Crisis-hit Turkey took lightning bolts from three major rating agencies on August 17. Two downgrades cut it further into junk territory and a warning was issued that the country’s reaction to its financial turmoil was unlikely to stabilise its currency and economy for a meaningful amount of time.

Standard & Poor’s—like the other two agencies issuing its note just as the country was preparing to enter its near-week-long Eid al-Adha religious holidays—cited “extreme lira volatility” in its decision to lower its rating on Turkey one notch to B+ from BB- and forecast that the country would fall into recession next year.

Moody’s Investors Service lowered its rating on Turkey to Ba3 from Ba2, concluding that a quick and positive resolution to Turkey’s turmoil was becoming less likely because of the “further weakening of Turkey’s public institutions and the related reduction in the predictability of Turkish policy making”—that was clearly a swipe at how since ‘upgrading’ his presidency to an executive presidency following the June 28 elections, President Recep Tayyip Erdogan has become almost all-powerful and the apparent master of Turkey’s monetary policy, despite the occasional protestations of the country’s central bank that things are otherwise.

Fitch Ratings—which lowered its rating on Turkey one month ago to BB from BB+—joined S&P and Moody’s in giving Ankara another wake-up jolt by warning that its “incomplete policy response” to the deepening economic trouble was unlikely to stabilise the lira and hugely debt-burdened economy for a period that would prove meaningful.

Growth-at-all-costs
Alluding to Erdogan’s growth-at-all-costs policy set, and apparent refusal to countenance interest rate hikes when the conventional wisdom is that an economy beset by overheating such as Turkey’s is in dire need of major tightening, Fitch said in a note: “Turkey's incomplete policy response to the lira's depreciation is unlikely on its own to sustainably stabilise the currency and the economy. We believe this would require an increase in the policy credibility and independence of the central bank, tolerance of weaker growth by policymakers, and a reduction in macroeconomic and financial imbalances.”

Fitch observed that the Turkish lira (TRY) recovered somewhat across the week after falling below TRY7 to the dollar, but it was still down around 35% against the dollar in the year to date. Foreign exchange reserves, including gold, dropped to $96.8bn at end-June from USD110.4bn at end-April.

“The abrupt tightening in financial conditions will sharpen the slowdown in GDP growth already under way,” Fitch also said. “A slowdown from 2017's unsustainable 7.4% growth and some depreciation of the real exchange rate were inevitable to reduce imbalances. Turkey's vibrant economy and favourable medium-term growth potential support sovereign creditworthiness, as does low government debt (28% of GDP at end-2017, of which foreign-currency debt was only 11% of GDP). But the absence of an orthodox monetary policy response to the lira's fall, and the rhetoric of the Turkish authorities have increased the difficulty of restoring economic stability and sustainability.”

Aggravated
In a note, S&P analysts were in tune with Fitch’s assessment, saying that Turkey’s economic risks were “aggravated by an absence of a rapid and effective policy response.”

The lira was steady following news of the downgrades, but it was nevertheless 3.3% weaker for the overall session after the US suggested more sanctions over the pastor Andrew Brunson dispute could be on the way. One dollar bought TRY6.022. By 00:40 Istanbul time on August 18 there had been negligible change in the rate.

Explaining its downgrade, S&P added: “The downgrade reflects our expectation that the extreme volatility of the Turkish lira and the resulting projected sharp balance of payments adjustment will undermine Turkey’s economy. We forecast a recession next year. Inflation will peak at 22% over the next four months, before subsiding to below 20% by mid-2019. We anticipate that 2019 will be the first year since 2009 in which nominal credit growth will be less than inflation, implying a major shift in real domestic financing conditions.”

In its downgrade comments, Moody’s said: “In Moody’s view, the probability that the Turkish authorities will manage to engineer a ‘soft landing’ of the economy is declining in the context of weakened institutions and increasing tensions with the US. Therefore, the risk of continued financial stress is significant, with potentially further negative implications for Turkish banks and corporates that have large external funding needs. Such a negative scenario would further increase the risk of a prolonged period of acute economic and financial volatility, which ultimately would weigh further on the credit risk profile of the government.”

August 17 also saw the Financial Times report that Turkey’s stand-off with Washington over the detention of Brunson—who faces what the US claims are contrived espionage and terrorism charges—centres on the collapse of a deal to free Brunson in return for the return to Turkey of Mehmet Hakan Atilla—a deputy CEO of Turkish state-controlled Halkbank—who was jailed by a New York Court for violating US sanctions against Iran. Diplomatic sources told the newspaper the agreement would have seen him returned to Turkey to serve out his sentence several weeks after Brunson’s release.

Atilla was sentenced to 32 months in jail in May for his role in a money laundering plot to evade Iran sanctions. Halkbank still potentially faces criminal action and fines worth billions of dollars for its role in the scheme involving $1bn of Iranian oil revenues.

The deal reportedly failed to move forward after Erdogan demanded further concessions over Halkbank. A source told the FT that these included a commitment from the US to drop any further investigation of the bank.

The newspaper report added that US officials have repeatedly told Ankara that they cannot interfere in the legal proceedings brought by federal prosecutors in the Southern District of New York.