Fitch expects the economy to remain more volatile than investment grade peers, but believes sovereign creditworthiness has become more resilient to shocks. At some point, an external financing shock and a recession are likely. However, the agency believes the country’s strong sovereign, bank and household balance sheets, and economic and exchange rate flexibility provide important buffers against shocks spreading into a wider financial crisis.
Turkey’s public finances are a key rating strength. Government debt dynamics are favourable due to a low general government budget deficit, which Fitch forecasts at 1.9% of GDP in 2012 (not counting privatisation receipts) and trend GDP growth above the real interest rate. Fitch estimates the general government debt/GDP ratio will be 37% at end-2012, down 9pp since end-2009, while it projects the ‘BBB’ range median at 41% of GDP, up 7pp since 2009.
The government extended the average maturity of debt to 4.5 years in mid-2012 from 3.5 years in 2009, while reducing the FX share to less than 30%. Lower budget deficits and debt maturities have reduced Turkey’s gross fiscal financing requirement to a projected 9% of GDP in 2012 from 17% in 2010. A relatively deep local capital market supports financing flexibility.
Turkey’s sound banking system underpins the rating. It has a capital adequacy ratio of 16.3%, is moderate in size and has a low non-performing loan ratio of 2.8%. However, credit growth has been brisk in recent years (although it slowed to 14% in September 2012), raising the loan/deposit ratio to above 100%. Household debt is low at only 18% of GDP.
Favourable growth prospects support the credit profile. Turkey’s potential growth rate of 4%-5% is boosted by demographic trends, an entrepreneurial culture and financial deepening. It improved its ranking to 43rd (out of 144) in the World Economic Forum’s latest competitiveness league table, up from 59th in 2011/12. GDP per capita is above the ‘BBB’ median. Turkey also outperforms the peer median on four out of six of the World Bank’s governance indicators.
Nevertheless, Turkey’s external finances remain a key rating weakness. Fitch forecasts the CAD at USD58bn (7.3% of GDP) in 2012, albeit down from USD77bn (10%) in 2011. The agency forecasts it to remain at USD63bn (7.2%) in 2013 which, together with maturing external debt payments, exposes the country to shocks to global liquidity. Nonetheless, foreign exchange reserves (including gold) have increased by USD24bn year to date to USD112bn and Turkey did not suffer a sudden stop to capital inflows during the Lehman or eurozone crisis stress tests. Turkey’s net external debt/GDP ratio is likely to trend up gradually over the forecast horizon.
Turkey also has a track record of volatile inflation and GDP growth, reflecting its low savings rate and dependence on external financing, as well as domestic policy management. Fitch forecasts inflation to decline to 7.4% at end-2012 and 6.5% at end-2013, from 10.5% at end-2011, but still well above the central bank’s inflation target of 5%. Although the new policy framework has traction and has helped to rebalance the economy under challenging conditions, it has failed to hit the inflation target and has been relatively discretionary and unpredictable.
The two-notch upgrade of the local currency IDR to ‘BBB’ opens up a one-notch uplift above the foreign currency IDR to reflect the sovereign’s somewhat greater capacity to finance itself in Turkish lira than in foreign currency, due to its power of taxation, the strong banking system and deep local capital market. The lengthening in maturity of local currency debt has further reduced its financing risks. The country’s relatively weak external finances also weigh less heavily on the local currency rating.
The main factors that could lead to positive rating action, individually or collectively, are:
- A material and durable reduction in the CAD, though Fitch does not anticipate this in the near term.
- A track record of lower and more stable inflation.
The main risk factors that could lead to negative rating action, individually or collectively, are:
- A ‘balance-of-payments crisis’ triggered by an external shock or a domestic policy mistake.
- A worse-than-expected increase in external debt ratios over the medium term, for example related to rapid credit growth and larger CADs.
- A major political shock with a material adverse impact on the economic and fiscal outlook.
The ratings and Outlooks are sensitive to a number of assumptions.
- Fitch’s economic and fiscal projections are based on the assumption that budget outcomes are broadly in line with the Turkish government’s Medium-Term Program 2013-2015, consistent with a declining government debt/GDP ratio.
- Fitch assumes that the eurozone remains intact and that there is no materialisation of severe tail risks to global financial stability that could trigger a sudden stop to capital inflows to countries like Turkey with large CADs and net external debtor positions. Such a scenario would likely trigger a downgrade.
- Some escalation in regional instability cannot be discounted and is within the tolerance of the rating. However, Fitch does not expect the civil war in Syria to draw Turkey into a full-scale military conflict. If such an event took place and had a significant economic and fiscal impact it could lead to a downgrade.
- Fitch assumes that Turkey’s membership of the Financial Action Task Force (FATF) is not suspended in February 2013 (as FATF threatened in October 2012 if Turkey failed to “adopts legislation to remedy deficiencies in its terrorist financing offence” and “establishes a legal framework for identifying and freezing terrorist assets consistent with the FATF Recommendations”); or if it is suspended, that does not precipitate countermeasures that materially adversely affect the capacity of Turkish entities to access international financing. If such a downside risk materialised it could lead to a downgrade.