International credit ratings agency Fitch Ratings has reaffirmed Turkey's Long-Term Foreign-Currency Issuer Default Rating (IDR) to Stable from Negative.
Fitch Ratings gives the following rationale behind its affirmation of Turkey’s credit rating :
“KEY RATING DRIVERS
Turkey's 'BB-' rating reflects weak external finances, a track record of economic volatility, high inflation and political and geopolitical risks. These factors are set against Turkey's large and diversified economy, GDP per capita and Ease of Doing Business indicators that compare favourably with 'BB' medians, and moderate levels of government and household debt.
Economic growth is recovering strongly, inflation has fallen from 20% at the beginning of last year, the current account has improved and external risks, although still high, have eased, supported by the real effective exchange rate adjustment and private sector deleveraging. The relative resilience of the banking and corporate sectors to the 2018 crisis contributes to our expectation for a 'V-shaped' recovery.
Fitch forecasts GDP growth of 3.9% in 2020 (an upward revision of 0.8pp since our last review), after 0.4% in 2019, driven by private consumption and a more gradual recovery in investment. Lower interest rates and a sharp pick-up in credit are fuelling domestic demand. Private bank lending is growing at 27% and consumer credit 46% (on a 13-week annualised basis), and we expect full-year aggregate credit growth above 15%. Pent-up demand, mildly positive labour market dynamics, a 15% minimum wage hike, and recovering confidence indicators also support stronger domestic demand. We forecast similar GDP growth in 2021, of 4.0% (but with stronger investment, some moderation in private consumption growth and a smaller drag from net exports), compared with the 'BB' category median of 3.4% in 2020-2021. We continue to estimate Turkey's trend rate of growth at 4.3%.
Turkey's large external financing requirement remains a source of vulnerability, but has reduced to around USD170 billion (including short-term debt) or 161% of foreign exchange reserves in 2020, from USD211 billion in 2018. This is driven by the current account moving to a surplus of 0.2% of GDP in 2019 from a deficit of 3.5% in 2018, mainly due to import compression, although export growth is also supported by the real effective exchange rate (12% below the end-2017 level) and buoyant tourism. Fitch forecasts the current account returns to deficit, of 0.9% of GDP in 2020 and 1.8% in 2021, as recovering domestic demand lifts imports and, to a lesser extent, high inflation begins to erode competitiveness gains.
Banks' external debt due over the next 12 months has fallen to USD82 billion, from USD90 billion a year earlier. Fitch expects banks' FX borrowing to remain muted in 2020, partly due to ongoing weak demand for FX credit (which declined 6% in 2019) and sufficient FX liquidity (which rose USD9 billion in 9M19 to USD86 billion, helped by an increase in FX customer deposits of USD32 billion in 2019). The corporate sector has steadily deleveraged, with the negative net FX position falling to USD176 billion in November from USD207 billion a year earlier, and the debt rollover rate was a robust 89% in December (on a rolling 12-month basis). Highly supportive global financing conditions have also helped limit downward pressure on the lira. Gross foreign exchange reserves increased to USD105.5 billion at end-December, from USD96.3 billion six months earlier.
Weak monetary policy credibility and the deeper than expected cuts in the policy interest rate from 24% in June to 10.75%, which took the real rate (based on current inflation) from 8.3% to -1.3%, increase risks of renewed market volatility. This followed the sacking of the central bank governor and replacement of other senior officials in the context of President Erdogan's unorthodox views on the relationship between inflation and interest rates. Inflation in Turkey has averaged 11.7% over the past five years, compared with the 'BB' median of 3.2%, and has been above the 5% central bank target since 2011. We forecast inflation will remain relatively high, reducing from 12.2% in January to 10.5% at end-2020, helped by tax adjustments and lower energy prices, and to 10.0% at end-2021.
There has been limited progress in the implementation of key structural reform measures set out in the New Economy Programme (NEP). However the recovering economy, together with the three-and-a-half-year window to the next scheduled elections, provides a more conducive backdrop for reform. Notwithstanding widespread speculation, it is not obvious what would be gained by calling early elections, in Fitch's view (despite reported tensions within the coalition government and the potential for the steady erosion of support to opposition parties). Notable measures the government plans to advance this year include a new insolvency law, complementary pension system, and severance pay reform.
We continue to view the NEP assumptions (for GDP growth of 5%, and inflation falling to the 5% target and the current account balancing by 2022) as highly optimistic. The Turkish economy has not previously sustained such a combination, and there has been a long-standing close correlation between stronger economic activity, high credit growth and an increasing current account deficit. It is currently unclear how the authorities view such trade-offs, with a risk that policy settings result in a build-up over time of unsustainable credit growth and greater external imbalances, particularly if structural reform progress remains slow.
A number of near-term geopolitical risks weigh on Turkey's rating. The US Risch-Menendez sanctions bill is likely to be enacted in 1H20, when it will require implementation within 30 days of sanctions listed by the earlier CAATSA, although we expect the US administration will select the lighter measures allowed. The extent to which other sanctions in the bill will be legislated, such as on Turkish banks and public institutions involved in operations in Syria, is currently uncertain. Direct clashes in recent weeks between Turkish and Syrian forces contribute to an increased risk of a further escalation, heightened tensions with Russia, and adverse spill-overs, compounded by the likely further displacement of Syrians from Idlib region. We view risks from Turkey's military operation in Libya, the US court case against Halkbank, and potential EU sanctions for gas drilling in Cyprus, as lower impact but still with the potential to damage investor sentiment.
