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November 22, 2012, Thursday

Why can’t credit rating agencies agree?

Two weeks ago Fitch upgraded Turkey to investment level. Two days ago, Moody's refused to upgrade Turkey to this level and kept its rating one notch below investment grade. Rival Standard & Poor's continues to keep Turkey two notches below investment grade. Why can't the global credit rating agencies agree? If we exclude the case of plot scenarios, we must find a consistent answer to this question. I think the starting point should be a comparison of Fitch's and Moody's arguments that lie behind their controversial decisions.

According to Fitch, the Turkish economy merited the upgrade because its financial risks have recently improved, the public debt ratio to gross domestic product (GDP) continues to fall, and it has a strong banking sector. Moody's agrees on these points. Indeed, its spokesman declared, “Turkey's government's financial strength has improved steadily over the past decade.” But the critical point, as I pointed out in my column of Nov. 9, “Upgrading Turkey,” is the external imbalances. The current account deficit (CAD) last year reached 10 percent of GDP. Since August 2011, the government, together with the central bank, has tried to shift domestic-led growth to a more balanced growth through complex monetary and fiscal policies. The rebalancing process worked till now. The CAD decreased along with growth, so the famous “soft lending scenarios” seemed to be well underway. There is a large consensus among forecasters that the CAD has declined to approximately 7 percent and the growth rate to 3 percent. But the first rate is still too high and the second too low.

Fitch estimates that the soft lending is likely to continue -- unless there is a reversal in the rebalancing policies. The rating agency forecasts 3.8 percent growth next year and a still narrowing CAD. Moody's is not so optimistic. “Given the structural nature of these imbalances, it will take time to be fully addressed,” says Moody's. In other words, Fitch's rival adopted a “wait and see” approach. Can it be blamed for being too cautious? I do not think so. Several risks exist, and they have to be carefully evaluated.

Moody's is not very clear about the risks it considers, but I think it is not very difficult to identify them. I already noted in my column mentioned above two of these risks: The risk of appreciation in the Turkish lira and the political risk of a reversal in the rebalancing policies. Turkey can face an increase of capital inflows that risks provoking an appreciating lira. This will certainly not help the rebalancing process since exports will be discouraged while imports encouraged. Recently Governor Erdem Başçı made clear that if the risk of appreciation occurs, the central bank will not hesitate to decrease its policy rate to prevent excessive capital inflows.

However, we cannot forget that in such a case the Turkish economy would face another risk, the risk of fueling domestic demand. The central bank has already relaxed to some extent its monetary policy that aimed to push banking loans rates a little bit down, and bank loans are slightly increasing right now. The 3 percent growth rate does not make anybody happy. For more than two years unemployment was decreasing, but nowadays signs of a reversal are quite perceptible. The central bank thinks that there is some room to maneuver for a controlled increase in domestic demand, but if it is obliged to lower interest rates further, one cannot guarantee that a skid can be avoided. In such a case, the pursuit of the rebalancing process can be questioned.

So, if Turkey wants to be upgraded by other rating agencies, it will be condemned to maintain the low growth regime for a while. The government's medium-term program, the official road map of the economy, forecasts 4 percent growth for 2013 and 5 percent for 2014, but it still assumes export-led growth. International institutions are not so optimistic. A recent IMF forecast estimates growth of 3.5 percent for the Turkish economy next year. Thus, appears the political risk.

The incumbent Justice and Development Party (AK Party) will be facing a period of successive elections starting in March 2014. I do not think that it will accept -- without reacting -- to low growth if it persists. In this case AK Party will be facing a dilemma: Would it be better in electoral times to have an upgrading from rating agencies or to control unemployment? I think that it will choose the second option. 

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