Fitch Downgrades Turkey to 'BB'; Outlook Negative
13 JUL 2018 4:02 PM ET
Link to Fitch Ratings' Report(s):
Turkey - Rating Action Report
Fitch Ratings-London-13 July 2018: Fitch Ratings 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
Fitch 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 Fitch'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.
Fitch 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 Fitch'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. Fitch 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, Fitch 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. Fitch 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, Fitch 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 Fitch'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 Fitch expects it to continue to shrink until 4Q. Fitch'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 Fitch 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. Fitch placed 25 banks on Rating Watch Negative on 1 June reflecting heightened risks following increased market volatility.
