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Link to ���������ֳ�' Report(s): Turkey - Rating Action Report

���������ֳ�-London-13 July 2018: ���������ֳ� has downgraded Turkey's Long-Term Foreign-Currency Issuer Default Rating (IDR) to 'BB' from 'BB+'. The Outlook is Negative.

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

KEY RATING DRIVERS
The downgrade of Turkey's IDRs and Negative Outlook reflects the following key rating drivers and their relative weights:

High
���������ֳ� believes downside risks to macroeconomic stability have intensified owing to the widening in the current account deficit (CAD), more challenging global external financing environment, jump in inflation and the impact of the plunge in the exchange rate on the private sector, which has significant foreign currency-denominated debt. In ���������ֳ�'s opinion, economic policy credibility has deteriorated in recent months and initial policy actions following elections in June have heightened uncertainty. This environment will make it challenging to engineer a soft landing for the economy.

���������ֳ� expects the CAD to widen to 6.1% of GDP in 2018, driven by higher fuel prices, and in 1H, higher household consumption. The fall in the lira, combined with ���������ֳ�'s forecast of lower oil prices and the ongoing tourism recovery, will cause the deficit to narrow to 4.1% in 2019. FDI is forecast to remain around 1% of GDP, meaning that the deficit will be largely debt financed. ���������ֳ� forecasts net external debt to rise to 35% of GDP at end-2018, compared with the current 'BB' range median of 8%.

Turkey's large gross external financing requirement leaves it vulnerable to shocks. For 2018, ���������ֳ� estimates it at USD229 billion, comprising a CAD of USD54 billion, medium and long-term amortisation of USD57 billion and short-term debt of USD118 billion. ���������ֳ� assumes that gross international reserves will decline to USD96 billion by end-2018, reducing Turkey's liquidity ratio to 70%. Net reserves are less than half of gross reserves.

Headline inflation jumped to a 15-year high of 15.4% (up 2.6% mom) in June, in the aftermath of the sharp depreciation of the lira (by 27% year to date). Although we expect the cumulative 500bp hike in the policy interest rate by the central bank (CBRT) since April to ease inflationary pressure, ���������ֳ� forecasts annual average inflation to be more than double the current 'BB' range median, at 13% in 2018 and 10.8% in 2019.

Notwithstanding the simplification of interest rate setting around the one week repo rate announced in June, monetary policy credibility has been damaged by comments by President Erdogan suggesting a greater role of the presidency in setting monetary policy after the elections. Subsequent amendments to the central bank's articles of association appear to strengthen the president's influence, notably over key appointments. Monetary policy has persistently been unable to bring inflation near its 5% target and inflation expectations have become unanchored.

In ���������ֳ�'s view, a sustained reduction of inflation would require an increase in the credibility and independence of monetary policy and tolerance of a period of weaker economic growth. The prospects for this as well as structural economic reform are uncertain. Key figures from the previous administration with reformist credentials were excluded from a new cabinet, appointed on 9 July, while the son-in-law of the president was appointed as Minister of Treasury and Finance.

The significant tightening of financial conditions will cause GDP growth to slow. After a buoyant 2% qoq in 1Q (7.4% yoy) and reasonable April, it is likely that the economy has contracted and ���������ֳ� expects it to continue to shrink until 4Q. ���������ֳ�'s base case is for GDP growth of 4.5% in 2018 and 3.6% in 2019, supported by healthy external demand, a continued recovery in tourism, infrastructure spending and employment growth. A period of growth below trend (estimated by ���������ֳ� at 4.8%) may allow a partial unwinding of imbalances. However, the risk of a hard landing for the economy has increased.

Currency weakness poses a test to the private sector, given its open net FX position of USD221 billion at end-April, while tighter financial conditions test its large external financing requirement. The private sector has regularly demonstrated capacity to cope with adverse financing and exchange rate shocks, but a series of recent corporate debt restructurings point to the crystallisation of risks stemming from high corporate borrowing in recent years.

Tougher financing conditions and a weaker economy will likely hit the performance of the banking sector, heightening pressure on asset quality, capitalisation and liquidity and funding profiles. External debt rollover rates for banks have held up, and banks generally have sufficient foreign currency liquidity to meet foreign currency wholesale liabilities maturing within a year. However, the cost of financing has gone up and market demand for some instruments has tailed off.

