Turkey: Fitch further lowers credit rating

Turkey’s long-term foreign currency debt rating was downgraded from BB- to B+ by Fitch, four steps below investment grade. The outlook was determined as “negative”. Turkey’s credit rating has dropped to the same level as countries such as Egypt and Bahrain. In a Friday evening statement by Fitch, the downgrade was cited by factors, including the country’s vulnerability to high inflation: “Turkey’s expansionary policy mix (including deep negative real rates) could stabilize inflation at high levels, leaving public finances exposed to exchange rate depreciation and inflation. It could increase retention and ultimately weigh on domestic confidence and rekindle pressures on international reserves.”

According to Fitch’s report; More frequent and intense periods of policy-induced financial stress have increased Turkey’s vulnerabilities in terms of high inflation, low foreign liquidity and weak policy credibility. Fitch does not expect the authorities’ policy response to curb inflation, including FX-protected deposits, targeted credit and capital flow measures, to sustainably mitigate macroeconomic and financial stability risks. From the last phase of 2021, the central bank adopted a different policy principle towards the economic goals of President Mr. Recep Tayyip Erdogan. In this context, while starting to lower interest rates, most emerging markets were doing the opposite to protect their currencies from global price pressures. The central bank cut the policy rate by a total of 500 basis points in four meetings until December and sent risk indicators, including CDS, to multi-year highs.

At the end of December, the lira lost half its value against the dollar before the government intervened to stem the currency’s decline. Some government measures, including a lira deposit scheme that protected savers from rapid depreciation, brought a level of stability to the lira, but inflation soared to 48.7% in January, the fastest rate of increase in two decades. In Fitch’s view, the new financial instrument’s capacity to sustainably improve confidence is limited in an environment of high inflation as well as unstable expectations. Also, if the instrument does not reduce domestic demand for foreign currency, maintaining a stable exchange rate without the use of interest rates would require additional capital flow measures, similar to the new foreign exchange intervention or the new practice requiring exporters to sell 25% of their income. Fitch forecasts inflation to reach 38% by the end of the year, an average of 41% in 2022 and 28% in 2023.

According to Fitch; The declining currency volatility and the introduction of foreign exchange-protected deposits in recent weeks allowed lira deposits to partially recover and caused some reversal in dollarization. The plan could reduce short-term risks to the stability of bank finances, improve sentiment in the near term and ease pressure on capital ratios. In this adverse scenario, official international reserves will come under pressure as a significant portion of banks’ foreign currency holdings, including currency swaps and reserve requirements, are held at the central bank.

international reserves; Gross reserves expected to rise to 118 billion US dollars in 2022 (4.2 monthly current foreign payments) as export rediscount credits, currency conversion of deposits, a new currency swap with the UAE (equivalent to 5 billion USD) and 1 billion Euro deposits from Azerbaijan’s Sofaz The latest figures from November-December show an increase in gross (US$114.7 billion) and net (US$16.3 billion) reserves, but the Central bank’s net foreign asset position (excluding FX swaps) remains negative.

For the current balance; Although it expects the current account deficit to decrease to 1.7% of GDP in 2022, external financing needs will remain high, according to Fitch. The external debt due in the next 12 months (end of November) amounts to USD 167 billion. Access to external finance for the government and private sector has been resilient to previous periods of stress but is vulnerable to changes in investor sentiment.

For the banking sector; Turkish banks are sensitive to currency volatility due to high external debt payments, the impact on asset quality (41% of foreign currency loans) and high deposit dollarization (61.5%). Additionally, Fitch estimates that 10% depreciation eroded the industry equity Tier 1 ratio by about 50 basis points, even though the BRSA extended the regulatory tolerance to soften the impact of lira depreciation on capital ratios.

Fitch expects the Turkish economy to slow down from 11% in 2021 to 3.2% in 2022, still balancing positive external demand dynamics, a recovery in the tourism sector and a harmonious policy stance against tighter financing conditions, deterioration in consumer confidence and negative impacts. Despite growth resilience, GDP per capita in US dollars has deteriorated since 2013 and fell by nearly US$4,000 to an estimated US$8,633 in 2021 due to the multi-year weakening of the currency.

Public finance; Fitch estimates that general government debt rose to 42% of GDP at the end of 2021, falling below the ‘B’ median of 68%, as the lira’s depreciation was offset by lower financing needs and net repayments of local currency debt. As 66% of central government debt is foreign exchange-linked, or more than 39% at the end of 2017, debt dynamics will be vulnerable to increased currency risks. Fitch estimates that Turkey’s fiscal deficit will fall to 3% of GDP at the general government level and 2.9% at the central government level in 2021. Fiscal risks arise from potential payments related to the FX-protected deposit program, fiscal measures to reduce the impact of inflation on the economy, increased interest payments and increased interest payments.

According to the agency; Geopolitical tensions eased last year and Turkey tried to re-establish its relations with the countries of the region. However, key foreign policy issues remain unresolved, such as Turkey’s purchase of the Russian S-400 missile system in 2019, US cooperation with the YPG in Syria, or maritime disputes in the Eastern Mediterranean. The evolution of relations with Russia is uncertain due to Turkey’s support and arms sales to Ukraine.

Factors that may be subject to a downgrade in grade or outlook:


·        Macro: Policy initiatives that increase macroeconomic and financial stability risks, such as the inflation-currency depreciation spiral or weaker depositor confidence.

·        External Financing: Signs of reduced access to external financing for the government or private sector, for example due to further deterioration of investor confidence, which could lead to balance of payments pressures, including continued decline in international reserves.

·        Structural: A serious deterioration in the domestic political or security situation or in international relations that seriously affects the economy and external finances.


Factors that may be subject to an increase in grade or appearance:


·        Macro: A reliable and coherent policy mix that reduces inflationary pressures and stabilizes them and mitigates macroeconomic and financial stability risks.

·        External Financing: A continuous improvement in the level and composition of international reserves, a reduction in external vulnerabilities due to a decrease in dollarization and a continuous improvement in the current account balance.

Credit Rating Profile:


·        Moody’s long-term external debt rating: B2, outlook negative

·        S&P long-term foreign currency debt rating: B+u, outlook negative

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