Rating Action Commentary
ֳ Revises Turkiye's Outlook to Stable; Affirms at 'B'
Fri 08 Sep, 2023 - 5:03 PM ET
Related Content:
Turkiye - Rating Action Report
ֳ - London - 08 Sep 2023: ֳ Ratings has revised the Outlook on Turkiye's Long-Term Foreign-Currency (LTFC) Issuer Default Rating (IDR) to Stable from Negative and affirmed the IDR at 'B'.
A full list of rating actions is at the end of this rating action commentary.
Key Rating Drivers
The revision of the Outlook on Turkiye's IDRs reflects the following key rating drivers and their relative weights:
Medium
Significant Policy Shift: The revision of the Outlook to Stable reflects the return to a more conventional and consistent policy mix that reduces near-term macro-financial stability risks and eases balance of payments pressures. There is still uncertainty regarding the magnitude, longevity and success of the policy adjustment to bring down inflation, partly due to political considerations.
Turkiye's 'B' ratings reflects a record of political interference, high inflation, weak external buffers relative to high external financing needs and financial dollarisation. These weaknesses are balanced against the sovereign's low general government debt relative to peers, a record of external market access and manageable debt repayment profile.
Improved Policy Consistency: President Erdogan appointed a new economic team that has re-introduced interest rates as the main monetary policy tool, and seeks to improve policy consistency by containing the increased budget deficit and slowing domestic demand by changing the composition and pace of credit growth. They have also allowed the lira to depreciate (26% since May), in marked contrast to the relative stability prior to the elections, which has eased pressures on international reserves.
Monetary Policy Normalisation, Political Risks: The Central Bank of the Republic of Turkiye has increased its policy rate by 1650bp to 25% since June. It aims to bring inflation expectations and core inflation under control, supported by changes in existing targeted financial regulations to increase deposit and credit rates above its main policy rate. Although we forecast the bank will lift its policy rate to 35% by end-2023 and remain at that level in 2024, there is a high degree of uncertainty about the future pace and duration of monetary policy tightening.
Pressures on Reserves Easing: Gross international reserves have noticeably recovered since mid-May and we forecast they will reach USD115 billion by end-2023 and remain relatively stable in 2024, bringing reserve coverage of current external payments to 3.2 months, slightly below the forecast 3.4 'B' median. The central bank's net foreign asset position remains significantly negative (minus USD67 billion) when excluding FX swaps.
Moreover, reserve coverage remains weak given high financial dollarisation (42.2%; 58.7% when including FX-protected deposits) and large external financing requirements. Authorities have signalled their intention to reduce FX protected deposits (USD125.3 billion in September), but this is dependent on sustained improvement in inflation and lira depreciation expectations.
Turkiye's 'B' IDRs also reflect the following key rating drivers:
High Inflation, Slower Growth: High inflation remains Turkiye's main risk and policy challenge. Annual inflation rose sharply in August to 58.9%, as strong core inflation pressures were exacerbated by the pass-through of the sharp lira depreciation, minimum wage increases and continued strength of domestic demand. We forecast end-year inflation at 65%, averaging 51.9% in 2023. The inflation trajectory remains highly uncertain, due to risks of backward indexation, inflation expectations, high commodity prices and additional lira depreciation.
Authorities are seeking to rebalance domestic demand away from consumption and towards investment and supporting exports. We forecast growth to reach 4.3% in 2023 before slowing to 3.0% in 2024, as reduced credit availability and easing of policy stimulus after the March local elections will be somewhat mitigated by earthquake reconstruction efforts and improved external demand.
High External Financing Needs: Turkiye's current account deficit will remain high in 2023, reaching 4.7% of GDP in 2023 reflecting strong domestic consumption and gold imports. We forecast the external deficit will ease to 2.9% of GDP in 2024 on the back of slower growth and improving external demand. Total external debt maturing over the next 12 months amounted to USD206 billion at end-June, leaving Turkiye vulnerable to changes in investor sentiment. The sovereign debt service profile is manageable, with USD2.6 billion principal payments remaining in 2023 and USD11 billion (USD8.9 billion Eurobonds) in 2024.
