TRY: Lira reacts modestly to positive rating assessments - Commerzbank

Turkey's economic policy credibility received a modest boost last week as both Moody's and Fitch offered more positive assessments of macroeconomic policies. Moody's upgraded Turkey's sovereign rating from B1 to Ba3 and revised the outlook to stable, citing improved policy credibility and reduced risk of reversal. The agency praised the central bank's (CBT's) aggressive tightening as successful in stabilising the Lira and anchoring inflation expectations - albeit temporarily. Moody's, however, flagged that FX reserves remain well below pre-2018 coverage ratios, and warned that further progress hinges on avoiding political interference and sustaining structural reforms, Commerzbank's FX analyst Tatha Ghose notes.

Risks of policy backsliding and high inflation

"Fitch, meanwhile, maintained a more cautious tone, holding its BB-rating with a stable outlook. While acknowledging improvements such as tighter monetary policy and better external financing conditions, it continued to highlight the risks of policy backsliding, high inflation, and increased short-term external debt rollover requirements. Fitch explicitly called out the weakness of the monetary framework due to limited CBT independence, and noted that household inflation expectations remain alarmingly high."

"Indeed, the latest household survey of July showed a sharp 1.5ppt increase in 12-month household inflation expectations to 54.5%. Only 26.6% of households now expect inflation to fall - down 4pts vs. June - while market participants and the real sector are more optimistic, forecasting inflation at around 23% and 39% respectively. The government's own forecast remains below both, at 17.5%."

"The Lira exchange rate reacted modestly to the more positive assessment, but it remains on its steady and rapid depreciation path. This is being partly masked by the ultra-weak US dollar itself. Against other major currencies, such as the euro, the Lira's depreciation appears almost exponential. Even against a 50-50 basket (USD and EUR), the depreciation rate is quite rapid - eyeballing the chart below, we can see that the exchange rate versus the basket is 20% weaker than it was six months ago in February - this implies a c.43% annualised rate of depreciation. Rate cuts at least will not help in this regard."