territory, cutting its credit rating by one notch from Ba3 to B1, outlook negative.
As Moody’s explained “today’s downgrade reflects the view that the risk of a balance of payments crisis continues to rise, and with it the risk of a government default.” Pretty self-explanatory.
The news spiked the lira – which continues to be inexplicably bid after every incremental piece of bad news by “unknown” traders – as much as 300 pips lower, before the loss was cut in half, and the USDTRY closed the day at 5.8951. Of course, now that not only is Turkey’s sale of sovereign debt going to be that much more expensive, but once Trump does in fact hike tariffs on Turkey, there will be the usual bevy of “traders” angrily asking how they failed to sell the lira at the current extremely generous levels when they could. And if they don’t, we will remind them.
Moody’s full note is below.
Moody’s Investors Service (“Moody’s”) has today downgraded the Government of Turkey’s long-term issuer ratings to B1 from Ba3 and has maintained the negative outlook. The senior unsecured bond ratings and senior unsecured shelf ratings have also been downgraded to B1 and (P)B1 respectively from Ba3/(P)Ba3.
Concurrently, Moody’s has downgraded to B1 from Ba3 the backed senior unsecured bond ratings of Hazine Mustesarligi Varlik Kiralama A.S., a special purpose vehicle wholly owned by the Republic of Turkey from which the Turkish Treasury issues sukuk lease certificates, and has maintained the negative outlook.
Today’s downgrade reflects Moody’s view that the risk of a balance of payments crisis continues to rise, and with it the risk of a government default. The B1 rating balances these risks against the country’s fundamental credit strengths, particularly its large, diversified economy and still-moderate levels of government indebtedness.
In a related decision, Moody’s lowered Turkey’s long-term country ceilings: the foreign currency bond ceiling to B1 from Ba2; its foreign currency deposit ceiling to B3 from B2; and its local currency bond and deposit ceilings to Ba2 from Ba1.
The short-term foreign currency bond ceiling and short-term foreign currency deposit ceiling remain at Not Prime (NP). Ceilings generally act as the maximum ratings that can be assigned to a domestic issuer in Turkey, including structured finance securities backed by Turkish receivables. The decision to align the foreign currency bond ceiling and the government bond ratings reflects Moody’s view that exposure to a single, common threat — loss of external confidence and capital — means that the fortunes of public and private sector entities in Turkey are, from a credit perspective, increasingly intertwined.
The impact of the continued erosion in institutional strength and policy effectiveness on investor confidence is increasingly outweighing Turkey’s traditional credit strengths including its large, diverse economy and the low level of government debt. Turkey is structurally highly reliant on external capital flows, and Moody’s confidence in its ability to continue to attract the large sums needed each year to repay debt and sustain growth is waning. It remains highly vulnerable to a further prolonged period of acute economic and financial volatility. Foreign exchange reserve buffers are weak and Moody’s expects them to weaken further over the next two years relative to economy-wide short-term liabilities. While policy announcements have been made, the political authorities have yet to implement a plan that would allow the economy to adjust to a new, more sustainable equilibrium due to the negative short-term economic impact that this adjustment would entail.
The government’s willingness or ability to implement policies that will sustain external investor confidence in the economy and financial system by addressing underlying weaknesses remains uncertain. Since mid-2018, the government has announced a number of economic reform packages. Ultimately, these announcements have been either reactive to particular pressures on the economy or a restatement of measures that would be credit positive if implemented, but have been discussed for years, and where little concrete has been done to execute on these policy aspirations. Most government measures, including those targeting the banking system, continue to be focused on the near-term priority of propping up economic activity at the expense of eroding the underlying resilience of the economy and its banking system to external shocks, in part by increasing its fragility to shifts in market sentiment.
