Fitch and S&P Global wrote notes about Turkey today, which express deep concern with recent policy changes. With Eurobonds revealing a spread to US bonds of 600 basis points and a CDS premium of 450 basis points, these warnings are a barrier to Treasury’s foreign borrowing. While neither Fitch nor S&P mention another downgrade, further depreciation of TL and new signs of weakness in tax collection could compel ratings agencies to review Turkey’s outlook once again. Today, the Treasury borrowed TL6.1 bn at 5 year maturity, paying 2.78% over CPI and 5-year TL bond yields surging to 19.66% in late trading. At 6 pm Istanbul time, dollar/TL trading is very active and volatile, with the exchange rate swinging between 7.88-7.92.
Fitch: CBRT Change Heightens Turkey’s Inflation, External Financing Risks
Fitch Ratings-London-23 March 2021: The replacement of Turkey’s central bank governor has damaged monetary policy credibility and the prospects for reducing inflation, Fitch Ratings says. A sharp fall in the lira and renewed uncertainty over policy direction brings the risk of renewed external financing pressures in a more risk-averse global financing environment.
President Erdogan replaced the governor of the Central Bank of the Republic of Turkey (CBRT), Naci Agbal, on 20 March with the academic and former banker and MP for the governing AKP, Sahap Kavcioglu. This followed an above-consensus 200bp hike in the policy interest rate two days earlier, a move seen by Fitch as reinforcing the improved policy mix under an economic team installed in November 2020. Policies under that team, and the concomitant easing of external pressures, were important factors in Fitch’s revision of the Outlook on Turkey’s ‘BB-’ sovereign rating to Stable from Negative in February.
Fitch has long viewed monetary policy credibility as a rating weakness relative to peers and we deduct one notch for it from our model implied rating. To assess the impact of Mr Agbal’s replacement, we will consider the policy direction under the new central bank governor and the evolution of the external position. Negative rating sensitivities include intensified balance of payments and macroeconomic stability risks, including a sustained erosion of international reserves or severe stress in the corporate or banking sectors, for example due to weaker investor confidence as a result of premature monetary easing.
President Erdogan has long held unorthodox views on interest rates, a position recently echoed by Mr. Kavcioglu. There has also been some criticism in the local private sector over higher financing costs against a relatively weak economic backdrop, but policy under Mr Agbal had been consistent with the authorities’ stated aim of reducing inflation.
The first statement from the new governor said that meetings of the Monetary Policy Committee will be held as scheduled (the next is due on 15 April) and emphasised the CBRT’s main objective of a “permanent fall in inflation”. But his previously stated views on interest rates cast doubt on the likelihood of policy measures to achieve this. We considered rebuilding economic policy credibility a challenging task even for the experienced Mr Agbal, a former finance minister. Mr Kavcioglu, the fourth CBRT governor in the past two years, does not have a comparable record. The rapid turnover of CBRT governors underlines the lack of political independence and the weak credibility of monetary policy.
In the past, the CBRT has used methods other than policy rate cuts to ease funding conditions for the private sector, notably through the interest rate corridor and policies to encourage credit growth. Resuming these policies would be a negative signal as they have previously seen adverse consequences and contributed to a widening of external imbalances, put pressure on the lira and ultimately underpinned the necessity for policy rate hikes.
Fitch will also monitor the CBRT’s response to the sharp fall in the currency (of around 9% against the USD) since the change of governor. In the first half of 2020 foreign exchange reserves were drawn down in an unsuccessful attempt to support the currency, casting doubts over the long-standing commitment to a floating exchange rate, which is a supportive factor for the rating. Reserves are low relative to Turkey’s large external financing requirement, and renewed foreign investor outflows and dollarisation would add to balance of payments pressures at a time when global financing conditions have worsened.
Risk of capital controls in Turkey elevated, but not baseline scenario: S&P Global
Credit ratings agency S&P Global said the risks of Turkey implementing capital controls were “elevated” but not the firm’s baseline scenario after the sudden sacking of the country’s central bank chief sent the lira crashing on Monday.
“Recent changes once again highlight the limited operational independence of the Central Bank of Turkey and overall low predictability of economic policy,” S&P’s analysts said.
“One of the key things to watch over the short-term, in our view, is the behaviour of domestic resident depositors and whether they increasingly convert to foreign currency in response to latest developments… Although risks are elevated, capital controls are not our baseline scenario.”
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