Turkish Blend: Turkey ETF Gets Some Support As Fitch Doesn't Downgrade

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Among emerging markets single-country exchange-traded funds, few have grabbed as many headlines or been the center of as much controversy in recent weeks as the Ishares Msci Turkey Inv Market Index Fd (TUR).

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Turkey And Ratings

Immediately following last month's failed coup attempt against President Recep Tayyip Erdoan, TUR endured swift punishment and noticeably higher daily turnover. Predictably, ratings agencies are expressing caution, to say the least, on Turkey. Last month, Moody's Investor's Service lowered its outlook on Turkish sovereign debt to negative, while putting the country on review for a possible downgrade to junk status. Moody's currently rates Turkish sovereign debt one notch above junk.

Speaking of ratings agencies and their impact on TUR and Turkish equities, the lone Turkey ETF may have gotten some reprieve last Friday when Fitch Ratings opted to keep Turkey's sovereign credit rating at BBB-, the lowest investment grade. However, Fitch did revise its outlook on that rating to negative from stable.

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An unsuccessful coup attempt in July confirms heightened risks to political stability. The authorities are responding to the coup attempt with a purge of the followers of those it blames, with around 70,000 public sector workers suspended so far. The scale of the purge generates uncertainty over capacity and continuity. The implications for checks and balances, which in Fitch's opinion have eroded in recent years, are unclear, as is the potential for further disruption from those behind the coup attempt. The overwhelming public opposition to the coup attempt and subsequent unity of most political parties could lessen political fractures, said Fitch in a note.

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In July, S&P Global Ratings trimmed Turkeys credit rating to BB, two levels below investment grade, with a negative outlook. Turkey has long had a troubled relationship with Standard & Poor's and Thursday's ratings cut is not going to do anything to repair that relationship.

Scratching Below TUR's Surface

Global investors are also concerned about how the political volatility in Turkey will affect the country's banks. That is of particular concern for TUR investors, because the ETF devotes over 44 percent of its weight to financial services, more than triple its weight to consumer staples, TUR's second-largest sector allocation.

External vulnerabilities are large but long-standing and financing has been resilient in the aftermath of the coup attempt. The gross external financing requirement (including short-term debt) for 2016 is forecast at 186 percent of end-2016 reserves and the international liquidity ratio is 76 percent, around half the peer median. A few planned corporate issuances were postponed in the immediate aftermath of the coup attempt, but since then the syndication rollover rates by banks have ranged between 64% and 145 percent and the cost of funding has risen only marginally, added Fitch.

On another way of looking at Turkey's external financing needs is that TUR could be significantly pinched if the dollar rises and the Federal Reserve boosts interest rates.

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