International credit ratings agency Fitch Ratings has published its report “External Pressures Remain Turkey's Main Credit Weakness”. In its report, Fitch warns that the main impact of the coronavirus on Turkey's sovereign credit profile is through external financing risks. Such risks are ever more apparent because of Turkey’s low foreign exchange reserves, the increasing use of F/X swaps in the reserves, negative real interest rates, and weak monetary policy credibility.
The agency’s report is as follows:
“Private-sector external debt rollovers have remained resilient despite financial market volatility as the pandemic took hold globally, but the fall in foreign-exchange (FX) reserves since end-February, added to weak monetary policy credibility and negative real interest rates increases risks of further external pressures.
At our most recent rating review in February, when we affirmed Turkey's sovereign rating at 'BB-'/Stable, one of the three qualitative notches deducted from the model-implied outcome was for weak external finances. This reflected low FX reserves and a large external financing requirement.
Since then, there have been sizeable FX interventions to support the Turkish lira. Gross FX reserves (including gold) fell to USD90 billion at 26 June from USD 106 billion at end-2019. If we calculate gross reserves minus swaps, there has been a much sharper fall, from USD 87 billion at end-December 2019 to USD 33 billion. These trends highlight the underlying pressure on reserves, which has increased external vulnerability since February.
Recent policy on FX interventions suggests that Turkey's prior, long-standing commitment to a flexible exchange rate has weakened. The marked increase in the proportion of reserves made up of FX swaps also creates a greater risk in the event of their large-scale withdrawal by banks.
However, the external financing positions of the banking and corporate sectors have been resilient. This resilience has been a supporting feature for Turkey's sovereign credit profile since the mid-2018 lira crisis. Banks' orderly foreign-currency deleveraging has continued and the rollover rate of 73% in April (on a rolling 12-month basis) was unchanged on 1Q20. Foreign-currency bank deposits are still growing. The corporate sector has also steadily deleveraged and its external debt rollover rate was 84% in April on a rolling 12-month basis, unchanged on March.
We forecast a stabilisation of Turkey's balance of payments in 2H20, but there are sizeable downside risks. Given the low level of reserves, we do not anticipate further large net FX interventions by the central bank and we believe the policy interest rate easing cycle has neared its end. The resumption of government external debt issuance and a lighter redemption profile in 2H20 will have some stabilising effect on the external position.
But we still see a risk of further interest rate cuts contributing to renewed external pressure, even though the monetary policy committee held rates at 8.25% last week. We anticipate broad continuity in the policy response to managing balance of payments pressures. Should external pressures become much more acute, the policy response would be more uncertain.”