UPDATE 1-Turkey hails new investment grading but worries about money flows

Fri May 17, 2013 7:27am EDT

* Upgrade stamps approval on decade of reform

* Move expected to boost investment flows

* Bond yields hit record lows, Turkish lira weakens

* Minister warns of lira appreciation pressure

By Daren Butler

ISTANBUL, May 17 (Reuters) - Turkey hailed its second investment grade rating on Friday, seeing it as a seal of approval from international markets for a decade of economic reform.

Investors joined in, driving sovereign bond yields to record lows.

Government enthusiasm was tempered, however, by some concern that the move, coinciding with a visit by Prime Minister Tayyip Erdogan to Washington, might trigger over-large capital inflows into the lira currency.

Moody's assigning a Baa3 rating with a stable outlook to Turkey late on Thursday, making it eligible for inclusion in a number of investment-grade only bond indices and adding to the economy's switch from an emerging market to a developed one.

Fitch Ratings lifted Turkey to investment-grade in November, while Standard & Poor's rates Turkey one notch below.

Since his conservative, pro-market AK Party first came to power in 2002, Erdogan has transformed a crisis-prone economy with chronic inflation into Europe's fastest growing country, tripling per capita income, in stark contrast with neighbouring euro zone member Greece, which Moody's rates 11 notches lower.

The largely Muslim country's success coincides with economic disarray in the European Union, which Turkey has long sought to join despite strong opposition from many in the bloc.

"Turkey long deserved this rating, or an even higher one, both economically and politically. I see this as a delayed recognition of what we deserved," Economy Minister Zafer Caglayan said in a statement.

"We now expect much greater investments, both in terms of direct and portfolio investments. The central bank needs to be ready for the pressures this will exert on the lira," he said.

Turkey's two-year benchmark bond yield hit an all-time low of 4.61 percent, extending Thursday's falls after the central bank cut key interest rates by 50 basis points

The yield rebounded to 4.74 percent in afternoon trade, but they were at more than 6 percent at the start of the year.

"(This) should attract longer term capital inflows into the economy and support growth. This is a very impressive achievement in turbulent global conditions," said Manik Narain, emerging markets strategist at UBS.

"LATE DECISION"

Deputy Prime Minister Ali Babacan, who is in charge of the economy, echoed Caglayan's criticism of the time it has taken for Turkey to attain its current rating levels.

"This decision is as correct as it is late. Due to the right steps that we have taken on the economy, our country's indicators in global markets have for a long time been on a similar level as those countries with investment-grade credit ratings," he said in a statement.

The lira was at 1.8387 against the dollar, having softened to 1.8300 on Thursday after the rate cut.

The main share index, which has surged 18 percent this year, was up 0.2 percent at 92,132.97 points, having touched a record intraday high in early trade. It outperformed the main global emerging markets stock index.

The central bank cut rates to stimulate the economy, which has been faltering a bit, and to keep the lira from appreciating due to monetary easing by other central banks.

"The central bank may be prepared to ease policy even more freely if capital inflows pick up due to this move. We think they will be keen to protect the exchange rate from appreciation given rising current account vulnerabilities," UBS' Narain said.

Addressing upgrade-related risks, Finance Minister Mehmet Simsek said in London there was concern about corporate liabilities, given Turkey's large current account deficit.

"An investment grade can lead to an excessive build up of risks and we may have to look into that. We can always step in to stop corporates borrowing," Simsek said, while welcoming the prospect of a bigger investment pool and more favourable rates.

Moody's said Thursday's one-notch upgrade was based on structural improvements in the economy and in public finances that will better insulate Turkey from external shocks. It expected Turkey's debt burden to decline in the coming years after falling 10 percentage points to a "manageable" 36 percent of GDP since the beginning of 2009.

Turkey's ability to finance debt is helped by a relatively low and decreasing share of debt denominated in foreign currencies, it said, estimating foreign debt stock dropped to 27.4 percent at the end of 2012 from 46.3 percent in 2003.

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