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Turkey with a rating of Ethiopia?

17 Aug 2018 13:53|Marcin Lipka

Today, S&P Global Ratings is going to assess Turkey's creditworthiness. The dramatic fall in the value of the local currency and the failure of the authorities to respond adequately to threats to the country's financial stability may cause Turkey's rating to fall to the level of the poorest countries in the world, namely Ethiopia, Zambia and Rwanda - writes Marcin Lipka, Conotoxia Senior Analyst.

In the year the lira lost more than 40% of its value in relation to the dollar, and the profitability of 10-year treasury bonds reaches 22%, while still at the beginning of May it was about 12%.

Will these fatal results be reflected in S&P's decision today to downgrade its rating and its announcement of further cuts in the case of its unwillingness to introduce reforms? If so, will the decision be reasoned?

From the border of Europe and Asia towards poor Africa

In June, Moody's announced that Turkey was on the watch list for the lowering of the rating. In July, Fitch reduced Ankara's creditworthiness and gave it a negative perspective.

S&P last evaluated Turkey in May. At that time, the agency lowered its rating to BB-. This is still 2 levels above Rwanda, Zambia or Ethiopia (score B). It is worth noting, however, that credit rating cuts can be very rapid, even from month to month. In case of Greece, the single reduction over one and a half months (March-April 2010) was 3 degrees and in 2011 the cuts were 2 degrees in each of the two S&P decisions.

Today, the pressure on S&P to cut ratings by more than one level may also be caused by CDS contracts (the cost of insolvency insurance) with a rating of 500 points lower than in the case of Rwanda, Cameroon and Senegal, which are rated "B" at 350-450 points. And the higher the valuation of CDSs, the greater the chance of the country's bankruptcy.

It is also worth noting that the risks presented by S&P in May were realised and were cited as an argument for further rating cuts. "We can downgrade Turkey if external financing conditions and the exchange rate deteriorate further, increasing risks for the private sector, which has significant external financing needs.

Since 1 May, the Turkish currency has lost more than 30% of its value to the dollar and 29% to the euro, which is likely to meet the conditions for rating cuts.

How easy is it to lose half the capital?

If S&P cuts Turkey's creditworthiness by two degrees today, Ankara will have a rating of Ethiopia, which is one of the poorest countries in the world and has a GDP per capita of only about 10%.

At first sight, this decision can be considered too rapid. However, if we look at Ethiopia from the perspective of the bond purchaser, it presents a lower risk than Turkey in some respects. According to S&P Ethiopia's estimates, this year's inflation is expected to be lower - 8.5% than Turkey's - 10.3%. Currently, inflation in Turkey is already at the level of about 16%, and this without the impact of the recent weakening of the lira. The exchange rate of the Ethiopian currency (creeping devaluation of only 5-6% per year - according to S&P) is also more stable than that of the Turkish currency.

Investors who are Turkey's creditors have been exposed to huge losses this year due to a strongly stimulating fiscal policy, price instability, a high current account deficit and a reluctance to turn to the IMF for financial assistance.

Foreign funds, which in May this year acquired Turkey's 10-year government bonds denominated in the lira lost about 35% in the local currency on this investment (profitability increase from 12% to 22%) and another 30% in the lira value decrease, if they now want to withdraw from these bonds and convert funds into euro or dollars. In total, therefore, it was easy to lose more than 50% of the capital, and a significant part of these losses is the result of the country's disastrous fiscal and monetary policy.

Probable verdict and Ethiopia in the perspective

Taking into account the mistakes that were made in the Turkish economy, in particular the lack of willingness to correct them (reluctance to fight inflation and to turn to the IMF), a serious deterioration of Turkey's creditworthiness is very likely today. If the Ankara authorities do not change their behaviour, a cut up to level B, e.g. Ethiopia, would also be reasonable.


17 Aug 2018 13:53|Marcin Lipka

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