By Daren Butler

By Daren Butler

ISTANBUL (Reuters) - Ratings agency Moody's cut Turkey's sovereign rating further into junk territory overnight, citing a continued weakening of its economic and political institutions and the increased risks from its wide current account deficit.

The rating was downgraded by one notch to Ba2.

"The government appears still to be focused on short-term measures, to the detriment of effective monetary policy and of fundamental economic reform," Moody's said.

 

Set against a negative institutional backdrop, Turkey's external position, debt and rollover needs had continued to deteriorate, it said.

The downgrade was largely shrugged off by Turkish financial markets.

Moody's had already cut Turkey's rating to a non-investment grade of Ba1 in September 2016 following an attempted coup, which undermined investor sentiment toward what was once seen as one of the world's most promising emerging markets.

One banker described the downgrade as a "surprise development" that could put some pressure on Turkish markets during the day, although he said there was no real fundamental difference between a Ba1 and Ba2 rating.

"I think this decision reflects the course of Turkey-U.S. relations, as we are not in a different place in an economic sense from where we were a year ago," said the banker, who declined to be identified.

Relations between the NATO allies have become increasingly strained over a range of issues, including U.S. support for a Syrian Kurdish militia that Ankara views as a terrorist group and the conviction of a Turkish bank executive in a U.S. sanctions-busting case.

There was limited reaction from Turkish assets. The lira <TRYTOM=D3> fell slightly to 3.8075 against the dollar by 0722 GMT from 3.8035 at the close on Wednesday. The main Istanbul share index <.XU100> edged 0.13 percent higher.

The 10-year benchmark bond yield rose to 12.28 percent from a close of 12.20.

"The mentioned risks are not new to the market and the focus is mostly on global risk sentiment rather than local developments," said BNP Paribas/TEB strategist Erkin Isik.

EXTERNAL SHOCK RISK

Moody's also referred to "the increased risk of an external shock crystallizing, given the country's wide current account deficits, higher external debt and associated large rollover requirements in the context of heightened political risks".

Turkey's central bank on Wednesday kept interest rates steady and said it would keep policy tight faced with double-digit inflation. President Tayyip Erdogan has repeatedly called for cheaper credit to boost the economy, leading to investor concern about political pressure on policy.

Erdogan has slammed ratings agencies decisions and accused Moody's of making a political move with its previous downgrade in 2016. "Put a few cents in their pockets and get the rating you want, this is how they work," he said at the time.

Moody's said the erosion of Turkey's executive institutions had continued with the widespread purge that followed the July 2016 failed coup. A state of emergency was subsequently imposed and remains in place.

In a crackdown since the failed putsch, more than 50,000 people have been jailed pending trial over alleged links to coup plotters, while 150,000 people have been sacked or suspended from jobs in the military, public and private sectors.

Moody's lifted its outlook on Turkey to "stable" from "negative", having cut it to negative in March 2017.

Among other agencies, Standard & Poor's has a BB sovereign rating on Turkey, in line with Moody's rating. In January last year Fitch downgraded Turkey to "junk" with a rating of BB+, one notch higher than Moody's and S&P.

Turkey depends on investment flows to fund its current account deficit - one of the biggest in the G20 - and service its foreign debt. Ratings downgrades could force it to pay more to borrow money in international markets.

Last year, the Turkish current account deficit widened 42 percent to $47.1 billion, exceeding the government's target.

(Additional reporting by Behiye Selin Taner; Writing by Daren Butler; Editing by David Dolan)

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