Moody on the Turkish economy

My latest column, in which I argued that the Turkish Lira would continue to slide until the Central Bank intervened with a significant interest rate hike, may have seemed pessimistic. But compared to a report and article that I read over the weekend, it is actually optimistic.

In his latest report on the Turkish economy, Mert Y?ld?z from Roubini Global Economics argues that credit rating agency Moody?s may cut Turkey?s sovereign credit rating from investment grade to junk. According to him, ?Moody?s would likely highlight spillovers to the economy from political uncertainty, high and rising external vulnerabilities and low growth potential.?

The decision would have a huge market impact. Y?ld?z notes that ?unlike with other countries at risk of losing investment grade status, a Moody?s downgrade of Turkey does not seem to have been fully priced in to the markets.? He expects the lira to depreciate further to 3.10 or 3.20 to the dollar as a result.

The downgrade would also mean that funds that can only invest in countries rated investment grade or above by at least two major rating agencies would have to exit Turkey. This would result in a bond sell-off, which could raise rates by 1-2 percentage points, according to Y?ld?z. The rising cost of borrowing would also ?adversely affect Turkish banks, probably resulting in an equity sell-off.?

Moody?s has underlined before Turkey?s strong fiscal balance and public debt as a justification of the current investment grade status. However, Y?ld?z argues that the country?s balance sheet is more vulnerable than it looks - and gives several reasons why it may weaken in the coming months.

For one thing, Treasury-backed debt, which has risen significantly recently, as well as the...