Fitch Affirms Turkey at ‘BB-‘; Outlook Stable

The agency issued the following statement



Turkey’s ratings reflect weak monetary policy credibility, high inflation, low external liquidity in the context of high financing requirements and geopolitical risks. These credit weaknesses are set against low government deficits and debt and stronger growth performance and structural indicators, such as GDP per capita and Human Development, relative to rating peers.


The Stable Outlook balances elevated policy uncertainty due to rising inflation, lack of central bank independence and the potential for de-stabilising stimulus ahead general elections due by 2023 against an easing of near-term external financing pressures due to a narrowing current account deficit, moderately higher international reserves, and banks and corporates’ uninterrupted access to sufficient external finance to roll-over large debt payments.

Policy uncertainty increased in March and remains high after the abrupt dismissal of the central bank governor, the third since July 2019, leading to sharp lira depreciation, portfolio outflows and tighter financing conditions. The central bank’s new management has kept its policy rate steady at 19% since March and maintained its predecessor’s commitment to a flexible exchange rate and the use of the one-week repo rate as its main policy instrument, preserving improvements in terms of transparency. Credit and fiscal policies also remain aligned with the objective to reduce inflation.

In Fitch’s view, political considerations limit the ability of the central bank to raise its policy rate despite rising inflation (18.95% yoy in July). Weak monetary policy credibility is reflected in a record of delayed response to mounting macroeconomic pressures or premature policy easing, and inflation remaining significantly above the 5% official target over an extended period.


Inflation Outlook


We expect inflation to ease to a still high 16.9% by end-2021, due to a favourable base effect and slowing domestic demand. The latter will be partly due to a marked slowdown in credit growth due to tighter financial conditions, the phasing out of 2020 credit stimulus and the introduction of macroprudential measures targeting retail loan growth. The potential for additional depreciation pressures, further deterioration in inflation expectations and indexation mechanisms such as wage agreements increase inflationary risks. We forecast inflation to average 14.6% and 11.8% in 2022-2023, remaining multiples above the forecast 3.4% ‘BB’ median.


GDP Growth

We have revised up our growth forecast up to 7.9% in 2021, from 6.3% in June, due to high carryover effect (especially after a strong performance in 1Q21) and continued resilience in economic activity. Slowing of domestic demand in 2H21 will be cushioned by strong export growth and a recovery in the tourism sector. We forecast growth to slow to 3.5% in 2022, based on our expectation that Turkey’s policy mix, especially monetary policy, avoids exacerbating macroeconomic imbalances.


Current Account Balance


The current account deficit has narrowed, as rapid export growth and a decline in gold imports have mitigated the impact of rising commodity prices, including energy imports. The full year current account deficit will decline to 3% of GDP in 2021, from 5.2% in 2020, as tourism export receipts improve yoy in 2H21. Under our baseline policy assumption and recovering tourism revenues, we expect the current account deficit to average 2.3% in 2022-2023, similar to the forecast ‘BB’ median.

International reserves have recovered due to strong export revenues, including export rediscounts, net external borrowing and the increase of the FX swap with China, after a decline in April-May. Reserves will receive a further boost from the special drawing rights allocation equivalent to USD6.4 billion and the recently announced FX swap with South Korea. We forecast reserves to reach USD109 billion at end-2021, but decline in 2022-2023 to USD100 billion given continued current account deficits and high financial dollarisation, and the limited upside for portfolio inflows, in our view.


FX  Reserves

Turkey’s reserve buffers, at 4.7 months of CXP cover, are low compared with 5.2 months for the ‘BB’ median, and relative to the country’s large external financing requirement, high deposit dollarisation and the risk of changing investor sentiment. In addition, the underlying position of international reserves remains weak. Net reserves (net of FX claims, mainly from Turkish bank placements) rose to USD25 billion in late-July (still considerably below the USD41.1 billion at end-2019), and reserves net of FX swaps with local banks remain negative.


Public finances continue to be a key rating strength



Turkey is on track to meet its reduced 2021 central government fiscal deficit target of 3.5% of GDP (original of 4.3%) on the back of strong revenue performance and prudent spending. The general government deficit will narrow to 3.9% of GDP, well below the forecast 5.8% of GDP for peers, as we expect the Unemployment Insurance Fund to provide a lower level of pandemic-related support, and a broadly balanced local government position.


Public Debt


General government debt will remain broadly stable at 39.7% of GDP in 2021, significantly below the forecast 59% ‘BB’ median. Currency risk has increased (57% of central government debt was foreign currency linked or denominated at May-2021, up from 39% in 2017). The objective of improving domestic debt composition in terms of costs, duration and currency remains dependent on reduced policy uncertainty and stronger investor confidence.


Banking System

The banking system continues to demonstrate resilience to financial market stress, most recently in March, although risks to banks’ Standalone Credit Profiles remain significant. The relative stickiness of deposits during periods of stress in recent years is a supportive factor for the rating. In addition, the banking sector’s available foreign-currency liquidity is sufficient to meet its short-term foreign currency debt, in particular when adjusting the latter for more stable sources of funding.

Nevertheless, the banking sector remains vulnerable to exchange-rate volatility due to the impact on capitalisation, asset quality, refinancing risk (given short-term foreign-currency financing) and high deposit dollarisation (56% including precious metals). The banking sector has increased its exposure to the sovereign both through government debt holdings (70% of domestic debt in May) and FX swaps with the central bank.



Geo-political risks

Geopolitical risks will remain elevated, but existing sanctions have so far had a limited impact on the economy. In addition to the S-400 issue and US cooperation with Kurdish forces in Syria, the relationship with the US has several potential flash points. Recent developments related to Cyprus could reignite tensions with the EU, and operations in northern Syria, Libya, and support for Azerbaijan in the conflict with Armenia could represent additional sources of tension with Russia.

General elections are scheduled for 2023 and the political calendar will have an impact on policy direction and expectations of economic actors, in Fitch’s view. Given the weakened credibility and policy buffers, the potential size of economic stimulus may have to balance the expected economic and political benefits against the risk of reigniting macroeconomic instability, which seems to have hurt the government’s support in 2020. Ongoing judicial proceedings against opposition parties and possible presidential candidates, potentially preventing them from participating in the election, and possible presidential candidates, potentially preventing them from participating in the election, could increase political uncertainty.


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Published By: Atilla Yeşilada

GlobalSource Partners’ Turkey Country Analyst Atilla Yesilada is the country’s leading political analyst and commentator. He is known throughout the finance and political science world for his thorough and outspoken coverage of Turkey’s political and financial developments. In addition to his extensive writing schedule, he is often called upon to provide his political expertise on major radio and television channels. Based in Istanbul, Atilla is co-founder of the information platform Istanbul Analytics and is one of GlobalSource’s local partners in Turkey. In addition to his consulting work and speaking engagements throughout the US, Europe and the Middle East, he writes regular columns for Turkey’s leading financial websites VATAN and and has contributed to the financial daily Referans and the liberal daily Radikal.