UPDATE 2-Moody's lifts Turkey to just below investment grade

* Current account, FX reserves may be key to investment grade-Moody's

* Moody's, Fitch ratings one notch, S&P two rungs below investment grade

* Upgrade triggers market rally

By Seda Sezer

ISTANBUL, June 20 (Reuters) - Credit-rating agency Moody's promoted Turkey to one level below investment grade on Wednesday and kept a positive outlook on the country's debt, triggering a rally in Turkish assets.

The agency cited a significant improvement in Turkey's public finances as a reason for raising its sovereign credit rating to Ba1 from Ba2.

Moody's senior analyst Sarah Carlson told Reuters that Turkey could move up to investment grade if the nation reduced its current account deficit, the central bank increased foreign exchange reserves and private sector external borrowing fell.

By 1137 GMT the lira firmed to 1.7925 versus the dollar , having dipped to even stronger levels below 1.7900, compared with 1.7980 before the upgrade announcement. Turkish stocks and bonds also strengthened.

Fitch also rates Turkey one notch below investment grade at BB+. Standard & Poor's rates it a rung lower at BB.

Moody's said the upgrade noted efforts to address Turkey's current account deficit, the biggest risk to the country's rating.

The deficit, which reached 10 percent of gross domestic product in 2011, is among the highest in the world and seen as the main weak spot in an otherwise booming economy. It is expected to decline to 8 percent of GDP this year.

"Looking ahead, an upgrade to an investment-grade rating will probably be dependent on Turkey becoming more resilient to balance-of-payment shocks, given the already favourable public-finance metrics," Moody's said in a statement.

It noted that Turkey's general government debt level was much lower than the norm among its rating peers, at 39.4 percent in 2011 compared with the Ba1 median of 54.6 percent, and compared well with the 38.5 percent median for the investment grade Baa3 group.

"We understand that for an investment grade rating upgrade Moody's wants to see further improvement in the current account deficit and its financing along with lower private sector external borrowing. To maintain this credit rating Turkey also has to preserve fiscal discipline," said Ozgur Altug, economist at BGC Partners in Istanbul.

CURRENT ACCOUNT INCENTIVE

Asked about Moody's positive outlook on the rating, Carlson also said an outlook typically lasts "18 months or so".

"It is important to stress that about 30 percent of outlooks result in an eventual rating change," she said, but emphasised that Turkey needed to keep up its efforts to reduce its external vulnerabilities and shore up its public finances.

"When we look at the details for a rating upgrade from now on, it is noted that a structural improvement should be seen in the current account deficit," said Oyak Securities economist Gulay Girgin. "We have an incentive scheme but this will show its impact in the medium to long term. So we've still got a way to go."

The yield on Turkey's benchmark bond fell to 8.92 percent after the rating upgrade, the lowest level since the end of February. Traders said that more foreign money went into bonds after the upgrade, encouraged by the success of a debt sale on Tuesday, when Turkey borrowed $1 billion in a tap of its dollar-denominated Eurobond maturing in 2041. Bankers quoted a yield of 5.75 percent and told Reuters demand was around $7 billion.