The longer that remains the case, the more the weakness implied by Turkey’s very high reliance on external capital across all sectors of the economy comes to dominate Moody’s analysis; and the greater the risk of further externally-sourced shocks involving further capital outflows, loss of reserves, weakening in the exchange rate, rises in inflation and severe damage to medium-term growth. As a result, Moody’s believes that the country’s vulnerability to an acute and highly disruptive balance of payment crisis that ultimately would significantly constrain the capacity and perhaps the willingness of the government to service its debt is now more aligned to a single B rating, despite its still moderate debt burden relative to similarly-rated peers.
Turkey is indeed once again facing intermittent currency crises after a period of relative calm that lasted from late September 2018 through February 2019. In consequence, both gross and net reserves have fallen since February, with the decline in net reserves being particularly pronounced. Gross and net reserve levels have been structurally weak for many years, but this decline contributes to a significant increase in external vulnerability for the country. In 2019, Moody’s expects that short-term external debt repayments, currently maturing long-term external debt, and total non-resident deposits will total more than 2.6 times the level of FX reserves. Moreover, funding costs have risen rapidly, with yields up by around 400 basis points since February.
The fall in FX reserves seems contrary to the central bank’s longstanding policy to allow the exchange rate to float freely, and raises further concerns about the transparency and independence of the central bank and, by extension, Turkey’s broader institutional framework.
External pressures are exacerbated by the ongoing disagreement between Turkey and the United States, this time relating to Turkey’s purchase of the S-400 missile system from Russia. The sanctions which the US Congress will consider if the purchase goes ahead, while largely undefined to date, cast a further shadow over Turkey’s economy and financial system.
RATIONALE FOR THE NEGATIVE OUTLOOK
The balance of risk is firmly tilted to the downside. The risk of an acute balance of payments crisis remains relatively low in the very near term, consistent for now with the highest rating level in the single-B rating category. However, weakening external buffers point to this being an unstable equilibrium, and the more time passes the more the government’s ability to steer the economy away from a more credit-negative path of a balance of payments crisis is diminished. This, in turn, increases the probability of more credit negative outcomes involving the need for capital controls, restrictions on access to foreign currency and (sanctions permitting) external support.
There are a number of possible near-term drivers for further instability. In Moody’s view, the re-run of the Istanbul mayoral election on 23 June 2019 creates potential for political unrest that could trigger a further material decline in the value of the lira and a further depletion of FX reserves. The imposition of sanctions on Turkey could also lead to a further, highly credit negative, market reaction. Moreover, depending on the sanctions imposed, it could also raise doubts over Turkey’s ability to access an IMF programme, should one be needed in the future to avoid an escalation of a balance of payments and economic crisis. Even if Moody’s does not currently expect that to be needed, the potential tension between sanctions and external support could in itself further undermine investor confidence in the credit.
WHAT COULD CHANGE THE RATING DOWN/UP
Moody’s would likely downgrade Turkey’s rating if it were to become clear that avoiding a more credit-negative path was becoming increasingly unlikely, perhaps because of the currency crisis deepening further. Any indication that capital controls were becoming more likely or that Turkey’s fiscal strength was deteriorating in a significant way would be credit negative. A material deterioration in relations with the US in the form of sanctions would also put downward pressure on the rating due to the implications that might have for receiving IMF assistance.
Given the negative outlook, upward rating movement is unlikely. However, the rating could be stabilised if the authorities were able to present and, crucially, implement a credible and broad-based programme for addressing external pressures and engineering a rebalancing of the economy. Significant external financial support, and the policy agenda that would likely accompany it, would also be supportive for the rating.
NATIONAL SCALE RATINGS
Moody’s will shortly publish an update to its National Scale Rating (NSR) map for Turkey to reflect the downgrade of the government’s long-term issuer rating. Moody’s NSRs are ordinal rankings of creditworthiness relative to other credits within a given country, which offer enhanced credit differentiation among local credits. NSRs are generated from Global Scale Ratings (GSRs) through correspondences, or maps, specific to each country. However, unlike GSRs, Moody’s NSRs are not intended to rank credits across multiple countries. Instead, they provide a measure of relative creditworthiness within a single country. The full maps can be accessed through the “Index of Current and Superseded Compendia of National Scale Rating Maps by Country”.
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