Turkey: S&P confirms Turkey's credit rating, outlook stable

Turkey's 'B+/B' long and short-term foreign currency country credit rating and 'BB-/B' long and short-term local currency country credit rating were affirmed by S&P, leaving the outlook as “stable”.

Turkey's 'B+/B' long and short-term foreign currency country credit rating and 'BB-/B' long and short-term local currency country credit rating were affirmed by S&P, leaving the outlook as “stable”. The stable outlook takes into account the continuing risks from Turkey's economic imbalances over the next 12 months. These are partially offset by the resilience of Turkey's private sector and the manageable net general government debt stock, which leaves room for fiscal policy response as needed.


Highlights in credit rating evaluation:


·        The Turkish economy will grow by 8.6% this year, aided by the positive rollover effects, the strong recovery in exports and the resilience of domestic activity against the pandemic.

·        We expect the net general government debt to reach 34% of GDP by the end of 2021.

·        Despite recent developments, we still see Turkey's balance of payments position as weak, while monetary policy is unpredictable.

·        Inflation is advancing at around 20% annually, the eighth highest rate among the 137 countries we evaluated.

·        We reaffirm our 'B+/B' FX and 'BB-/B' local currency ratings for Turkey. Outlook “stable”.


If we look at the negative and positive scenario evaluations that may be the subject of a possible credit rating action;


(-) The worsening of banks' access to external financing or the further dollarization of domestic savings may adversely affect the rating. The organization is not treating this as a baseline scenario at this stage.

(-) Weakening asset quality following the large-scale credit stimulus in 2020 may put pressure on the banking system, especially state banks, which expanded their balance sheets faster last year.

(+) We may consider an upgrade in Turkey's balance of payments position, especially if the Central bank's net foreign exchange reserves strengthen beyond our estimates.

(+) We can raise the rating if we observe the sustainability and improved predictability of public policy and the effectiveness of monetary policy.


Although the recovery after the pandemic is seen as strong, it has been highlighted as a risk factor since the possibility of uncertainty in policy is seen as high in the institution report. In terms of economic growth performance, especially the strong outlook in production is above the average of many other developing countries. In terms of balance of payments and foreign exchange incomes, tourism made a significant positive contribution especially in 3Q21. The lifting of restrictions on the epidemic, as well as the removal of Turkey from the red travel lists by several EU countries, the UK and Russia, allowed tourism to resume, boosting service exports. However; The rise in exchange rates due to weak lira returns and the increase in energy prices globally pose a risk that will increase the balance of payments deficit of Turkey, which is a highly importing country. The gradual abandonment of the supportive monetary policy of the central banks of developed countries, especially the Fed, may complicate the financing effect through the decrease in fund flows to developing countries.


As the subject of downside factors; It is pointed out that the balance of payments risks within the framework of foreign exchange movements and the limited reaction of monetary policy limit the potential. However, higher inflation and lower availability of foreign exchange reserves at the Central Bank may contribute to wider economic imbalances. It is interpreted that the direct risks of the Covid-19 pandemic have decreased for Turkey within the framework of the population full vaccination or at least one dose vaccination rate. Almost all restrictions on social contact were lifted in July 2021, and no new restrictions are expected, although some risks remain from the emergence and spread of new virus variants.


Despite the strong recovery, policy-making uncertainty is seen as the most significant risk. Here, the distance from the CBRT's policy aim in establishing price stability and the recent policy actions and the compelling effects of the changes in the CBRT are mentioned. In terms of the early interest rate change in the CBRT, the depreciation of the lira accelerated after the 200 basis point cut in MPC in October. The lira has eroded more than 20% against the dollar this year, declining more than any other emerging market currency. S&P expects the CBRT's monetary policy to continue to loosen. It points to risks of greater volatility in the foreign exchange market, in addition to inflationary pressures, with adverse secondary effects for asset quality and potentially growth. It is mentioned that the mismatch between monetary policy and inflation could force the central bank to abruptly reverse course and raise rates significantly after the previous policy easing, as happened in 2018 and 2020. We would like to point out the compelling factors stemming from the financial market and inflationary effect regarding a similar policy sudden transformation as a factor of reservation. Regarding growth and real sector activity; We think that the desire to reduce loan rates will still keep the policies in an expansionary direction, but local and global inflationary factors and the transformation effects in financial conditions do not provide the "economic conditions" for easing.


On the threshold of all these factors, we see that the strong growth profile is constrained by inflation and policy uncertainties. While the institution determined its growth forecast for 2021 as 8.6%; It forecasts growth of 3.3% for 2022 and 3.1% for thereafter. S&P forecasts inflation to average 17.3% this year to 12% in 2022, but points out that there is a risk of it being higher.


In terms of foreign exchange reserves;


The central bank's gross foreign exchange reserves also rose from $93 billion at the end of 2020 to just over $120 billion in early October 2021. Net usable foreign exchange reserves are $34 billion (4.5% of GDP) when domestic swaps and commercial banks' required foreign exchange reserves at the CBRT are netted off. The following factors contributed to this:


·        Rediscount credit, which the CBRT provides to exporters in local currency, but is repaid in foreign currency,

·        Turkey's conclusion of additional swap agreements with foreign counterparties, including the People’s Bank of China and the Bank of Korea,

·        IMF's special drawing rights allocation of $6.3 billion.


In terms of public finance;


·        Turkey's financial position remains strong compared to many other emerging markets and continues to support country credit ratings.

·        Most of the support measures related to the pandemic last year came in the form of credit provisions, with the overall government deficit reaching 2.9% of GDP.

·        The increase in public leverage is higher, primarily due to the depreciation of the Turkish lira, as more than half of the public debt is now denominated in foreign currency.

·        Given the economic recovery and the withdrawal of some support measures related to the pandemic, we expect the fiscal deficit to fall to 2.5% of GDP in 2021.

·        The government has also recently increased corporate income tax, which should have increased income.

·        We estimate that net general government debt will account for 34% of GDP by the end of 2021, which is modest for an emerging market and leaves room for the government to ease fiscal policy in an unfavorable economic scenario.

·        The government has issued Eurobonds many times in recent months, showing access to the international capital market.

·        The focus has also recently shifted to domestic issuance of longer maturity and local currency debt.

·        Although financial leverage remains low, we see risks arising from contingent liabilities. We foresee that the government may have to support the financial sector, especially state banks. Additional support may be needed as a result of rapid loan growth over the past year and recent exchange rate volatility.


Banking sector;


·        We still expect the asset quality to deteriorate, especially due to the withdrawal of tolerance and support measures and the maturity of the large loan stock opened by banks last year.

·        In mid-October 2021, the global Financial Action Task Force graylisted Turkey, citing oversight issues over money laundering and terrorist financing prevention.

·        Still, in the last two years, Turkish banks have consistently been able to roll over their maturing foreign debts, including during difficult times. This was evident at the height of uncertainty, after the currency crisis of August 2018 and just after the onset of the pandemic in 2020.

·        In recent years, residents have been gradually shifting their savings to foreign currencies and gold, but with confidence in the financial system without attracting large deposits.

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