By Paul Taylor
PARIS (Reuters) - Turkey's achievement of investment-grade status crowns a decade of rapid growth, financial stability and political reform by a "tiger" economy on the seam of Europe and Asia, but the rising power still faces pitfalls in a dangerous neighborhood.
Moody's Investors Service raised its rating on Ankara's sovereign bonds to Baa3, or investment grade, from Ba1 late on Thursday, following in the footsteps of Fitch credit ratings agency, which took that step last November.
The upgrade came on a day when Prime Minister Tayyip Erdogan was showcasing Turkey's global prestige on a visit to the White House, and in a week when the emerging nation of 75 million made a final loan repayment to the International Monetary Fund.
"It was a major strategic step for Turkey," said Erdal Tanas Karagol, economic director of the SETA think-tank in Ankara.
"This will help the current ruling party prepare long-term plans, to set higher goals and will create a suitable international environment to carry out those plans."
The boost puts Turkey 11 notches on Moody's rating scale above historic rival Greece, on the other side of the European Union frontier, and should drive more foreign direct investment (FDI) to an economy that still has great potential to grow.
"The ratings agencies are finally catching up with the fact that the Turkish government has done a huge amount of work in the last decade to put the country onto a stronger economic and political footing," said Simon Quijano-Evans, head of emerging market research at Commerzbank in London.
Government debt has fallen to 30 percent of gross domestic product from more than 100 percent in the crisis years early last decade. Inflation and the budget deficit are falling.
Turkey's IMF program and candidacy to join the EU provided a strong policy anchor in the early years of Erdogan's mildly Islamist conservative AK party government from 2003. But the pace of political reform has slowed as EU accession talks have run into the sand due to Cypriot and French obstruction.
"There is a sense of a lost anchor," said Sinan Ulgen, chairman of the Istanbul Center for Economics and Foreign Policy Studies, EDAM.
The EU had lost influence on issues such as media freedom, tolerance of dissent and freedom of expression because Turks no longer believed they were wanted inside the European bloc. Rights groups complain Erdogan is falling short on democracy.
Ulgen said the rating upgrade was a triple vote of confidence in the resilience of the Turkish economy despite Europe's debt crisis, in sound economic and fiscal management, and in a strengthened geopolitical relationship with the West.
"Turkey is a stable partner for the United States in a region which is likely to remain unstable for years to come," Ulgen said of Washington's NATO ally.
So far, instability in Syria, Iraq and between Iran and Western powers has barely affected Turkey's fast rising prosperity, even if has undermined the government's declared policy of "zero problems with the neighbors".
A double car bombing on its southern frontier last week highlighted the risk of Syria's civil war spilling across the border, with the Turks harboring more than 100,000 Syrian refugees, including military defectors and rear bases for rebels fighting former Turkish ally President Bashar al-Assad.
Worsening internal strife in Iraq and the possibility of a Western or Israeli military strike on Iran's nuclear program also pose security risks for Turkey.
But Ulgen said it was the country's internal political future that posed the biggest challenge to its peaceful rise as a regional power with global ambitions.
"The biggest challenge is whether Turkey is going to succeed in reaching a settlement with its own Kurds," he said. The conflict has killed 40,000 people in the last three decades.
Talks between the Ankara government and jailed separatist leader Abdullah Ocalan led to a historic ceasefire declaration by the Kurdistan Workers Party (PKK) in March under which fighters began withdrawing from positions in southeastern Turkey last week.
The peace plan, popular in opinion polls so far, is a gamble for Erdogan who could face a national backlash before elections next year if it stumbles.
"An unstable environment, deriving from any political risk could jolt the economy to a strong and unexpected degree despite the positive outlook," said Mehmet Altan, professor of political economy at Istanbul University.
A senior NATO source who has long dealt with Turkey said Ankara faced a deteriorating regional security environment and had become a recipient of NATO protection with allied Patriot missiles deployed on its soil for the third time since 1991.
The source said Washington was keen for Turkey to repair damaged ties with Israel and ease tension with Cyprus at a time when the discovery of new offshore gas reserves in the eastern Mediterranean could be a win-win proposition for all sides.
Ankara has the alliance's second largest armed forces after the United States. A key achievement of Erdogan's government has been gradually to cement civilian control over the military in a country which witnessed three coups between 1960 and 1981.
Quijano-Evans said the ratings upgrade should drive more FDI into Turkey, which had attracted less than its share compared to other emerging markets.
That could help the country press ahead with import substitution policies in areas such as metals and petrochemicals to reduce its current account deficit, and diversify its exports away from its depressed core market in western Europe.
It could also help with a number of ambitious grand projects including a third major international airport for Istanbul, a "Kanal Istanbul" shipping lane to be carved out parallel to the Bosphorus from the Black Sea to the Sea of Marmara, and a bid to host the 2020 Olympic Games.
In the economic as well as the political and diplomatic spheres, some analysts see a risk of "imperial overreach" as Turkey's global ambitions rise.
Ulgen said Erdogan's effort to reshape the constitution to create a strong executive presidential system with himself at the pinnacle was one such risk. But dogged opposition, including within Erdogan's own party, meant he was unlikely to succeed.
"We see the risk of overreach very clearly in foreign policy on Syria, where Turkey thought it had much more ability to influence governments in the region and it hasn't been able to push out Assad," he said.
But the NATO source, speaking on condition of anonymity because the alliance does not comment on its members' policies, said there was a risk of hubris as Erdogan sought to build a legacy comparable with that of Mustafa Kemal Ataturk, who founded modern Turkey after the collapse of the Ottoman empire.
"Turkey wants to call itself a global power," he said. "It has great potential but it still has a lot of problems and difficult relations in the neighborhood."
(Additional reporting by Parisa Hafezi in Istanbul, Nick Tattersall in Washington and Sinead Cruise and Toni Vorobyova in London; Editing by Alastair Macdonald)