According to Press Release by Fitch Ratings London dated 19 August 2016, Fitch Ratings has affirmed Turkey’s Long-Term Foreign and Local Currency Issuer Default Ratings (IDR) at ‘BBB-‘. The Outlooks have been revised to Negative from Stable. The issue ratings on Turkey’s senior unsecured foreign and local currency bonds have also been affirmed at ‘BBB-‘. The Country Ceiling has been affirmed at ‘BBB’ and the Short-Term Foreign and Local Currency IDRs at ‘F3’.
The issue ratings on Turkey’s Hazine Mustesarligi Varlik Kiralama Anonim Sirketi’s (Hazine) Foreign and Local Currency global certificates (sukuk) have also been affirmed at ‘BBB-‘.
KEY RATING DRIVERS
The revision of the Outlook on Turkey’s IDRs reflects the following key rating drivers and their relative weights:
An unsuccessful coup attempt in July confirms heightened risks to political stability. The authorities are responding to the coup attempt with a purge of the followers of those it blames, with around 70,000 public sector workers suspended so far. The scale of the purge generates uncertainty over capacity and continuity. The implications for checks and balances, which in Fitch’s opinion have eroded in recent years, are unclear, as is the potential for further disruption from those behind the coup attempt. The overwhelming public opposition to the coup attempt and subsequent unity of most political parties could lessen political fractures.
Security conditions have worsened outside of the context of the coup attempt. Terrorist attacks in Istanbul and Ankara have caused multiple fatalities. The removal of a large number of senior military officials may hinder the capacity to address ongoing security challenges, in Fitch’s opinion. The attacks are having a material impact on the tourism sector, which directly constitutes around 3% of GDP and 13% of current external receipts. Revenues from foreign tourist arrivals were down 41% yoy in 1H16. A diplomatic rapprochement with Russia should provide some support to the sector, but without a significant improvement in security conditions, a broad-based recovery is unlikely.
Political uncertainty is expected to impact economic performance and poses risks to economic policy. Growth is forecast to dip due to lower investment, although a strong start to the year means that at a Fitch-forecast 3.4% of GDP in 2016, it will be above the peer median. The prospects for significant structural reform that would shift the structure of growth from private consumption have diminished in Fitch’s opinion, although the government continues to progress with its more modest agenda. The central bank and commercial banks are facing renewed political pressure on interest rates. Fitch does not expect the fiscal stance to weaken in response to the coup attempt.
Turkey’s IDRs also reflect the following key rating drivers:
External vulnerabilities are large but long-standing and financing has been resilient in the aftermath of the coup attempt. The gross external financing requirement (including short-term debt) for 2016 is forecast at 186% of end-2016 reserves and the international liquidity ratio is 76%, around half the peer median. A few planned corporate issuances were postponed in the immediate aftermath of the coup attempt, but since then the syndication rollover rates by banks have ranged between 64% and 145% and the cost of funding has risen only marginally.
The current account deficit has continued to narrow due to the lagged impact of lower oil prices on the import bill, despite the drop in tourism revenues, and Fitch forecasts it to bottom at 4.3% of GDP in 2016, before rising to close to 6% of GDP by 2018. Funding remains largely debt-based, although maturities continue to rise gradually. As a result, net external debt is forecast to rise from 35% of GDP (BBB median 5.8%) at end-2015 to 39.3% of GDP by end-2018 (double the end-2010 level). Reserves increased by 10% over 1H16 due to the lower current account deficit and a fall in central bank FX sales and are forecast to end the year equivalent to 6.5 months of current external payments, a ratio that is forecast to decline to 5.8 months by 2018 as imports rise. Net reserves are around one-third of gross reserves.
Headline fiscal performance has remained solid this year, with a central government primary surplus of 1.3% of projected full year GDP in 1H16, despite the implementation of spending commitments made at the late-2015 election (most of which are one-off). However, this was supported by one-off receipts worth around 1% of GDP and lower capex. Fitch expects a small primary deficit this year, but debt/GDP is forecast to fall to 32.2% at end-2016, compared with a peer median of 40.2%. Security spending and refugees pose expenditure pressures. Fitch assesses the fiscal restraint in the face of multiple political events as impressive compared with rating peers and highlights the importance of the fiscal anchor to the government.
Average inflation has fallen so far in 2016, due to food prices, but at forecast 8.2% remains well above the peer median of 1.7%. Core inflation (CPI-I) was 8.7% in July, above the average cost of central bank funding. The central bank has narrowed the interest rate corridor by trimming the top end by a cumulative 200bps since March, although it points to a slowdown in credit growth as evidence of tighter financial conditions. Plans to continue to simplify the policy framework and improve communication could over time address risks around policy coherence.
The banking sector functioned smoothly through the coup attempt and deposit outflows were minimal. NPLs are 3.3% and capital adequacy, at 15.8% at end-June, is slightly above the peer median. The banking system is consistent with Turkey’s investment grade rating, with a ‘bbb’ on Fitch’s Banking System Indicator.
SOVEREIGN RATING MODEL (SRM) and QUALITATIVE OVERLAY (QO)
Fitch’s proprietary SRM assigns a score equivalent to a rating of ‘BBB’ on the Long-Term FC IDR scale.
Fitch’s sovereign rating committee adjusted the output from the SRM to arrive at the final LT FC IDR by applying its QO, relative to rated peers, as follows:
External finances: -1 notch, to reflect a very high gross external financing requirement and very low international liquidity ratio.
Fitch’s SRM is the agency’s proprietary multiple regression rating model that employs 18 variables based on three year centred averages, including one year of forecasts, to produce a score equivalent to a LT FC IDR. Fitch’s QO is a forward-looking qualitative framework designed to allow for adjustment to the SRM output to assign the final rating, reflecting factors within our criteria that are not fully quantifiable and/or not fully reflected in the SRM.
The following factors, individually or collectively, could trigger a a downgrade:
– Prolonged or deepened political instability, insecurity or geopolitical stresses that undermine economic performance or economic policy credibility.
– A materialisation of stresses stemming from external financing vulnerabilities.
– A reversal in the declining trend in debt/GDP or a worsening of external imbalances.
As the Outlook is Negative, Fitch does not anticipate developments with a high likelihood of triggering an upgrade. However, the following factors, individually or collectively, could lead to a revision of the Outlook to Stable:
– A more stable and predictable domestic political and security environment.
– Implementation of reforms that address structural deficiencies in the economy.
– Continued commitment to fiscal stability.
– Economic relations with key trading partners will not deteriorate seriously.
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