Fitch Ratings became the first of the big three rating agencies to restore Turkey to investment-grade status last month when it upgraded the sovereign by one notch to BBB-.
The agency cited as the primary driver for the move its conviction that Turkey’s economy is on course for a "soft landing" after overheating in the wake of the global financial crisis.
Fitch’s most recent forecasts predict full-year GDP growth of 3%, down from 9.2% in 2010. By end-December, the current account deficit is expected to have moderated to 7% of GDP from 10% a year earlier and inflation to drop by 3.1 percentage points to 7.4%.
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| Mark Mobius, executive chairman of Templeton Emerging Markets Group |
Analysts and investors, many describing the upgrade as overdue, have broadly welcomed the move. "It has been a long time coming and probably should have been done before this," says Mark Mobius, executive chairman of Templeton Emerging Markets Group. "We have been investing in Turkey for over 20 years as a result of its dynamic economy and improving governance." Tim Ash, head of emerging market research at Standard Bank, agrees. "There’s been a paradigm shift in Turkey over the past five years in terms of stable single-party government, strength of public finances, strength of the banking sector and diversification of trade, and the rating agencies don’t seem to have adjusted to the new reality," he says.
"[The rating agencies are] overly focused on external financing risks and as a result are missing the wood for the trees."
Fitch, however, has responded robustly to criticisms of its timing. "The Turkish economy in 2011 had badly overheated and generated large imbalances at a time when the eurozone crisis had intensified and there was a lot of uncertainty over the global financial outlook," says Ed Parker, managing director at the agency.
"That’s not the sort of environment in which anyone would expect a rating agency to upgrade a country with a large current account deficit and external financing needs to investment grade."
Rating agencies and market participants are also divided over the extent of political risks to Turkey. Parker points to the World Bank’s governance indicators, which rank Turkey among the lowest 20% of countries globally for political instability and violence.
"Turkey is in a region that can be unstable and it doesn’t always get on with all of its neighbours," he says. "Our base case is that the problems between Turkey and Syria won’t escalate into a full-scale military conflict because we don’t see any appetite within Turkey for that, but you can’t rule out that kind of downside risk completely."
For Mobius, however, Turkey’s location is a potential strength. "Turmoil in the Middle East and in Turkey’s neighbouring countries may seem to be a vulnerability but, in fact, can be a positive variable, since Turkey is seen and will continue to be seen as a haven of stability in the area and should attract more tourism and investment," he says. "In addition, Turkey’s close ties with the EU make it a strategic and important bridge."
The key question now for market participants is whether Turkey can achieve the second investment-grade rating necessary for inclusion in global investment-grade indices. The likeliest candidate for a further upgrade is Moody’s, which on June 20 raised the sovereign one notch to Ba1 with a positive outlook.
In a note on the Fitch move, Barclays’ emerging market research team tipped Moody’s to raise Turkey to investment grade within five to six months, while acknowledging that the agency "recently repeated its usual general language on growth sustainability, current account adjustment, external vulnerability and inflation".
Ash at Standard Bank concurred, pointing out that Moody’s has raised Turkey’s local-currency rating to investment grade and adding that he sees a "high likelihood" the foreign-currency equivalent will be raised to match within the next half year.
Standard & Poor’s, however, seems determined to remain the exception. The agency has Turkey two notches away from investment grade at BB and revised the outlook from positive to stable in April, citing concerns about the potential "less buoyant external demand and worsening terms of trade" on the country’s heavy external debt burden.
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If and when Turkey does achieve a second investment-grade rating, the primary impact is expected to be seen in portfolio flows driven by global indices. Barclays puts the potential increase in demand for Eurobonds from the country at $2 billion to $2.5 billion. Ash agrees, but adds that the positive effects on foreign direct investment inflows might equal or surpass those on bond market investments. "Ratings drive FDI as well as portfolio investors," he says. "A lot of big multinationals use them as a general bill of health for an economy, so a move to full investment-grade status could prompt an upturn in FDI inflows, which would be good for growth and for financing the current account."
