Fitch Ratings has affirmed Turkiye's Long-Term Foreign-Currency Issuer Default Rating (IDR) at 'B' with a Negative Outlook.
The agency says, that "Turkiye's 'B' rating reflects weak external finances, growing economic distortions due to increasingly interventionist and unconventional policies as well as political and geopolitical risks. These factors are set against Turkiye's large and diversified economy, relatively low levels of government debt and a manageable sovereign debt repayment profile.
The Negative Outlook reflects our view that Turkiye's expansionary and inconsistent policy mix, characterised by negative real rates and increasing use of regulatory measures and controls, will keep FX demand and depreciation pressures on the lira, weaken international reserves, maintain inflation at a high level, and weigh on the availability and cost of external financing."
Monetary Easing, Interventionist Policies:
The central bank lowered its policy rate to 8.5% in February, but authorities increasingly rely on targeted regulations to lower domestic financing costs, manage the allocation and pace of credit, to ease pressures on the lira by controlling FX demand, and reduce financial dollarisation. In Fitch's view, this policy approach could create vulnerabilities to the until now resilient banking sector by increasing its exposure to sovereign debt at negative real yields, and adversely impacting profitability and potentially asset quality.
Moreover, the increasing number and frequency of measures increases regulatory uncertainty and could exacerbate liquidity risks by undermining depositor confidence and/or reduce access to external financing.
High Inflation, Slowing Growth:
Annual inflation declined to 55.2% in February from a peak of 85.5% in October, benefiting from a favourable base effect and improved exchange rate stability since 2H22. We expect inflation to average 56.5% in 2023, among the highest of Fitch-rated sovereigns, reflecting the government's focus on supporting growth and employment and inflation inertia. Backward indexation, high expectations and additional lira depreciation remain upside risks.
Fitch forecasts GDP growth slows to 2.5% 2023, from 5.6% in 2022, with the negative impact of the February earthquakes on economic activity partly balanced by the fiscal and credit stimulus in the run-up to the May elections. We expect growth to increase modestly to 3% in 2024, due to improving external demand and the reconstruction process offsetting a less expansionary policy stance.
Renewed Pressure on Reserves:
After increasing to USD129 billion in 2022, gross international reserves have again come under pressure, declining to USD120 billion in early March. Although the Saudi Fund for Development recently agreed to deposit USD5 billion at Turkiye's central bank, the international reserve structure remains vulnerable, with the central bank's net foreign asset position significantly negative (minus USD57 billion) when excluding FX swaps. We forecast international reserves to decline to USD105 billion by end-2023, bringing reserve coverage of current external payments to 3.0 months, slightly below the forecast 'B' median of 3.2 months.
Reserve coverage is weak, given still high bank deposit dollarisation (42.2%; 58.7% when including FX-protected deposits) and large external financing requirements. FX protected deposits (USD84 billion in early March) not only create fiscal costs (0.6% of GDP on budget in 2022) and FX-linked contingent liabilities for the sovereign, but could also add to domestic FX demand in the event of reduced rollovers.
High External Financing Needs:
After expanding to 5.4% of GDP in 2022, the current account deficit will likely remain high (4.3% of GDP in 2023) despite lower energy prices due to policy stimulus. External debt maturing in 2023 amounts to USD190.2 billion, leaving Turkiye vulnerable to changes in investor sentiment. Net errors and omission reached close to 50% of the current account deficit in 2022, and limited visibility on their nature adds to the risk of additional pressure on international reserves.
Resilient but Costly External Financing:
There is a record of resilience in access to external financing for the sovereign and private sector. The sovereign has issued USD11 billion since October, including two issuances for USD5 billion in 2023. Turkiye faces external bond amortisations of USD5.7 billion and USD9.0 billion in 2023 and 2024, respectively. The private sector has also maintained access to external funding, although banks have reduced external funding, partly reflecting high costs and reduced demand for FX loans.
Low Deficits and Debt:
Turkiye's fiscal deficit declined to 0.9% of GDP at the central government level in 2022 (estimated 1.1% at the general government level), significantly outperforming the 3.5% budgeted target. We forecast that the general government deficit will widen to 4.4% in 2023 and 4.9% in 2024 due to the impact of weaker economic activity on revenue, fiscal stimulus in the electoral year, expenditure pressures related to high inflation as well as post-earthquake relief and reconstruction.
The policy challenge is for authorities to identify sources of financing without a significant additional build-up of sovereign exposure for banks or feeding inflationary pressures, and access external financing to avoid pressures on the already high external deficit and weak external liquidity.
Increased Fiscal Risks:
The combination of potentially higher interest rates, weaker exchange rate and high inflation could negatively impact the debt trajectory and fiscal balances. We estimate that general government debt declined to 31% of GDP in 2022, well below the 57% 'B' median estimate, reflecting high nominal GDP growth, a more stable exchange rate, negative rates in domestic financing and a primary surplus. The share of foreign-currency denominated debt at end-2022 remained high at 65.5%. Although the share of domestic debt subject to interest rate re-fixing within 12 months has declined since 2020, it also remains high at 58.4%.
Elections Approaching, Challenging Diplomatic Balance:
General elections (presidential and parliament) will take place on 14 May 2023. The six-party opposition alliance under the 'Table of Six' has named the head of the CHP party Kemal Kılıçdaroğlu as its presidential candidate. The management of the February earthquakes relief and reconstructions efforts has become a major factor impacting the electoral dynamics.
Political and policy uncertainty remain elevated due to high political polarisation, a potentially close electoral outcome, stark difference between the current government and opposition on the direction of economic policy, and implementation challenges. Policies post elections could also be influenced by the outcome of parliamentary elections, coalition politics and the run-up to local elections scheduled to take place in 2024.
Geopolitical Risks Remain:
Geopolitical risks remain sizeable. Turkiye has continued to play an active diplomatic role regarding the war in Ukraine, for example, by facilitating the extension of the 'grain corridor'. Although Turkiye has maintained its support for the territorial integrity of Ukraine, it has not joined in US and EU sanctions against Russia and has strengthened bilateral economic relations with Russia. Turkiye's objections to ratification of Finland and Sweden's NATO membership create another source of friction with the US and Western allies.
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, the agency reported on its website.
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