In the wake of the Turkey Crisis, rating agency Moody's recently downgraded the Government of Turkey's long-term issuer ratings to Ba3 from Ba2 and changed its rating outlook to ‘negative’. The move was in line with market expectations, as the rating agency had initiated a “review for downgrade” on 1 June 2018 with continuing weakening of the country’s currency. Senior unsecured bond ratings and senior unsecured shelf ratings were also downgraded to Ba3 and (P)Ba3 respectively.
Concurrently, Moody's downgraded to Ba3 from Ba2 the senior unsecured bond rating 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 changed its rating outlook to negative.
The key driver for Moody's downgrade is the "continuing weakening of Turkey's public institutions and the related reduction in the predictability of Turkish policy making,” the agency said. That weakening is exemplified by heightened concerns over the independence of the central bank, and by the lack of a clear and credible plan to address the underlying causes of the recent financial distress, notwithstanding recent statements by the government.
“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 the risk of a balance of payments crisis continues to rise,” the agency added.
In a related decision, Moody's lowered Turkey's long-term country ceilings: 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.
The short-term foreign currency bond ceiling was also lowered to Not Prime (NP) from Prime-3 (P-3) and the short-term foreign currency deposit ceiling remains unchanged 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 narrow the gap between the ceilings and the government bond rating is informed by Moody's view of weakening institutional strength.
When Moody's placed Turkey's Ba2 rating on review for downgrade on 1 June, the rating agency stated that the outcome of the review would mainly rest on the coherence and predictability of the policies pursued by the government and the extent to which the policy framework would restore adequate financing of Turkey's large external borrowing requirements.
Since then, financial stress has increased further, most visibly in the sharp depreciation of the Turkish Lira, which has now lost close to 40% of its value against the US dollar since the start of the year. Consumer price inflation has reached 15.85% in July, up by more than five percentage points since the start of the year and the highest inflation rate since December 2003.
Domestic funding conditions have deteriorated with bond yields on the government's domestic securities reaching above 20% in mid-August. While Turkish banks have so far managed to maintain access to the international inter-bank markets for funding, the tightening financing conditions and the weakening Lira will further increase pressure on domestic borrowers with foreign-currency debt.
“Our view of a further decline in the predictability and effectiveness of economic policy making is exemplified by concerns over the central bank's independence. This particularly follows the centralization of powers at the presidency level following the elections in June with the president now having the sole responsibility for appointing the central bank governor, deputy governor and other members of the country's Monetary Policy Committee.”
Since the elections, the central bank has refrained from raising policy rates despite significantly increasing its inflation forecasts for this year and next. “The discrepancy between the central bank's inflation forecasts and targets and its unwillingness to pursue an appropriate policy to achieve those targets further undermines the central bank's credibility,” Moody’s concluded.
