On Friday Fitch downgraded Turkey’s long-term credit rating by one notch, to BB, negative outlook; in-line with Moody's, and one notch above S&P’s BB- rating. We highlighted our concerns last month, ahead of the elections, as the economic fundamentals looked increasingly shaky and the lira collapsed; currently down 20.5% ytd. Also, inflation hit a 15-year high of 15.39% yoy in June off the back of the tumbling lira. In terms of other key economic points, Fitch stated that Turkey’s credit account deficit is expected to widen to 6.1% this year saying it “believes downside risks to macroeconomic stability have intensified owing to the widening in the current account deficit (CAD), more challenging global external financing environment, jump in inflation and the impact of the plunge in the exchange rate on the private sector, which has significant foreign currency-denominated debt.” Adding, “economic policy credibility has deteriorated in recent months and initial policy actions following elections in June have heightened uncertainty. This environment will make it challenging to engineer a soft landing for the economy.”
To add to the destabilisation, it is well known that recently sworn in President Erdogan is not a big fan of higher interest rates and just last week, Erdogan appointed his son-in-law Berat Albayrak as Turkey’s finance and treasury minister; a move that appeared to upset markets. Albayrak did try and calm markets by promising to do whatever it takes to contain market conditions; however, rating agency Moody’s highlighted its concerns about the country’s central bank’s independence. Adding that the appointment is credit negative “given the importance of that institution’s role in addressing the growing imbalances in Turkey’s economy and financial system.” Turkey will require further borrowing to finance its budget deficit, as such Fitch said: “Turkey’s large gross external financing requirement leaves it vulnerable to shocks”. The rating agency estimates external borrowing is close to USD300bn for this year; this debt could come under pressure as investors continue to dump bank stock, which could lead to debt defaults.
Turkey’s USD 30-year yield currently stands at ~7.5%, with a risk-adjusted expected return and yield of 21.25%, however, the bond offers less than 1.3 notches of credit notch protection, using the better BB rating. The nation’s 5-year CDS is trading at 325bps, only marginally tighter than that of Tunisia. Although these levels may look pleasing to some, we would not touch Turkey, no matter how “attractive” it might look, the nation is rejected from our investable universe purely from a 2 star NFA position. 7 star rated Abu Dhabi on the other hand looks far more compelling. Its benchmark USD 30-year yields 4.4% and offers an expected return and yield above 16%. Indeed this is not as attractive as Turkey’s, however, the bond is rated AA by S&P and Fitch and is 3.7 notches cheap and Abu Dhabi’s 5-year CDS is only 65bps; so a much “safer” option.