EMRE DELİVELİ >Impact of Eurozone downgrades on Turkey

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Fridaythe 13th lived up to its name in the final hours of the day with the passing ofTurkish football legend LefterKüçükandonyadis and Turkish-Cypriot leader Rauf Denktaş. 

Bothmen had been having health problems for a while. Lefter was probably devastatedby the match-fixingallegations, which have put his beloved Fenerbahçe’spresident behind bars despitea lack of any solid evidence. But the suffering they went through in theirfinal days is nothing compared to the Eurozone’s slow death. 

Shortlybefore the clock hit midnight, credit rating agency Standard & Poor’s, orS&P, downgradednine Eurozone countries, including AAA-rated France and Austria. Those two werecut one notch, while Italy and Spain went down two notches and Portugal wasdowngraded to junk. 

Ifthese downgrades were to lead to general risk aversion in markets, it would bedevastating for the Turkish economy. The Central Bank of Turkey’s mainscenario of lira appreciation in 2012 assumes that some of the extraliquidity being provided by the European Central Bank, or ECB, will find itsway to Turkey. 

Butthere is no reason to expect a “sudden stop”yet. Friday’s downgrades were completely expected. If you really thought thatFrance was “risk-free” (what AAA means) or that Portugal, with its ten-yearbond yielding 10 percentage points more than Germany's bunds, wasinvestment-grade, please tell me what you've been smoking. I need to escapereality as much as I can. 

Infact, the yield on neither French nor EuropeanFinancial Stability Facility, or EFSF, bonds rose by much after theannouncement, although the euro dipped against the dollar. However, S&Pwill also downgradethe EFSF very soon, unless Eurozone officials restructure it to maintainits risk-free rating, in which case the fund would shrink. 

Atfirst glance, this does not seem to be as bad as it sounds for Turkey. With theEFSF weakened, it will be up to the ECB to support the Eurozone, which wouldmean even more of that liquidity that the Central Bank of Turkey would like tosee. 

Buteven if this emerging markets-friendly scenario materializes, the downgradesalso mean that European banks, according to the new Basel rules, will have to setaside more capital for their sovereign bond holdings. Unless the ECB comes tothe rescue, they will then have to deleverage, by an amount even greater thanthe $ 2-2.5 trillion most analysts were estimating before Friday. 

Thisis where the real danger lies for Turkey. BIS banking statisticsreveal that Eurozone banks are holding more than $ 150 billion of net foreignclaims on Turkey- a hefty sum even if this exposure were to be reduced by 10percent. 

Youcould argue that local-currency claims do not require external funding, andthey barely moved during the post-Lehman crisis period.  Three-quarters of Greek and two-thirds ofSpanish banks’ exposure are in liras. But even the sum of cross-border claimsand local claims in foreign currency amounts to almost $ 90 billion. 

Ihope the ECB will save the day, and I will smile at my pessimism. But if itdoesn’t, the debate on whetherCentral Bank of Turkey’s reserves are enough could move in a brand newdirection.


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