Home Ratingové hodnotenia a Výskum Aktuálne platné ERA affirms BB rating to Turkey, outlook Stable
ERA affirms BB rating to Turkey, outlook Stable
Piatok, 12 Júl 2019

The unsolicited credit rating assigned to Turkey stems from sizable imbalances in the external and corporate sector, economic instability, high inflation, and a below average score in governance indicators, which are also demonstrated by concerns about the independence of the central bank. The assessment is positively affected by relatively low government debt levels.

Rating components

Macroeconomic factors

Economic factors

Low

Debt and current account sustainability factors

Moderate

Public finance factors

Moderate

Private finance factors

Moderate

Foreign exchange stability factors

Low

Liquidity factors

High

Final assessment

Moderate

Forward-looking factors

Political and economic stability

Low

Efficiency and reforms potential

Moderate

Final assessment

Low

Overall score

Moderate

Final rating

BB


Macroeconomic factors of rating assessment

Despite the contraction, Turkey’s debt levels remain low. The private sector and external position is undergoing a rapid adjustment after a period of strong imbalances. Risk stemming from high external and FX/denominated debt, however, remains sizable.


Economy is contracting following sharp depreciation of the Lira:

The Turkish economy is negatively impacted by the sharp depreciation of the Lira that took place in the spring and summer of 2018 resulting from high external imbalances, low credibility of the monetary policy, and FED tightening. The Lira lost almost 30% of its value against the dollar in 2018. In August, the year-to-date losses accounted for more than 45%. The depreciation has led to a sudden, sharp tightening of both foreign and domestic financial conditions (the central bank increased its one-week repo rate from 8% to 24%). Moreover, it has spilled over into higher inflation. In 2018, annual inflation increased to 16.3%, the highest since 2003 and far above the 5% inflation target. Inflation expectations had already been weakly anchored prior to depreciation, and the last time the central bank met its inflation target was in 2009.

Tighter financial conditions along with higher inflation, in turn, have caused a massive reversal in economic momentum, which had been fueled to a large extent by private credit expansion. GDP growth slowed from 7.4% to 2.6% in 2018 and is expected to turn negative in 2019. Both consumption and investment (mainly in construction) are in sharp contraction (-4.7% and -13% in the first quarter, respectively), while a weaker Lira provided a boost to exports, which grew 9.5% year-on-year.

Nevertheless, it was not enough to keep economic activity from contracting. Real GDP fell 2.6% y/y in Q1. The unemployment rate rose form less than 10% in Q2 2018 to above 14% in Q1 2019, the highest since 2009. The biggest losses have been recorded in the construction sector, where employment fell by more than 25% year-on-year in the first quarter.


Turkish Lira exchange rate against USD and consumer prices index (year-on-year change %)

Sources: TCMB, ERA


Survey indicators remain at low levels and point to ongoing weakness in the economy, which is also due to a worsening external environment. Nonetheless, the massive monetary tightening has been successful in stopping the depreciation of Lira and has thus laid the foundation for gradual economic stabilization. ERA expects the economy to start growing again next year after contracting 1.5-2.5% in 2019. But recovery will remain fragile given the imbalances in the private and external sectors and slowing global growth.

From the medium-term perspective, ERA sees the potential growth rate in the region of 3-4%. A positive impact will come from demographics, while subdued investments are expected to be a headwind. From the longer-term perspective, relatively lower R&D spending and weaker education scores will constrain growth.


Debt levels remain low, but share of FX debt increases:

Turkey entered the current recession with low debt levels. The general government debt to GDP ratio stood at 28.3% in 2017, far lower than in the early 2000s when it peaked above 75% of GDP. This reduction was achieved thanks to high nominal GDP growth (which has averaged 15% in the last 15 years) and relatively low deficits given high growth rates. In 2018, the debt to GDP ratio rose to 30.4% and ERA expects it to increase further.

The deficit target for 2019 at 1.9% is very optimistic given the shortfall of revenues resulting from negative pressure on the tax base and overspending compared to the target. ERA expects the deficit for 2019 to be between 3 and 4%, which should lead to a further increase in the debt to GDP ratio above 31%. Contingent liabilities related to the Credit Guarantee Fund, PPP projects, and other treasury guarantees account to almost 13% of GDP.

Although the debt levels are sustainable, some recent trends cause concern. The share of both external and foreign currency debt on the public debt have increased substantially as a result of devaluation and increased tapping of foreign debt markets. According to latest figures (May 2019), external public debt accounted for more than 45% of total debt and foreign currency debt for more than 50%. At the beginning of the decade these ratios were below 30%. Such development makes Turkey's debt more sensitive to foreign investors' sentiments.