Resilient External Financing: There is a record of resilience in access to external financing for the sovereign and private sector. Sovereign yields have come down significantly since the appointment of the new economic team and the government has reportedly agreed significant financing from Middle East partners, including USD51 billion investment commitments from the UAE over three years, of which approximately USD8 billion could be allocated to sovereign sukuks. Additional multilateral support is also possible. However, the precise timing of the disbursements remains uncertain.
Increased Deficits, Manageable Debt: Pre-election stimulus and the cost of the February earthquakes' relief and reconstruction efforts will lead to significant expansion of the central government deficit to 5.3% of GDP (estimated at 5.4% at the general government level) in 2023. The government introduced a series of tax increases in mid-2023 and intends to maintain an underlying central government deficit (without taking into account earthquake reconstruction costs) below 3% of GDP. We forecast the general government deficit will widen to 6.3% in 2024, as the main year of earthquake reconstruction and possible easing ahead of the local elections, before declining to 4.8% of GDP in 2025.
We forecast that general government debt will reach 33.7% of GDP in 2023, balancing high nominal GDP growth and negative rates in domestic financing against increased pace of borrowing and the depreciation of the lira. Debt subject to interest rate re-fixing within 12 months has declined since 2020 but remains high at 62%. Moreover, despite increased issuance of local-currency debt and repayment of foreign-currency debt in the local market, the share of foreign-currency denominated debt at end-July remained high at 67.1%.
Reduced Political Uncertainty, Geopolitical Tensions: Near-term political uncertainty has declined after the May general elections. Nevertheless, we consider that the space for policy normalisation continues to be conditioned by political factors, including the proximity of the March 2024 local elections. Post-elections, Turkiye has moved quickly to reduce tensions with NATO allies, signalled its intention to revive the negotiation process for the upgrade of the Customs Union with the EU and continued to rebuild relations with countries in the region. Turkiye continues to play an active diplomatic role regarding the war in Ukraine, for example, by negotiating the extension of the 'grain corridor'.
ESG - Governance: Turkiye has an ESG Relevance Score (RS) of '5' for both Political Stability and Rights and for the Rule of Law, Institutional and Regulatory Quality and Control of Corruption. Theses scores reflect the high weight that the World Bank Governance Indicators (WBGI) have in our proprietary Sovereign Rating Model. Turkiye has a medium WBGI ranking at the 35th percentile reflecting a recent track record of peaceful political transitions, a moderate level of rights for participation in the political process, moderate but deteriorating institutional capacity due to increased centralisation of power in the office of the president and weakened checks and balances, uneven application of the rule of law and a moderate level of corruption.
RATING SENSITIVITIES
Factors that Could, Individually or Collectively, Lead to Negative Rating Action/Downgrade
-Macro: A return to unconventional policy mix or an incomplete policy rebalancing that increases macroeconomic and financial stability risks, for example, an inflation-exchange rate depreciation spiral, weaker depositor confidence and/or increased vulnerabilities in banks' balance sheets.
-External Finances: Increased balance of payments pressures, including sustained reduction in international reserves, for example, due to reduced access to external financing for the sovereign or the private sector and/or sustained widening of the current account deficit.
-Structural Features: Serious deterioration of the domestic political or security situation or international relations that severely affects the economy and external finances.
Factors that Could, Individually or Collectively, Lead to Positive Rating Action/Upgrade
-Macro: Greater confidence in the sustainability of the current policy normalisation and rebalancing process resulting in improved macroeconomic stability, including a sustained reduction in inflation.
-External Financing: A reduction in external vulnerabilities, for example, due to sustained narrowing of the current account deficit, increased capital inflows, improvements in the level and composition of international reserves and reduced dollarisation.
Sovereign Rating Model (SRM) and Qualitative Overlay (QO)
ֳ's proprietary SRM assigns Turkiye a score equivalent to a rating of 'BB-' on the Long-Term Foreign-Currency (LT FC) IDR scale.
ֳ's sovereign rating committee adjusted the output from the SRM score to arrive at the final LT FC IDR by applying its QO, relative to SRM data and output, as follows:
- Structural: The removal of the -1 notch reflects ֳ's view that the risk of geopolitical tensions and domestic political instability have substantially eased after the May general elections and are comparable to similarly-rated sovereigns.
