ֳ

Rating Action Commentary

ֳ Affirms Turkey at 'BB+'; Outlook Stable

Fri 19 Jan, 2018 - 4:13 PM ET

ֳ-London-19 January 2018: ֳ has affirmed Turkey's Long-Term Foreign-Currency Issuer Default Rating (IDR) at 'BB+' with a Stable Outlook.

A full list of rating actions is at the end of this rating action commentary.

KEY RATING DRIVERS
Turkey's IDRs reflect the following key rating drivers:

Turkey's ratings balance high external financing vulnerabilities, pronounced political and geopolitical risks and high levels of inflation and macroeconomic volatility against low public debt ratios backed by a long commitment to fiscal stability and strong growth performance. Structural indicators are generally better than peers.

Fiscal performance deteriorated in 2017 due to various counter-cyclical measures (worth an estimated 0.34% of GDP on the central government budget), with the central government deficit officially projected at 2% of GDP, up from 1.6% in 2016, and in line with the peer median. Policy tightening is planned for 2018, with taxes being raised and stimulus scaled back. However, ֳ expects this to be reversed in 2019 as policy is loosened ahead of elections.

Government debt levels remain well below peers despite the widening of the deficit. Debt/GDP is estimated at 28.4% of GDP at end-2017, compared with a peer median of 47.8%. Turkey's large and diversified revenue base means that debt/revenue is less than half the 'BB' and 'BBB' medians. Debt/GDP is expected to rise over the forecast period, but should stay below 30%. Contingent liabilities are rising, but from a low base and are unlikely to have a material impact on government finances over the forecast period.

Political and geopolitical risks weigh on Turkey's ratings and World Bank governance indicators have fallen below the 'BB' median. The domestic political scene remains focused on presidential and legislative elections, the first under the constitution that was approved in the April 2017 referendum. ֳ assumes the polls will be held in November 2019, the deadline under the new constitution. Tolerance of dissenting political views is reducing in the opinion of independent observers. A state of emergency was extended for another three months in January and a purge of followers of the group that the government considers responsible for the coup attempt in July 2016 continues. Security incidents in 2017 were confined to the unresolved conflict in the south east.

Bouts of tense rhetoric with key bilateral partners are becoming regular events, potentially souring relations with the EU and US and bringing economic risks. The conviction of an employee of a state-owned bank for evading Iranian sanctions in January 2018 brings the risk of fines for the institutions implicated, which could have broader implications for the external financing of the financial sector.

The current account deficit is large and persistent, and has resumed widening. ֳ estimates a deficit of 5.3% of GDP in 2017, pushed up by higher commodity imports, from 3.8% in 2016. The deficit will remain on an upward trend, despite a recovery in tourism, reflecting rising import growth. With FDI likely to remain at around 1% of GDP, the deficit will remain largely debt financed. Net external debt is forecast to rise to 34% of GDP by 2019, compared with a peer median of 14.1%.

External financing requirements are large, both in absolute and relative terms, and are a major weakness in the sovereign credit profile. The external financing requirement (including short-term debt) is projected to rise to USD214 billion in 2018, 226% of projected end-2017 reserves. Turkey's strained international liquidity ratio (81.6% at end-2017) makes it vulnerable to shifts in investor sentiment. However, the private sector has a track record of meeting its FX obligations and banks diversified the nature and tenor of their external market funding sources in 2017. The combination of likely tighter global financial conditions over 2018 and particularly 2019 and a potentially more heated pre-election political environment could again test this resilience.

Monetary policy has persistently proven unable to bring inflation near to target and a complex policy framework undermines transmission mechanisms, in ֳ's opinion. Inflation averaged 11.1% in 2017 making Turkey one of only two ֳ-rated sovereigns that are rated above the 'B' category to record double digit inflation last year. Inflation expectations have risen and ֳ expects inflation to stay in double digits for the bulk of 2018.

Economic growth was very strong in 2017, at an estimated 6.8%, and five-year average growth, at 5.6% is well in excess of the peer median of 3.5%. Growth was boosted by stimulus measures in 2017, supported by solid growth in major trading partners and a gradual recovery in tourism. A slowdown in growth to 4.1% is expected in 2018 due to tighter fiscal and monetary policy and reduced availability of credit. Growth should rebound in 2019 to 4.7%, reflecting ֳ's expectation of renewed stimulus ahead of the elections.

