Turkey’s lira dropped sharply, stocks slid and the country’s bonds sold off as markets gave their verdict on rating agency Moody’s downgrading the country’s debt to junk.

Moody’s concerns about foreign outflows, declining foreign exchange reserves and a low growth outlook were delivered on Friday evening, by which time the lira was already weakening in anticipation of a negative rating.

The sell-off continued on Monday. The lira has slumped 1.9 per cent since Friday against both the dollar and the euro, pushing the dollar’s value close to TL3 and the euro to TL3.36.

Turkey’s Bist 100 index was down 4 per cent while a drop in 10-year government bonds pushed their yield 40 basis points higher.

Market sentiment against Turkey helped to deflate emerging markets, pushing the MSCI EM index 1.2 per cent lower. Turkey’s downgrade was “a good reminder about political risk” for EM, said Brown Brothers Harriman.

Markets have been reassessing Turkey since July’s failed coup — which was swiftly followed by a ratings downgrade from S&P — as investors question president Tayyip Erdogan’s commitment to reform.

Moody’s said the current account deficit and the external liabilities of corporations, banks and government sectors amount to 26 per cent of GDP.

“This large external funding need exposes the country to sudden shifts in investor confidence, which has been weak and volatile over the past 18 months, as reflected in the volatility of the Turkish lira (vis-à-vis the US dollar) and substantial volatility in portfolio flows,” the agency said.

Rabobank said factors in Turkey’s favour included a substantial cut in the current account deficit in the last five years, while projections of average annual growth of 4 per cent “may also prove a valid argument to consider purchasing Turkish assets”.

According to Citigroup, Turkey’s background macro environment “is not as bad as the markets feared” but in the medium-term fixed income and FX may remain volatile in Turkey because of the country’s looser fiscal policy stance and a likely widening current account gap.

With two rating agencies conferring junk status on Turkey, capital outflows were likely to weigh on the lira in the short term, said Lee Hardman, MUFG currency analyst.

But he added that a low volatile environment has built carry trade demand this year and that has helped underpin the lira even in times of political stress.

“In this environment, the lira could continue to hold up better than expected following the downgrade to junk status,” Mr Hardman said.

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