Impact of Eurozone Downgrades on Turkey
Below is my latest Hurriyet Daily News column, which you can also read at the Daily News website.
I have a short addendum coming up tomorrow, but before that, I should boast that I was right on target with the EFSF downgrade. But honestly, you didn’t need to be Nostradamus to see that one coming:) And if you would like to read more about the Turks who passed away on Friday, here is what Daily News had to say on Lefter and Denktas.
Anyway, on to the column:
Both men had been having health problems for a while. Lefter was probably devastated by the match-fixing allegations, which have put his beloved Fenerbahçe’s president behind bars despite a lack of any solid evidence. But the suffering they went through in their final days is nothing compared to the Eurozone’s slow death.
Shortly before the clock hit midnight, credit rating agency Standard & Poor’s, or S&P, downgraded nine Eurozone countries, including AAA-rated France and Austria. Those two were cut one notch, while Italy and Spain went down two notches and Portugal was downgraded to junk.
If these downgrades were to lead to general risk aversion in markets, it would be devastating for the Turkish economy. The Central Bank of Turkey’s main scenario of lira appreciation in 2012 assumes that some of the extra liquidity being provided by the European Central Bank, or ECB, will find its way to Turkey.
But there is no reason to expect a “sudden stop” yet. Friday’s downgrades were completely expected. If you really thought that France was “risk-free” (what AAA means) or that Portugal, with its ten-year bond yielding 10 percentage points more than Germany’s bunds, was investment-grade, please tell me what you’ve been smoking. I need to escape reality as much as I can.
In fact, the yield on neither French nor European Financial Stability Facility, or EFSF, bonds rose by much after the announcement, although the euro dipped against the dollar. However, S&P will also downgrade the EFSF very soon, unless Eurozone officials restructure it to maintain its risk-free rating, in which case the fund would shrink.
At first glance, this does not seem to be as bad as it sounds for Turkey. With the EFSF weakened, it will be up to the ECB to support the Eurozone, which would mean even more of that liquidity that the Central Bank of Turkey would like to see.
But even if this emerging markets-friendly scenario materializes, the downgrades also mean that European banks, according to the new Basel rules, will have to set aside more capital for their sovereign bond holdings. Unless the ECB comes to the rescue, they will then have to deleverage, by an amount even greater than the $ 2-2.5 trillion most analysts were estimating before Friday.
This is where the real danger lies for Turkey. BIS banking statistics reveal that Eurozone banks are holding more than $150 billion of net foreign claims on Turkey- a hefty sum even if this exposure were to be reduced by 10 percent.
You could argue that local-currency claims do not require external funding, and they barely moved during the post-Lehman crisis period. Three-quarters of Greek and two-thirds of Spanish banks’ exposure are in liras. But even the sum of cross-border claims and local claims in foreign currency amounts to almost $ 90 billion.
I hope the ECB will save the day, and I will smile at my pessimism. But if it doesn’t, the debate on whether Central Bank of Turkey’s reserves are enough could move in a brand new direction.
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