S&P affirms Turkey’s F/X and Local Currency ratings with stable outlook

International credit ratings agency S&P Global has reaffirmed Turkey’s foreign currency and local currency credit rating at B+ with a stable outlook.

The rationale behind the agency’s decision was given as follows on its website :

 

“Overview

 

The COVID-19 pandemic will likely push the Turkish economy into recession and drive the fiscal deficit to widen to around 5% of GDP.

Nevertheless, we forecast that by end-2020, net general government debt will amount to a contained 34% of GDP, leaving fiscal room to manoeuvre, despite rising contingent liabilities.

Consequently, we are affirming our unsolicited 'B+/B' foreign-currency and 'BB-/B' local-currency sovereign credit ratings on Turkey. The outlook is stable.

 

Rating Action

 

On May 6, 2020, S&P Global Ratings affirmed its unsolicited long-term foreign currency sovereign credit rating on Turkey at 'B+' and its unsolicited long-term local currency sovereign credit rating at 'BB-'. The outlook is stable.

We affirmed the unsolicited short-term foreign and local currency sovereign credit ratings at 'B'.

We also affirmed the unsolicited national scale ratings at 'trAA+/--/trA-1+'.

 

As a "sovereign rating", the ratings on Turkey are subject to certain publication restrictions set out in Art 8a of the EU CRA Regulation, including publication in accordance with a pre-established calendar," published Dec. 20, 2019, on Ratings Direct). Under the EU CRA Regulation, deviations from the announced calendar are allowed only in limited circumstances and must be accompanied by a detailed explanation of the reasons for the deviation. In this case, the reason for the deviation is a material deterioration in global economic and financial conditions as a result of the coronavirus pandemic that could have a direct impact on Turkey's growth, fiscal, and external metrics. The next scheduled publication on the sovereign ratings on Turkey will be on July 24, 2020.

 

Outlook

 

The stable outlook balances the downside economic risks stemming from the coronavirus pandemic over the next 12 months against the resilience of Turkey's private sector, alongside the still-contained stock of net general government debt. We expect that, despite currency volatility and COVID-19-related interruptions to economic activity, the Turkish GDP will recover in the second half of this year.

 

Downside scenario

 

We could lower our ratings if the impact of the COVID-19 pandemic on Turkey's growth, fiscal, and balance of payments metrics turns out to be greater than we currently forecast. We could also lower the ratings if we saw an increasing likelihood of systemic banking distress with potential negative repercussions for public finances. Currency volatility, for example, could weigh on asset quality, while also posing risks for banks rolling over their foreign debt or residents increasingly converting their savings to foreign currency.

 

Upside scenario

 

We could consider an upgrade if Turkey's growth turned out higher than we forecast over the medium term while external imbalances declined and net general government debt remained contained. We could also raise the ratings if the government successfully devised and implemented a credible and transparent economic reform program focused on structural macroeconomic improvements, including strengthening the banking system as well as bolstering the central bank's foreign exchange (FX) reserves and monetary policy effectiveness.

 

Rationale

 

The COVID-19 pandemic will have a negative impact on the Turkish economy in the guise of weaker foreign trade and tourism as well as the direct effects of the virus on domestic demand, alongside increased currency volatility.We forecast world GDP to contract by 2.4% this year. Moreover, we project a 7.3% output contraction in 2020 in the euro zone, the market for over 30% of Turkish goods exports. We also anticipate that the Turkish tourism sector will be particularly hard hit because it will likely take more time for international borders to reopen and air travel to resume, even if some other restrictions are lifted earlier across the world. As such, we now expect that this summer's tourism season is likely to be largely lost. Consequently, Turkey's exports will contract by 10% in real terms or around 15% in USD terms this year.

 

We forecast both Turkey's domestic consumption and investments to contract, with the latter shrinking by almost 3%, reflecting high uncertainty, diminished consumer purchasing power, and a weaker Turkish lira raising the burden of servicing foreign-currency denominated debt and thereby limiting the scope for investments. We note that Turkey has not implemented the across-the-board lockdown measures common to some other countries in Europe, opting instead for curfews during certain times and a number of other targeted measures that vary by province. Nevertheless, we understand that many businesses are closed or are reporting a notable drop in economic activity as people stay home.

 

There is significant uncertainty surrounding our forecasts and in particular the speed with which the Turkish economy can recover from this unprecedented shock. A second wave of the coronavirus, either in Turkey or in Europe, could worsen the outlook for recovery. At the same time, we have yet to see how much the activity will recover once the measures start being lifted. Some companies might have to be liquidated because of their weakened financial standing, combined with still-subdued demand from cautious consumers.

 

That said, we consider Turkey's economy to be large and dynamic with a young and growing population. The private sector has a long track record of contending with volatile domestic and external conditions, including the exchange rate. In our view, this should once again help Turkey weather a period of weaker foreign trade conditions and high uncertainty. Since the market volatility of August 2018, there has been only modest capital flight by Turkish residents, although non-resident portfolio investment is close to historical lows.

