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Clouds gather over Turkey economy after downgrade

Turkey has snarled with anger over a downgrade of its debt to junk status, but its previously robust economic performance risks being bruised by lower growth, stalled reforms and rule of law concerns after the July 15 coup bid. Strong growth since the ruling party of President Recep Tayyip Erdogan came to power in 2002 amid the wreckage of financial crisis has been one of the Turkish strongman's political aces. Millions of Turks now enjoy higher incomes and backwaters in the nation's interior have been transformed into thriving manufacturing hubs. Meanwhile, Turkey has impressed even Erdogan's critics with resilience in the face of global economic troubles, posting growth of 4.0 percent in 2015 and defying predictions of meltdown in the wake of the coup. But downgrade by Moody's on Friday came after a slew of indications the economy was starting to hurt, with July industrial production plummeting and second quarter growth slowing to 3.1 percent from 4.7 in the first. "The growth outlook is weak. Domestic demand seems to have slowed sharply after the coup attempt, due to a hit to confidence," William Jackson, emerging markets economist at of Capital Economics in London told AFP, projecting growth to be just 2.0 percent in 2017. - 'Rule of law concerns' - The move by Moody's to downgrade to Ba1 its assessment of Turkey's capacity to pay back debts brought the rating into junk status, a level deemed speculative due to a higher default risk. With Standard and Poor's also downgrading Turkey's rating deeper into junk in July, only Fitch, of the world's big three ratings agencies, still assesses Turkish debt at so-called investment grade. The government reacted with pique, with Prime Minister Binali Yildirim saying on Saturday that Moody's was biased and government spokesman Numan Kurtulmus alleging the move was "politically motivated". Explaining its decision, Moody's pointed to some long-standing troubles in the Turkish economy, in particular the high current account deficit and external debt which together it said will account for 26 percent of GDP in 2016 and 2017. But Moody's also touched a nerve by suggesting Ankara's response to the failed July 15 coup -- which has seen tens of thousands either arrested or dismissed from their jobs -- would negatively impact growth. It cited concerns about the "predictability and effectiveness" of government policy and the rule of law. - 'Likely to disappoint' - Michael Harris, global head of research at investment bank Renaissance Capital, said it was "very understandable" Ankara was unhappy over the downgrade after it showed fiscal discipline, kept the debt to GDP ratio in check and launched a key pensions reform. But he said markets were looking closely at the rule of law, in particular when the three month post-coup state of emergency comes to an end in October. "Long term, any deterioration in the rule of law has an impact on the willingness to invest," Harris told AFP. "If Turkey wants to remain a high growth country getting the rule of law right is important. This can only become apparent after the state of emergency ends," said Harris. An immense headache for the government is the plunge in tourism which was apparent even before the coup, coming after attacks blamed on jihadists and Kurdish militants. Tourism accounts for 4.4 percent of GDP in Turkey. Foreign visitor arrivals were down 36.72 percent in July, according to tourism ministry figures, with visitors from the key tourism market of Russia down over 93 percent. "The negative impact of tourism has already been very costly even before the coup attempt with seasonally adjusted unemployment in June the worst it has been since 2010," said Harris. "Turkey has plenty of growth potential, but until confidence improves and the political pain is behind us, the likelihood is the Turkish economy will disappoint." - 'Accelerate reform' - The markets showed some resilience in the wake of the downgrade with the Turkish lira partially making up losses against the dollar and a 10-year bond auction being more than three times over-subscribed as investors were seduced by the higher yields. Deputy Prime Minister Mehmet Simsek, a figure highly respected by financial markets, said that Turkey's economic fundamentals were "healthy" and able to resist crises. "The best response to the rating agencies is to accelerate reforms and protect financial discipline," he wrote on Twitter. Yet Jackson said there had been a "lot of discussion" in recent years about economic reforms in Turkey "with little actually happening". "It's highly likely that growth in the coming years will be much weaker than it was over the past decade," said Jackson.