Government external debt and foreign currency debt (% of total) for Turkey and peers (2018)

Sources: National Authorities, ERA


Private sector contraction had limited impact on banks' balance sheets:

The private sector is undergoing a sharp adjustment after years of credit fueled boom in the corporate sector. The debt of private non-financial companies to GDP roughly doubled to around 70% in early 2018 (before the currency crashed) compared to the beginning of the decade. This boom was financed to a large extent by debt from abroad; since 2010, the private sector external debt to GDP ratio rose from 25% to 40% and the corporate FX debt to GDP ratio from 23% to 41%. During this period, the credit to GDP gap was heavily positive (on average over 10% according to the BIS).

After a heavy tightening of financial conditions, this credit-fueled boom stopped. CPI-adjusted loan growth fell from over 10% y/y in 2017 to -9% in the first five months of 2019. As a result, private sector investment contracted. Ongoing tight financial conditions along with negative business sentiment are pointing to subdued investment activity in the short-term. IMF forecasts that investment to GDP could decline sharply from 29.2% to 24.5%. The household sector is also facing headwinds, home sales fell by 20% y/y in the first five months of 2019.

On the other hand, the banking sector has not been significantly affected yet. The NPL ratio rose from 2.9% in early 2018 to 4.1% in April and the system-wide core capital adequacy ratio fell from its peak of 14.7% in late 2018 to below 13%. Given the state of the economy, banking sector indicators are still relatively solid.

Nevertheless, the banking sector remains vulnerable. Further deterioration in banking system assets cannot be ruled out, especially in the case of a prolonged period of subdued growth or renewed strong selling pressure on the currency. Further risks stem from banks' reliance on external short-term funding and high corporate FX debt exposure.


Non-financial corporation debt to GDP ratio and its five-year change for Turkey and peers (2018)

Sources: BIS, ERA


Current account deficit is falling sharply, but external debt continues to increase

Turkey's external position underwent a sharp rebalancing following the depreciation of the Lira and contraction in domestic demand. The current account deficit fell from 5.6% to 3.6% of GDP in 2018 (the lowest since the 2009 crisis) and is expected to return close to balance in 2019.

On the other hand, the revaluation of foreign currency liabilities due to depreciation has increased the external debt to GDP ratio, which stood at 60.6% in Q1 2019, with almost 95% denominated in foreign currencies. Almost two-thirds of the external debt is owed by the private sector (30% financial institutions, 36% corporate sector), which is more prone to losing access to foreign markets for refinancing.

To counter the selling pressure on The Lira, The Turkish central bank burned reserves at a strong pace. In 2018, the volume of foreign reserves dropped by 13.6% (USD 14.7 bln), the most since the 2001 crisis. While the import cover remains sustained given the collapse of imports (reserves can cover more than 5 months of imports), coverage of foreign currency external debt dropped close to 20%, the lowest since the early 2000's and below its emerging markets peers. In recent months, reserves have stabilized. Nevertheless, in the case of renewed selling pressure on the Lira (which cannot be ruled out), reserves may not provide an adequate buffer to counter this pressure.


Foreign exchange reserves to FX debt for Turkey and peers (2018)

Sources: World Bank, National Authorities, ERA


Forward-looking factors of rating assessment

Turkey demonstrates a declining trend in governance indicators. The main driver is decreasing political stability, but other indicators have also decreased somewhat. The independence of central bank is a source of concern, which makes the economy susceptible to future monetary shocks.


Governance indicators are in a downward trend:

Turkey has demonstrated considerable deterioration in governance indicators in recent years. All five indicators monitored by ERA have notched down since 2013. Most noticeably, the political stability and absence of terrorism indicator, which fell due to 2016 coup attempt, several terrorist attacks, and involvement in the Syrian conflict.

While the indicators of political and economic stability (aside from the aforementioned political stability and absence of terrorism indicator, rule of law and control of corruption also belong to this category) are below the global average, the indicators for reform capacity are slightly above the global average. This is also demonstrated by the fact that Turkey scores above average in global competitiveness indicators.

Another source of concern is the independence of the central bank, which failed to react in a timely manner to the 2018 selling pressure on the Lira and has thus worsened the monetary shock to the economy. Going further into history, the central bank's track record on keeping inflation close to its target is poor, which can also be attributed to the government's pressure for loose monetary policy. Failure to improve the independence of the central bank increases the risk of monetary and economic instability in the future.