 

Overall, in our baseline scenario we expect the Turkish economy to contract by 3.1% in real terms in 2020 before recovering by 4.2% in 2021. Our medium-term growth forecasts are largely unchanged, with growth at 3.5% in 2022 and 2023.

 

Turkey has reported over 100,000 coronavirus infections to date, but an estimated 60,000 (and reducing) are currently active. A continued drop in infection rates could bode well for a gradual reopening of the economy in the coming weeks. In fact, the government has recently revealed a normalization plan that outlines the anticipated gradual easing of restrictions.

 

The government has introduced a number of steps to support the economy through the pandemic. These include

Additional payments for health sector employees and families in need.

Tax deferrals.

Layoffs have been banned for three months, and the government will contribute to salary payments for affected employees and businesses.

The credit guarantee fund has been doubled in size to TRY50 billion to ease access to credit for domestic companies, particularly in the SME sector.

Several monetary and credit measures, including lowering the key central bank interest rate, introducing some forbearance measures, voluntary (as opposed to across the board) debt payment moratoria, as well as launching central bank government bond purchases to support market liquidity among others.

 

We forecast that as a result of the implemented measures, but also reflecting weaker economic activity and a drop in revenues, the general government budget will record a deficit of 5% of GDP in 2020. This compares with an estimated 3% of GDP deficit last year (with Central Bank dividend payments included as a revenue). According to the authorities, some of the fiscal expenditures (including automatic stabilizers) will be covered by the unemployment insurance fund, which has an accumulated cash position of about 2% of GDP, and would therefore not lead to a direct increase in government debt.

 

Consequently, we estimate that net general government debt will rise to 34% of GDP by end-2020 compared to 29% at the end of last year. The weaker Turkish lira will also contribute to this rise; Turkey's public balance sheet is vulnerable to currency movements given that close to 50% of government debt is foreign-exchange-denominated and the lira has depreciated since the start of the year. Still, we consider that Turkey's debt level leaves policy room for the authorities to respond.

 

Although fiscal leverage remains low, we consider that there are risks from contingent liabilities. We estimate that direct government guarantees and commitments under Public Private Partnership agreements remain limited at below 10% of GDP. More notably, however, we believe the government may have to extend support to the financial sector, particularly public banks, in an adverse scenario. We note that one recapitalization already happened last year (0.7% of GDP) and more support may be required both as a result of previous rapid loan growth and the effects of the COVID-19 pandemic on Turkish households and the corporate sector. We consider that bank asset quality is likely to deteriorate in the coming months. The Turkish lira is currently trading at about 7.2 per U.S. dollar, having depreciated by close to 18% since the start of the year. The weaker exchange rate puts additional pressure on the domestic corporate sector given that a significant proportion of its debt is still denominated in foreign currency, even despite some reduction in its short open FX position.

 

Turkey's balance-of-payments vulnerabilities remain elevated. Last year the current account recorded a 1% of GDP surplus and we expect it will remain in surplus this year given weak economic activity and imports contraction. Still, gross external financing needs are high with the economy needing to rollover debt close to US$168 billion (24% of GDP) over the next 12 months with a large share concentrated in the banking sector in terms of non-resident deposits and syndicated loans. So far, non-resident deposits have remained stable, and several banks--including Akbank, Ziraat, and Vakifbank--have managed to refinance their credit lines this year with rollover rates of 80%-90%. However, we think that ongoing refinancing needs continue to present downside risk. We believe that there is a connection between banks' capacity to refinance themselves and the stability of the exchange rate. With limited capacity to intervene in the FX market, and policy rates at close to 0% in real terms, the central bank's ability to counteract currency pressures is limited, in our opinion. Political pressure on the independence of the central bank and to keep rates low continues.

 

The central bank's FX reserves have trended down and deteriorated in quality as its borrowing has picked up via swap lines on the liability side in foreign currency. We net these obligations out and expect net FX reserves (usable reserves) to drop below US$10 billion this year from around US$30 billion last year before staging a gradual recovery over the medium term. We view this as rather limited firepower to counteract further exchange rate volatility or to meet unexpected external financing requirements. At the same time, during periods of low capital inflows into the financial account, Turkey's net errors and omissions position typically shifts into surpluses--as was the case in 2015 and 2018. These surpluses may indicate corporate foreign currency assets abroad, unrecorded in Turkey's IIP.

 

We consider that Turkey's institutional arrangements remain comparatively weak and continue to constrain the sovereign ratings. In the June 2018 presidential and parliamentary elections, the president and the Adalet ve Kalkinma Partisi (AKP)-led coalition secured a victory that was the final chapter in Turkey's transition to an executive presidential system. We see limited checks and balances between government bodies, with power concentrated in the hands of the executive branch, and so rendering future policy responses difficult to predict.

 

Nevertheless, a degree of domestic political competition remains, as highlighted by the results of last year's local elections, when opposition parties secured mayorships of large cities including Istanbul, Ankara, and Izmir, among others, and the electoral authorities acknowledged these results. We consider that this outcome may lead to greater scrutiny of public spending, but the situation remains fluid.

 

We also consider that some geopolitical risks remain, including from Turkish military involvement in Northern Syria.

 

Key Statistics

 

Table 1