March 11, 2024 (MLN): Fitch Ratings has upgraded Turkiye's Long-Term Foreign-Currency Issuer Default Rating (IDR) to 'B+' from 'B' and a Positive outlook.

Key Rating Drivers

The upgrade of Turkiye's IDR and the Positive Outlook reflects the following key rating drivers and their relative weights:

High

Stronger Policies, Reduced Vulnerabilities:

The upgrade reflects increased confidence in the durability and effectiveness of policies implemented since the pivot in June 2023, including greater-than-expected frontloading of monetary policy tightening, in reducing macroeconomic and external vulnerabilities.

Inflation expectations have eased and external liquidity risks have moderated, reflected by more favourable external financing conditions, higher reserves, lower FX-protected deposits and a narrowing current account deficit.

The Positive Outlook reflects Fitch's expectation that Turkiye's overall macroeconomic policy stance should be consistent with a significant decline in inflation (albeit inflation will likely remain significantly higher than rating peers), as well as a continued reduction in external vulnerabilities in terms of lower current account deficits and stronger liquidity buffers.

Reduced External Liquidity Risks:

International reserves stood at $131 billion at the beginning of March, $32bn higher than June 2023.

Reserves declined in the first two months of the year, but in Fitch's view the decline is temporary and reflects reduced portfolio inflows, maturing FX-protected deposits, winter-related seasonality in external payments and some election-related uncertainty.

The structure of reserves remains weak, as the central bank's net foreign asset position (minus FX swaps) remains negative, at minus $62bn in early March, although this is an improvement from minus $76bn in June.

Fitch expects that lower current account deficits, sustained improvement in external financing conditions and some portfolio inflows will lift international reserves to $148bn at end-2024 and $159bn by end-2025, raising reserve coverage to 4.5 months of current external payments, above the 3.7 months projected for 'B' peers.

FX-protected deposits, which we view as a contingent claim on international reserves, declined to $77bn at end-February from $130bn at the end of August.

Policy Shift Makes Progress:

The central bank has tightened monetary conditions through a combination of larger-than-expected interest rate hikes to 45% (3650bp since June), absorption of excess liquidity through reserve requirements and deposit auctions, and targeted credit policies.

Inflation expectations have eased, and overall credit growth has slowed, but it remains high for household loans.

FX and FX-protected deposits declined to 56% of total deposits at end-February 2024 (down 13pp since June 2023), driven by lower FX-protected deposits.

Any premature easing of monetary policy or additional stimulus in terms of income or fiscal policy, although not expected, would undermine the benign effects of the policy adjustment given the high level of inflation and inflation expectations, and weakened monetary policy transmission mechanisms

Inflation Declines, but Remains High:

Fitch forecasts inflation to average 58% in 2024 and finish the year at 40%, above the central bank's intermediate target of 36%.

Fitch's base case assumes that a tight monetary policy stance in combination with strengthened consistency of fiscal, income and credit policies will bring inflation down to 29% in 2025, still multiples of the projected 'B' and 'BB' medians.

Medium

Lower Current Account Deficits:

As subdued external demand will dampen exports, the majority of the external deficit correction will come from lower consumer and gold imports due to slower domestic demand and the expected continuation of the policy rebalancing process.

The entity forecasts the current account deficit to fall to 2.6% of GDP in 2024, from 4.2% of GDP in 2023, while recovery in Turkiye's main trading partners, continued growth in tourism receipts and a relatively tight policy stance will lead the deficit to decline further to 2.2% of GDP in 2025, below the 2.6% projected for the 'B' median.

Total external debt maturing over the next 12 months was $226bn at end-2023, leaving Turkiye vulnerable to changes in investor sentiment. There is a record of resilience in access to external financing for the sovereign and private sector.

Turkiye's 'B+' IDR also reflect the following key rating drivers:

Wider Deficits, Low Debt:

The central government budget deficit rose to 5.2% of GDP, the largest since 2009, but below the 6.4% budgeted projection.

As earthquake-related spending reached an estimated 3.6% of GDP in 2023, the government comfortably met its objective to maintain an underlying central government deficit (without accounting for earthquake reconstruction costs) below 3% of GDP.

Fitch forecasts that the central government budget deficit will remain roughly stable in GDP terms at 5.2%, as we expect that year to be the main year for earthquake reconstruction (projected at 2.6% of GDP), before declining sharply to 3% of GDP in 2025 as reconstruction costs fade.

It further estimates that general government debt declined to 30.4% of GDP in 2023, as high nominal GDP growth and negative real government yields in the domestic market outweighed higher borrowing and significant lira depreciation.

Moreover, debt is expected to remain relatively stable, but interest payments to increase (10.3% of government revenues in 2025), as the share of debt subject to interest rate re-fixing within 12 months is high at 54%.

Despite increased issuance of local-currency debt and repayment of foreign-currency debt issued in the local market, the share of foreign-currency denominated debt remained high at 64% in 2023.

Growth to Slow Down:

Growth was resilient at 4.5% in 2023, but we expect that a tighter policy mix weighing more forcefully on domestic demand and private consumption after 1Q24, combined with relatively weak external demand, will result in growth slowing to 2.8% in 2024.

Growth could then pick up slightly to 3.1% in 2025 on improved growth prospects for Turkiye's main trading partners.

Local Elections, Geopolitics:

The agency’s base case assumes that the outcome of the local elections in March will not lead to a policy reversal.

Governance indicators, as measured by the World Bank, have weakened continuously over the past decade and represent a weakness relative to 'B' and 'BB' peers.

The volatile regional environment and the efforts to maintain an active and independent foreign policy bring geopolitical challenges, but these are not expected to affect the rating in the near term.

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 33rd percentile reflecting 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 Sensitives

Factors that Could, Individually or Collectively, Lead to Negative Rating Action/Downgrade

-Macro: Failure to maintain a policy mix consistent with reducing risks to macroeconomic and financial stability, including through a significant decline in inflation.

-External Finances: Failure to improve the level and composition of international reserves, for example, as a result of reduced market confidence in the commitment to consistent macroeconomic policies.

-Structural Features: Deterioration of the domestic political or security situation or international relations that affects the economy and external finances.

Factors that Could, Individually or Collectively, Lead to Positive Rating Action/Upgrade

-Macro: Evidence of sustained progress in Turkiye's disinflation process and greater confidence that the current policy normalisation and rebalancing process will lead to a sustained decline in inflation.

-External Finances: Sustained strengthening in external buffers, for example due to increased capital inflows, which in turn leads to improvements in the level and composition of international reserves and reduced dollarisation.

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Posted on: 2024-03-11T10:51:10+05:00