Average of World Governance Indicators for Turkey (ERA score, 1-10):

Sources: World Bank, ERA


Outlook: Stable

The forecast has been assigned based on expectations of a soft landing of the global economy, stabilization of the domestic economy, and the gradual decline of inflation to pre-2018 levels.

The Stable outlook assumes that the rating will most likely stay unchanged within the 12-month horizon.


Key assumptions

• Gradual recovery from the current recession. Return to growth in 2020;

• Decline in inflation close to 10%;

• Soft landing of the global economy.


Potential outlook or rating change factors

A positive rating action may be prompted by:

  • The government's adherence to the enhanced policy of regulatory quality and CBRT independence;
  • Rebuilding reserve buffers;
  • Decrease in external debt and foreign currency debt of the private sector.


A negative rating action may be prompted by:

  • Renewed strong selling pressure on the Lira, causing further increase in inflation, revaluation of foreign exchange denominated liabilities and further depletion of liquidity reserves;
  • Longer period of subdued growth following the current contraction;
  • Substantial increase in the NPL ratio to levels restricting the banking sector's borrowing capacity.


Appendix 1. Peer-analysis materials


General government debt to GDP (%) 2018:

Source: IMF


General government fiscal balance to GDP (%) 2018:

Source: IMF

Appendix 2. Major sovereign indicators

Indicators

2014

2015

2016

2017

2018

2019_F

GDP, bln USD

934.1

859.4

863.4

851.5

766.4

735

GDP growth rate, %

5.2

6.1

3.2

7.4

2.6

-2.0

GDP per capita, ‘000 USD

12

10.9

10.8

10.5

9.3

8.9

Population, mln

77.7

78.7

79.8

80.8

82.0

83.0

Unemployment, year-average, %

9.9

10.3

10.9

10.9

11.0

14.0

Consumer inflation, year-average, %

8.9

7.7

7.8

11.1

16.3

14.5

External debt to GDP, year-end %

43.4

46.5

47.5

53.5

56.7

62

Public debt to GDP, %

28.8

27.6

28.3

28.3

30.4

31.5

Gross Domestic Investment to GDP, %

29.0

28.4

28.2

31.0

29.2

24.5

International reserves, bln USD

127.3

110.5

106.1

107.7

93.0

95.0

Trade balance, bln USD

-63.6

-48.1

-40.9

-60.0

-41.8

-3.6

Exports, bln USD

168.9

152.0

150.2

166.2

174.6

182.2

Imports, bln USD

232.5

200.1

191.1

225.1

216.4

185.8

Current account to GDP, %

-4.6

-3.7

-3.8

-5.6

-3.6

0


Appendix 3. List of material data sources

International Monetary Fund

World Bank

Bank for International Settlements

Eurostat

Turkstat

Central Bank of the Republic of Turkey

TR Ministry of Treasury and Finance


Regulatory disclosure

The unsolicited credit rating and outlook were issued in accordance with ERA methodology for sovereign entities in the version from July 4, 2018 (available at www.euroratings.co.uk, section Methodology). In the same section is a rating scale including an explanation of the importance of each rating category and a default definition. Information on the rate of historical failure is available at www.cerep.esma.europa.eu, and the explanatory statement of the meaning of those default rates is available at www.euroratings.co.uk (Regulatory Framework/Disclosure). This rating is issued as an unsolicited rating, i.e. was not initiated by the rated entity or a related third party. The rated entity did not participate in the rating process and the information and documentation for its development was obtained from publicly available sources in accordance with ERA methodology. ERA did not have access to the rated entity’s internal documents. ERA, in the context of routine care, verified all sources entering the rating process. ERA considers the scope and quality of the information entering the analytical process to be sufficient to assign a credit rating. The disclosure of the unsolicited rating and outlook was preceded by the approval of the Rating Committee. No actual or potential conflicts of interest have arisen. Since July 30, 2012, ERA has been a registered credit rating agency according to Regulation (EC) No 1060/2009 of the European Parliament and of the Council of September 16, 2009, on credit rating agencies. The rated entity was notified on July 9, 2019 and after the notification there were no changes or amendments in the rating. The rating was first released for distribution on January 18, 2019.

Download pdf:

Turkey_report.pdf


Approved by the Rating Committee:

Zuzana Hrebičková, Acting

Head of credit rating analysts

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