Fitch forecasts the general government deficit remains at 3.2% of GDP in 2020, and edges down to 3.0% in 2021, anchored by the high prioritisation the government attaches to hitting its fiscal targets. Use of one-off measures in 2019 such as transferring the central bank accumulated reserve (0.9% of GDP), and cutting capital spending (by 20% in real terms) contained the increase in the central government deficit to 2.9% of GDP from 2.0% in 2018. Fitch views the 2020 budget target for nominal revenue growth of 17% as achievable given the expected pick-up in GDP growth, phasing out of special consumption taxes, and additional taxes on higher-rate income, property, and the digital sector (totalling 0.2% of GDP). We anticipate the government would implement additional in-year measures in 2020 and 2021 if the central government budget is off track.
General government debt is projected to be broadly flat at 32.3% of GDP in 2020-2021, having increased from 28.2% in 2017, well below the current 'BB' category median of 46.5%. We anticipate only a gradual reversal of the shift towards foreign-currency and shorter-term debt issuance since 2018 (the average maturity of domestic borrowing in 2019 was just 30.1 months, compared with 71.2 in 2017). Contingent liabilities have increased from a low base, and we expect direct government guarantees (including the Credit Guarantee Fund) to stabilise at near 5% of GDP in 2020 and 2021, on top of which we estimate other contingent liabilities from public-private partnerships of a similar magnitude. On-budget transfers relating to these guarantees increased close to 70% in 2019 to 0.4% of GDP.
Banking sector metrics reflect the challenging operating conditions, but short-term risks have eased alongside economic stabilisation. The NPL ratio increased to 5.4% in January from 3.9% at end-2018 and Fitch expects a further rise (partly due to still-high Stage 2 loans of 11%) but at a declining pace. High impairments and weak GDP growth lowered the return on equity to 11.5% in 4Q19 from 14.7% a year earlier, although stronger credit should drive a moderate improvement in profitability this year. The average funding cost fell to 7.3% in December from 8.1% in June, and is likely to further benefit from the lower policy interest rate. The common equity Tier 1 ratio was unchanged in 2H19 at 14.2%, supported by new issuance and foreign currency loan deleveraging. Pre-impairment profit provides a buffer to absorb credit losses but is weaker in state banks, and capital ratios remain sensitive to potential lira depreciation. We anticipate only a gradual improvement in the deposit dollarisation ratio, which remains high at 50.8% despite falling 3.4pp in 2H19.
SOVEREIGN RATING MODEL (SRM) AND QUALITATIVE OVERLAY (QO)
Fitch's proprietary SRM assigns Turkey a score equivalent to a rating of 'BBB-' on the Long-Term Foreign-Currency (LT FC) IDR scale.
Fitch's sovereign rating committee adjusted the output from the SRM to arrive at the final LT FC IDR by applying its QO, relative to rated peers, as follows:
- Macroeconomic policy and performance: -1 notch, to reflect weak macroeconomic policy credibility and coherence and downside risks to macroeconomic stability.
- External finances: -1 notch, to reflect a very high gross external financing requirement and low international liquidity ratio.
- Structural features: -1 notch, to reflect an erosion of checks and balances and institutional quality, downside risks in the banking sector and the risk of developments in geopolitics and foreign relations that could impact economic stability.
Fitch's SRM is the agency's proprietary multiple regression rating model that employs 18 variables based on three-year centred averages, including one year of forecasts, to produce a score equivalent to a LT FC IDR. Fitch's QO is a forward-looking qualitative framework designed to allow for adjustment to the SRM output to assign the final rating, reflecting factors within our criteria that are not fully quantifiable and/or not fully reflected in the SRM.
The main factors that may, individually, or collectively, result in positive rating action are:
- Greater confidence in the sustainability of the external position alongside healthy GDP growth.
- Implementation of structural reforms that raise domestic savings, reduce dollarisation and make GDP growth less dependent on credit growth and external borrowing.
- An improvement in governance standards, political or geopolitical risks for example from the conflict in Syria, and from US sanctions.
- A sustained decline in inflation and a rebuilding of monetary policy credibility.
The main factors that may, individually, or collectively, result in negative rating action are:
- Disruption to the path of economic stabilisation and rebalancing, potentially caused by policy settings that result in a build-up of unsustainable credit growth, higher inflation and greater external imbalances.
- Renewed stresses in the corporate or banking sectors, potentially stemming from a sudden stop to capital inflows or currency volatility.
- A marked worsening in the government debt/GDP ratio or broader public balance sheet.
- A serious deterioration in the domestic political or security situation or international relations.
Turkey has an ESG Relevance Score of 5 for Political Stability and Rights as World Bank Governance Indicators have the highest weight in Fitch's SRM and are highly relevant to the rating and a key rating driver with a high weight. Turkey faces geopolitical risks and security threats and is involved in conflicts in neighbouring countries.
Turkey has an ESG Relevance Score of 5 for Rule of Law, Institutional & Regulatory Quality and Control of Corruption as World Bank Governance Indicators have the highest weight in Fitch's SRM and are therefore highly relevant to the rating and are a key rating driver with a high weight.
Turkey has an ESG Relevance Score of 4 for Human Rights and Political Freedoms as the Voice and Accountability pillar of the World Bank Governance Indicators are relevant to the rating and a rating driver.
Turkey has an ESG Relevance Score of 4 for International Relations and Trade. Bilateral relations with key partners have been volatile, including threats of US sanctions and periodic tensions with the EU. This turbulence hurts investor confidence, brings risks to external financing and can impact trade performance and is a rating driver for Turkey.
Turkey has an ESG Relevance Score of 4 for Creditor Rights as willingness to service and repay debt is relevant to the rating and is a rating driver for Turkey, as for all sovereigns.”