- Macro: -1 notch, to reflect Turkiye's weak macroeconomic policy credibility and predictability due to a track record of delayed response to mounting macroeconomic pressures, premature policy easing and political interference.
- External Finances: -1 notch, to reflect a very high gross external financing requirement, low international liquidity ratio, a weak central bank net foreign asset position, and risks of renewed balance of payments pressures in the event of changes in investor sentiment.
ֳ'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.
Country Ceiling
The Country Ceiling for Turkiye is 'B' in line with the LT FC IDR. This reflects no material constraints and incentives, relative to the IDR, against capital or exchange controls being imposed that would prevent or significantly impede the private sector from converting local currency into foreign currency and transferring the proceeds to non-resident creditors to service debt payments.
ֳ's Country Ceiling Model produced a starting point uplift of 1 notch above the IDR. ֳ's rating committee applied an offsetting - 1 notch qualitative adjustment to this, under the Balance of Payments Restrictions pillar reflecting Turkiye's introduction and current maintenance of export surrender requirements since 2022. Moreover, authorities have relied in targeted financial regulations to reduce FX demand and convert FX deposits to FX-protected or lira deposits.
REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING
The principal sources of information used in the analysis are described in the Applicable Criteria.
ESG Considerations
Turkiye has an ESG Relevance Score of '5' for Political Stability and Rights as World Bank Governance Indicators have the highest weight in ֳ's SRM and are therefore highly relevant to the rating and a key rating driver with a high weight. As Turkiye has a percentile rank below 50 for the respective Governance Indicator, this has a negative impact on the credit profile.
Turkiye has an ESG Relevance Score of '5' for Rule of Law, Institutional & Regulatory Quality and Control of Corruption as World Bank Governance Indicators have the highest weight in ֳ's SRM and are therefore highly relevant to the rating and are a key rating driver with a high weight. As Turkiye has a percentile rank below 50 for the respective Governance Indicators, this has a negative impact on the credit profile.
Turkiye has an ESG Relevance Score of '4'for Human Rights and Political Freedoms as the Voice and Accountability pillar of the World Bank Governance Indicators is relevant to the rating and a rating driver. As Turkiye has a percentile rank below 50 for the respective Governance Indicator, this has a negative impact on the credit profile.
Turkiye has an ESG Relevance Score of '4' for International Relations and Trade, as Turkiye faces the risk of renewed balance of payments pressures in the event of changes in investor sentiment given the high external financing requirements., which has a negative impact on the credit profile, is relevant to the rating and a rating driver.
Turkiye has an ESG Relevance Score of '4' for Creditor Rights as willingness to service and repay debt is relevant to the rating and is a rating driver for Turkiye, as for all sovereigns. As Turkiye has track record of 20+ years without a restructuring of public debt and captured in our SRM variable, this has a positive impact on the credit profile.
The highest level of ESG credit relevance is a score of '3', unless otherwise disclosed in this section. A score of '3' means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. ֳ's ESG Relevance Scores are not inputs in the rating process; they are an observation on the relevance and materiality of ESG factors in the rating decision. For more information on ֳ's ESG Relevance Scores, visit .
Additional information is available on
PARTICIPATION STATUS
The rated entity (and/or its agents) or, in the case of structured finance, one or more of the transaction parties participated in the rating process except that the following issuer(s), if any, did not participate in the rating process, or provide additional information, beyond the issuer’s available public disclosure.
APPLICABLE CRITERIA
APPLICABLE MODELS
Numbers in parentheses accompanying applicable model(s) contain hyperlinks to criteria providing description of model(s).
- Country Ceiling Model, v2.0.0 (1)
- Debt Dynamics Model, v1.3.2 (1)
- Macro-Prudential Indicator Model, v1.5.0 (1)
- Sovereign Rating Model, v3.14.0 (1)
ADDITIONAL DISCLOSURES
ENDORSEMENT STATUS
| Hazine Mustesarligi Varlik Kiralama Anonim Sirketi | UK Issued, EU Endorsed |
| Turkiye | UK Issued, EU Endorsed |