New York, March 17, 2017 — Moody’s Investors Service (“Moody’s”) has today changed Turkey’s rating outlook to negative from stable. Moody’s has also affirmed Turkey’s government debt and issuer ratings at Ba1 and shelf ratings at (P)Ba1.
The change in the rating outlook to negative captures a combination of inter-related drivers:
– The continuing erosion of Turkey’s institutional strength;
– Its weaker growth outlook;
– Heightened pressures on Turkey’s public and external accounts;
– And in consequence, the increased risk of a credit shock.
The affirmation of Turkey’s Ba1 rating reflects the government’s high economic and fiscal strength, which continues to provide a buffer against the risks posed by its diminished institutional strength and high external vulnerability; and the economy’s intrinsic dynamism, which Moody’s would expect to be revitalized if structural reforms were enacted as intended and political uncertainty was reduced.
Concurrently, Moody’s has affirmed the Ba1 senior unsecured bond rating of Hazine Mustesarligi Varlik Kiralama A.S., a special purpose vehicle wholly owned by the Republic of Turkey. The outlook was changed to negative from stable.
Turkey’s country ceilings remain unchanged at Baa2/Prime-3 (foreign currency bonds), Ba2/NP (foreign currency bank deposits) and Baa1 (local currency debt and deposits).
RATIONALE FOR CHANGING TURKEY’S RATING OUTLOOK TO NEGATIVE FROM STABLE
Since Moody’s last rating action in September, domestic and external pressures on Turkey’s credit profile have risen materially.
The tense domestic political environment following last July’s failed coup has persisted for longer than expected, a situation that the referendum on April 16 to centralize executive powers within the presidency is unlikely to alter given the large divide between the ruling Justice and Development (AK) Party and the opposition over the proposed constitutional changes. The actions taken to reduce various forms of opposition to the government since July last year have undermined the country’s administrative capacity and damaged private sector confidence.
Partly as a consequence, Turkey has experienced a further slowdown in growth. While Moody’s expects the particularly poor economic performance registered in the third quarter of 2016 to be temporary, the impact of ongoing political and geopolitical tensions on domestic confidence, and the heightened external pressures that led to a steep depreciation of the lira and high inflation, will suppress growth in the near-term relative to expectations last year. Over the longer term, potential growth will remain relatively low by historical standards in the continued absence of the structural economic reforms originally planned, such as in the labor market, to boost sagging productivity.
The authorities’ policy response has focused primarily on supporting short-term economic activity and has increased moral hazard. The central bank has relaxed macro-prudential rules in order to stimulate credit growth, reversing measures undertaken in 2012-2014 to restrain growth in household debt. The authorities have encouraged banks to increase lending, to restructure payment schedules and to allow companies to repay foreign currency-denominated loans in Turkish lira at a favorable exchange rate. And the central bank has held its key policy interest rate negative in real terms in the face of rising inflationary pressures (with inflation exceeding the 5%±2% target), primarily it seems to avoid increasing financing pressures on domestic firms. Moody’s believes that such measures risk increasing macro-economic imbalances, while failing to address the fundamental structural issues impeding growth.
According to Moody’s, weaker growth is negatively impacting Turkey’s key credit anchor — its healthy public finances and low government debt. The government has taken a range of measures to mitigate the domestic impact of the sluggish economy, including providing wage subsidies to firms and postponing the due dates for their tax and social security payments. Stopping such support will be difficult since the factors weighing on consumption and investment, such as higher inflation and interest rates and declining productivity, are structural rather than cyclical. Moody’s expects the increase in government spending to continue into 2018, the fiscal deficit to widen and bond yields to continue to rise, with adverse implications for Turkey’s debt metrics.
Turkey’s external vulnerability is a long-standing credit weakness, but has been accentuated in recent months by a number of factors. While some, such as rising US interest rates, are external to Turkey, most reflect domestic developments that have undermined domestic and foreign investor confidence, or geopolitical considerations, such as terrorist attacks, that have had significant adverse consequences for tourism. The lira has weakened sharply, with capital inflows intermittently insufficient to finance the current account, eroding the central bank’s already weak foreign exchange reserve buffer. As a consequence, Turkey’s External Vulnerability Indicator remains elevated at an estimated 202% in 2017, well above the 50% level seen in most of Turkey’s emerging market peers. The depreciation has exacerbated the corporate sector’s already large foreign currency debt service costs at a time when profitability is being squeezed by high inflation and rising interest rates. With a sizeable share of banking system loans denominated in foreign currency, domestic banks’ asset quality is also under pressure, although the banks’ capital buffers remain relatively healthy.
RATIONALE FOR AFFIRMING TURKEY’S Ba1 ISSUER RATING
In all of these respects, the pressures on Turkey’s credit profile have risen since the last rating action. However, the sovereign retains some important credit strengths that mitigate these pressures and that continue to support a Ba1 rating.
Turkey’s key strengths include its large size and its flexible, middle-income economy, which benefits from favorable demographics, specifically its relatively young population, and diverse trade linkages. These factors continue to support a potential growth rate of about 3.3%, according to the IMF. The government’s fiscal deficit, debt and debt affordability metrics remain materially stronger than most similarly-rated peers. Furthermore, as a result of a proactive debt-management strategy, debt maturities have been lengthened and debt is largely issued at fixed rates. This structure has helped to soften the pass-through of the lira weakness to the government’s debt metrics and debt affordability.
WHAT COULD CHANGE THE RATING UP/DOWN
Potential upward movement in Turkey’s issuer rating is constrained by balance-of-payments pressures as long as external imbalances and refinancing requirements remain large. However, upward rating pressure could materialize in the event of structural reductions in these vulnerabilities or material improvements in Turkey’s institutional environment or competitiveness. Reductions in political risk emanating either from the geopolitical or domestic political environment, while credit positive, would not result in upward rating actions in the absence of sustainable improvements in external vulnerability although such developments could lead to a stabilization of the rating outlook.
Turkey’s sovereign rating would likely be downgraded if there is a material increase in the probability of a balance of payments crisis. Such an event would likely be associated with some combination of a rapidly falling exchange rate, a sharp further reduction in reserves or sustained capital outflows. Sustained lower growth and a related worsening in the government’s fiscal strength could also precipitate a downgrade, as could a further erosion of institutional strength.