Headline NPLs remain stable at around 3%, but the volume of at-risk restructured loans and watch-list loans continues to rise, although the switch to IFRS9 complicates the assessment. Banks may not be able to fully pass on higher CBRT rates, putting pressure on margins, and the high loan-to-deposit ratio (127%; 152% TRY) and weaker demand for foreign currency lending will likely constrain credit growth. ���������ֳ� placed 25 banks on Rating Watch Negative on 1 June reflecting heightened risks following increased market volatility.

Turkey's 'BB' IDRs also reflect the following key rating drivers:

Fiscal performance has deteriorated modestly at the central government level over the first five months of the year, but this does not yet capture a pre-election economic support package; the largest item of which was a bonus for pensioners that cost TRY21 billion (0.6% of GDP). Although spending growth is likely to ease after the elections, the slowing economy will hit fiscal revenues. As a result, ���������ֳ� forecasts the general government deficit to widen to 2.9% of GDP in 2018 from 2.1% in 2017. A tightening of policy is assumed from 2019 in line with the completion of the electoral cycle.

Moderate general government debt is a rating strength and is forecast to remain so despite the deterioration in headline fiscal performance. At 28.1% of GDP at end-2017, general government debt/GDP is well below the current peer median of 44.5%. Debt/revenue of 83.8% was almost half the current peer median, reflecting the large revenue base. Contingent liabilities, which are rising from a low base (driven primarily by PPPs), are unlikely to have a material impact on public finances over the forecast period, but pose a risk over the medium term. Significant infrastructure projects, likely to be PPP financed, are being discussed ahead of the centenary of the formation of the Turkish Republic in 2023.

President Erdogan secured a new term with 52.6% of the vote in the presidential election on 28 June, which completed the transition to an executive presidency under a new constitution that was approved by a narrow margin in 2017. The ruling AKP won 42.6% of the vote at the concurrent parliamentary election and the dynamics of its coalition with the nationalist MHP are to be tested. Local elections, due in March 2019, will complete the electoral cycle and are expected to be keenly contested.

Political and geopolitical risks weigh on Turkey's ratings and World Bank governance indicators have fallen below the 'BB' median. Tolerance of dissenting political views is reducing in the opinion of independent observers. The state of emergency is expected to be lifted in July, but the President has significant capacity to rule by decrees under the new constitution and a purge of followers of the group that the government considers responsible for the coup attempt in July 2016 continues.

There are a number of active pressure points in relations with the US and EU. 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. Turkey remains involved in active conflict in neighbouring Syria. The composition of the ruling coalition suggests progress toward the resolution of the conflict in the south east is unlikely.

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:
- Macroeconomic policy and performance: -1 notch, to reflect political pressure on monetary policy and uncertainty over the commitment to macro stability.
- External finances: -1 notch, to reflect a very high gross external financing requirement and low international liquidity ratio.
- Structural features: -1 notch, to reflect an erosion of checks and balances leading to 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 a downgrade are:
- A sudden stop to capital inflows or hard landing of the economy, particularly if it heightens stresses in the corporate or banking sectors.
- Failure to rebalance the economy and implement reforms that provide a path to addressing structural deficiencies and reducing inflation and external vulnerabilities.
- A marked increase 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 a stabilisation of the Outlook are:
- A sustainable rebalancing of the economy evident in a reduction in the CAD and inflation that reduces external vulnerabilities.
- A political and security environment that supports a pronounced improvement in key macroeconomic data.

KEY ASSUMPTIONS
- ���������ֳ� forecasts Brent Crude to average USD70/b in 2018, USD65/b in 2019 and USD57.5/b in 2020.

The full list of rating actions is as follows:

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

Contact:

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

Secondary Analyst
Ed Parker
Managing Director
+44 20 3530 1176

Committee Chairperson
Tony Stringer
Managing Director
+44 20 3530 1219



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

Additional information is available on
Applicable Criteria
Country Ceilings Criteria - Effective from 21 July 2017 to 19 July 2018 (pub. 21 Jul 2017)
Sovereign Rating Criteria - Effective from 23 March 2018 to 19 July 2018 (pub. 23 Mar 2018)
Sukuk Rating Criteria - Effective from 16 August 2017 to 25 July 2018 (pub. 14 Aug 2017)

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