Summary: For those who want to see the glass half empty, the EU debt crisis has arisen as the most commonly used argument. In that context, Ireland has become an easy target to attack as the country has one of the most rapidly growing public debt stocks. However the real concern is the possible spill over of the debt saga to more important and bigger countries of Europe, such as Spain. However, Spain has one advantage (residents have a greater share in the debt market) that is not valid for the smaller EU countries. Turkey is in a relatively more advantageous position, as the country has not suffered any deterioration in the debt dynamics and the government debt is mostly owned by the residents. Turkey’s distinct position has been priced by the markets, while it is the rating agencies’ turn to reflect these favorable aspects to credit ratings.
The Eurozone debt crisis, China’s measures to cool off the economy and U.S. labor market that has failed to enjoy a meaningful rebound so far… All have become the major themes this year that feed into the pessimistic views regarding the global economy. These topics happened to be used alternately to justify the stock market sell-offs observed in the long term upward trend. The combination of all of these unpleasant factors tends to exaggerate the pressure even further. The markets have been suffering such bearishness over the last days that dampen the global risk appetite. The stock markets and the bond yields are tumbling, accompanied with a higher U.S. Dollar, lower commodity prices, yet a more valuable gold. Fortunately, the deterioration in sentiment seems to have remained limited. What then is preventing the gauges of risk appetite, such as the VIX index from climbing as extensively as was the case during the Greece debt crisis in May? One reason is that the EU acted quickly to launch the support mechanism, which is co-financed by the IMF (EFSF – European Financial Stability Facility), while the other reason is the relatively small size of Irish economy, like Greece. However, the severity of the problems regarding Ireland is not proportional to the size of the economy. The banking sector in Ireland has grown more than three times as big as GDP, with the main creditors being the private banks of big European countries. Therefore unlike Greece, where the public finances constitute the roots of the crisis, in the case of Ireland there is this fear of contagion to other countries. The real concern is the possibility of the debt problems spreading to more important countries in Europe, such as Spain, where CDS has already climbed to 310 bps, a warning that this risk has started to be partially priced. In order to soothe the fears about Ireland, the EU officials soon announced that some EUR80-90bn may be drawn from the EFSF to bail out Ireland. The details of the rescue package are expected to be shaped at the EU finance ministers’ summit on December 7th. In due course, the ECB has been providing EUR130bn to the Irish banks that correspond to 20% of their total assets. Ireland and Greece have the fastest growing public debt and explains why these countries have become targets for the markets.
At this point, one can question why other countries in the top 5, such as Japan, U.K. and the U.S. do not face similar pressure. We believe that the answer lies at the composition of the creditors. Non-residents own more than 70% of the total government debt instruments in countries like Greece, Ireland and Portugal. This structure of the bond market, where residents have much less power, intensifies the dismal impact from sell-off pressure during periods of surging fears regarding the public debt. Whereas, countries such as Japan, Canada or the U.K can avoid panic more easily, since the public debt is mostly owned by residents. In that context, Portugal and Spain which are often speculated to be the next destination of debt crisis stand at a distinct position and Spain is likely to tackle the pressure more easily despite the recent surge in their risk premiums. Glancing at Turkey’s position, the relatively limited foreign participation in the government debt securities seems to be another advantage for Turkey in the post-crisis environment. In fact, the increase in the debt stock has remained subdued in this period and the share of non-residents is still below 13%, despite some late up-tick. Turkey ranks among the countries with the lowest foreign participation in the public debt market after Japan and Canada. Turkey’s CDS trades at 140 bps as of November 25th, lagging below most developed and developing nations.
While the financial markets rate Turkey’s credit worthiness in the “investment grade,” thanks to the favorable growth performance that improves debt dynamics, there has also been improvement in the rating agencies’ view on the country. The outlook has been upgraded to positive on November 24th by Fitch, who already sees Turkey closer to the investment grade than their peers do. With this move, the big difference between the market valuations and the credit ratings tend to narrow a little bit. Fitch noted that implementation of fiscal policy consistent with a downward trend in the government debt-to-GDP ratio could result in upgrade, adding that if Turkey comes through parliamentary elections and prospective constitutional amendments without a material increase in political instability this would also be supportive. Gathering all these statements, it is understood that the earliest possible timing for upgrade would be after the general elections in mid-2011. This expectation would remain as a catalyst for relative strength of TRY assets.
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