ֳ has a stable outlook for the banking sector reflecting resilience in banks' credit profiles and financial metrics despite a challenging operating environment and macro volatility. Headline non-performing loans are low and stable at around 3% of total loans. However, the volume of at-risk restructured and watch-list loans has increased. Sector capitalisation (capital adequacy ratio 17.2% at end-September) is underpinned by solid internal capital generation, low unreserved NPLs and regulatory forbearance. Turkey scores a '3' on ֳ's macro-prudential risk indicator, based on past rises in house prices and real credit growth. These increases are now moderating, but rapid credit growth and its financing are a potential source of vulnerability to the banking sector. Credit growth picked up in 2017 reflecting government initiatives to stimulate the economy, but has slowed, and in the absence of further stimulus will be constrained by a loan-to-deposit ratio of 126% (148% for TRY) and rising financing costs.

Turkey is a large and diversified economy with a vibrant private sector. Human Development and Doing Business indicators, as measured by the World Bank, are in excess of the 'BB' median. GDP per capita is double the peer median, although the volatility of economic growth is well in excess of peers reflecting a vulnerability to regular domestic and external shocks.

SOVEREIGN RATING MODEL (SRM) and QUALITATIVE OVERLAY (QO)
ֳ's proprietary SRM assigns Turkey a score equivalent to a rating of 'BBB' on the Long-Term Foreign-Currency (LT FC) IDR scale.

ֳ'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:
- External finances: -1 notch, to reflect a very high gross external financing requirement and low international liquidity ratio.
- Structural features: -1 notch, to reflect a political environment that may continue to adversely affect economic policymaking and performance, and the risk of serious terrorist attacks.

ֳ'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. ֳ'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.

RATING SENSITIVITIES
The main factors that, individually, or collectively, could lead to negative rating action are:
- Heightened stresses stemming from external financing vulnerabilities, potentially reflecting deteriorating bilateral political relations.
- Weaker public finances reflected by a deterioration in the government debt/GDP ratio to a level closer to the peer median.
- A serious deterioration in the political or security situation.

The main factors that, individually, or collectively, could lead to positive rating action are:
- Implementation of reforms that address structural deficiencies and reduce external vulnerabilities.
- A political and security environment that supports a pronounced improvement in key macroeconomic data.

KEY ASSUMPTIONS
- ֳ forecasts Brent Crude to average USD52.5/b in 2018 and USD55/b in 2019.

The full list of rating actions is as follows:

Long-Term Foreign-Currency IDR affirmed at 'BB+'; Outlook Stable
Long-Term Local-Currency IDR affirmed at 'BBB-'; Outlook Stable
Short-Term Foreign-Currency IDR affirmed at 'B'
Short-Term Local-Currency IDR affirmed at 'F3'
Country Ceiling affirmed at 'BBB-'
Issue ratings on long-term senior unsecured foreign-currency bonds affirmed at 'BB+'
Issue ratings on long-term senior unsecured local-currency bonds affirmed at 'BBB-'
Issue ratings on short-term senior unsecured local-currency bonds affirmed at 'F3'
Issue ratings on Hazine Mustesarligi Varlik Kiralama Anonim Sirketi's foreign-currency global certificates (sukuk) affirmed at 'BB+'
Issue ratings on Hazine Mustesarligi Varlik Kiralama Anonim Sirketi's local-currency global certificates (sukuk) affirmed at 'BBB-'

Contact:
Primary Analyst
Paul Gamble
Senior Director
+44 20 3530 1623
ֳ Limited
30 North Colonnade
London E14 5GN

Secondary Analyst
Toby Iles
Director
+852 2263 9832

Committee Chairperson
Tony Stringer
Managing Director
+44 20 3530 1219


Media Relations: Peter Fitzpatrick, London, Tel: +44 20 3530 1103, Email: peter.fitzpatrick@fitchratings.com.

Additional information is available on

Applicable Criteria
Country Ceilings Criteria (pub. 21 Jul 2017)
Sovereign Rating Criteria (pub. 21 Jul 2017)
Sukuk Rating Criteria (pub. 14 Aug 2017)

Additional Disclosures
Dodd-Frank Rating Information Disclosure Form
Solicitation Status
Endorsement Policy


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