Moody’s and S&P downgrade Turkey on weak response to fiscal distress

Turkey had its sovereign credit rating downgraded by Moody’s Investors Service and S&P Global Ratings, as it sinks further into an economic crisis with little clarity from its leadership on how it plans to steer the country out of a turmoil that could push it into recession next year.

Moody’s downgraded the government of Turkey’s long-term issuer ratings to Ba3 from Ba2 and changed its rating outlook to negative on Saturday. Its senior unsecured bond ratings and senior unsecured shelf ratings were also cut to Ba3 and (P)Ba3 respectively.

S&P slashed Turkey’s sovereign credit rating to ‘B+’ from ‘BB-’ but assigned a stable outlook on Friday. The rating agency, citing extreme volatility of the Turkish lira among the reasons for the downgrade said the depreciation of the currency may lead to a balance of payments crisis that could undermine the Turkish economy and lead it into a recession in 2019.

“The key driver for [the] downgrade is the continuing weakening of Turkey’s public institutions and the related reduction in the predictability of Turkish policy making,” Moody’s said in its note.

“That weakening is exemplified by heightened concerns over the independence of the central bank, and the lack of a clear and credible plan to address the underlying causes of the recent financial distress.”

Turkey’s lira has lost more than 40 per cent of its value against the US dollar this year, prompting fears of a sell-off in emerging markets.

"This follows Turkey’s prolonged economic overheating, external leveraging, and policy drift," S&P said. “We now expect the economy will contract by 0.5 per cent in real terms in 2019, underpinned by declining consumption and falling investment.”

Turkey's currency took a 20 per cent hit last Friday after US President Donald Trump announced a doubling of steel and aluminium tariffs on its Nato ally, in retaliation to the continued detention of American pastor Andrew Brunson in Turkey, who has been held since 2016 on charges of plotting a coup attempt against Turkey’s president Recep Tayyip Erdoğan.

The lira rallied on Wednesday after Turkey’s banking regulator took measures to shore up the currency. However, Washington later threatened more economic sanctions unless Turkey frees Mr Brunson.

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One of Turkey’s high criminal courts on Friday rejected Mr Brunson’s request to be released from house arrest and permitted to travel abroad, Turkey’s state news agency reported. The lira weakened again to 5.86 against the dollar that day, from a previous close of 5.8150.

The ratings agencies said the persistently volatile lira and wide current account deficit risk undermining the Turkish economy. Moody’s said the tighter financial conditions and weaker exchange rate, associated with high and rising external financing risks, are likely to fuel inflation further and undermine growth, and said the risk of a balance of payments adjustment continues to rise.

Moody's in June placed Turkey's credit rating on review following the downgrade in March to Ba2, two levels below investment grade. Mathias Angonin, a sovereign analyst at Moody's, told The National ahead of the rating action that the agency is likely to downgrade it "if we conclude that policy-making is unlikely to be able to prevent a further deterioration in Turkey's external position".

S&P on Friday said the weakening of the lira is putting pressure on the indebted corporate sector and has considerably increased the funding risk for Turkey’s banks. The policy response from Turkish authorities so far has been “limited”.  S&P already rates Turkey’s bonds as ‘junk’, meaning they are considered high-risk investments.

Moody’s on Saturday also lowered Turkey’s long-term country ceilings, including the foreign currency bond ceiling to Ba2 from Baa3; its foreign currency deposit ceiling to B1 from Ba3, and its local currency bond and deposit ceilings to Ba1 from Baa2.

Ceilings generally act as the maximum ratings that can be assigned to a domestic issuer in Turkey.

“The decision to narrow the gap between the ceilings and the government bond rating is informed by Moody’s view of weakening institutional strength,” it said.