Monday, October 11, 2010

Weekly Hurriyet Column: Economist Wars: The Ratings Wars

Below is the unedited version of my column for this week. You can read the final version at the Daily News website, but since I have been editing my columns myself on the Daily News website since March, you won't see much of a difference between the two. 

For a change, I have no addendum this time around, except that I really love my cheesy title.

Anyway, on to the column:

As the wise Yoda would say, begun again the ratings war has.

The Financial Times, or FT, beyondbrics blog featured several guest posts on the curious case of Turkish sovereign ratings last week. I say curious because according to one camp of economists, Turkey’s sovereign ratings are way too low, and the country deserves an upgrade to investment grade.

There are different strands of this argument. As Credit Agricole Cheuvreux’s Simon Quijano-Evans argues in the first of the FT series, one is to note that markets, as evidenced by the low spreads of Turkish credit default swaps, or CDSs, have already priced in an upgrade.

It is true that Turkey’s sovereign ratings look unjustifiably low compared to its CDS spreads. But the CDS market, despite its sheer size, is rather illiquid, according to data from Depository Trust and Clearing Corporation, a clearing house for over-the-counter derivatives.

Even if you adjust for liquidity, you have to remember that CDS spreads also depend on global factors. A simple statistical exercise reveals that U.S. interest rates and global risk appetite weigh much more on Turkish CDSs than domestic developments. In fact, sovereign CDSs tend to move together a lot, although country-specific factors do affect long-run trends and structural breaks.

But irrespective of the CDS argument, Turkey’s economic fundamentals seem to speak for themselves. Many analysts who argue for an upgrade point at the country’s sound banking system, low debt ratio, high growth rate and even status as a regional power.

Not so fast, Murat Üçer of Global Source Partners and Turkey Data Monitor warns in a follow-up post. He notes the country’s vulnerabilities such as the challenging balance of payments and inflation outlooks, unbalanced fiscal-monetary policy mix as well as structural and institutional weaknesses.

There is no way to resolve the fundamentals debate. As I argued when the first ratings war broke out more than a year ago, for every indicator that shows Turkey is underrated, you can find another that illustrates it is overrated.

A useful simplification would be to note the dichotomy in Turkish data between “stocks” and “flows”. Stocks look good, whether it be bank capital or debt-to-GDP ratios. But the flows story of the need to ensure high-quality capital flows to sustain growth looks shakier by the day.

There is also a much subtler argument: Analysts like Royal Bank of Scotland’s Tim Ash agree that Turkey’s economic indicators paint a mixed picture, but also argue that they are nevertheless better than some peers with higher ratings. At his FT guest post, Tim looks at the likes of Egypt, Hungary, Latvia and Poland to prove that Turkey is underrated relative to peers.

To me, that reflects the peers’ mess-up (and the agencies’ sluggish response) more than anything else. But it also presents an enormous window of opportunity, as Murat underlined in a phone chat. According to him, Turkey could easily move to investment grade and beyond if it capitalized on this opportunity by focusing on the much-needed reform agenda.

Tim also argues that sovereign ratings should gauge where a country stands relative to others as well as default probabilities and willingness to pay, but not necessarily economic strength. He is right if you look at how the agencies define ratings. But in practice, the agencies would have to change their whole methodology, as Murat notes. I would not count on them too much, as these were the guys who naively bought into the IMF Stand-by and fiscal rule fairytales, not to mention their role in the global crisis. 

That’s why I think that this should not be a war among economists, but by them, against the rating agencies.

Emre Deliveli is a freelance consultant and columnist for Hurriyet Daily News & Economic Review and Forbes as well as a contributor to Roubini Global Economics. Read his economics blog at

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