Fitch: Turkey Rate Rise Shows Responsiveness, Risks Remain

Thu Jul 25, 2013 11:36am EDT

LONDON, July 25 (Fitch) The increase in the Central Bank of Turkey's (CBT) overnight lending rate signals the Turkish authorities' greater readiness to address the risks presented by currency weakness, high inflation, and falling capital inflows, Fitch Ratings says. However, Turkey is still vulnerable to shifts in market sentiment, its external finances remain a key sovereign rating weakness, and balancing growth, price and exchange rate stability concerns present a policy challenge. Balance of payments data indicate that Turkey suffered a halt to capital inflows in May, with portfolio debt flows recording a minor outflow compared to a net inflow of USD8.9bn in April. Net capital inflows are essential to economic growth in Turkey: a current account deficit of 6-7% of GDP mirrors a comparable imbalance between savings and investment. With the current account deficit showing signs of renewed widening this year, following last year's narrowing, declining capital inflows represent a greater near-term potential risk to Turkey's economy than the possibility that tighter monetary policy constrains domestic demand. Favourable economic growth prospects support Turkey's sovereign credit profile. GDP increased by 1.6% in the first three months of this year from the previous quarter, and data on industrial production and imports suggest that Q213's reading could also be strong. The CBT had been intervening in the currency markets to defend the lira, which hit an all-time low against the US dollar earlier this month, but Turkey's international liquidity ratio is weak and it does not have a sufficient stock of FX reserves to maintain this strategy for long. We estimate that reserves may have dropped from a peak of USD114bn (excluding gold) in April to around USD100bn in mid-July, reflecting both central bank intervention and portfolio capital outflows. The sharp drop in net capital inflows, currency depreciation, and fall in international reserves remain within the tolerance of Turkey's 'BBB-' rating. However, recent developments serve to highlight Turkey's vulnerability to shocks against a background of domestic political and social unrest and volatile investor sentiment towards emerging markets in general, as speculation about the eventual withdrawal of quantitative easing continues. As we have previously said, persistent political and social unrest could deter tourism, destabilise short-term capital inflows, push up inflation and damage economic growth. Although the CBT's still relatively new monetary policy framework has traction and has helped to rebalance the economy under challenging conditions, it has failed to hit the inflation target of 5%, suggesting that up until recently supporting growth may have taken priority over price stability. Credit growth has remained elevated and inflation rose to 8.3% year-on-year at the end of June, up from 6.5% in May. The CBT raised the overnight lending rate for the first time in nearly two years, to 7.25% from 6.5%, while leaving the one-week repo rate unchanged. The Monetary Policy Committee's statement said that a "cautious stance will be maintained until the inflation outlook is in line with medium term targets... additional monetary tightening will be implemented when necessary." We upgraded Turkey to 'BBB-' from 'BB+' in November. The Outlook on the rating is Stable. Contact: Paul Rawkins Senior Director Sovereigns +44 20 3530 1046 Fitch Ratings Limited 30 North Colonnade London E14 5GN Ed Parker Managing Director Sovereigns +44 20 3530 1176 Mark Brown Senior Director Fitch Wire +44 20 3530 1588 Media Relations: Peter Fitzpatrick, London, Tel: +44 20 3530 1103, Email: peter.fitzpatrick@fitchratings.com. The above article originally appeared as a post on the Fitch Wire credit market commentary page. The original article can be accessed at www.fitchratings.com. All opinions expressed are those of Fitch Ratings. ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: here. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEBSITE 'WWW.FITCHRATINGS.COM'. PUBLISHED RATINGS, CRITERIA AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. FITCH'S CODE OF CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL, COMPLIANCE AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM THE 'CODE OF CONDUCT' SECTION OF THIS SITE. FITCH MAY HAVE PROVIDED ANOTHER PERMISSIBLE SERVICE TO THE RATED ENTITY OR ITS RELATED THIRD PARTIES. DETAILS OF THIS SERVICE FOR RATINGS FOR WHICH THE LEAD ANALYST IS BASED IN AN EU-REGISTERED ENTITY CAN BE FOUND ON THE ENTITY SUMMARY PAGE FOR THIS ISSUER ON THE FITCH WEBSITE.

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