Turkey Foreign And Local Currency Ratings Affirmed; Outlook Stable. S&P Turkey Rating 2019

  • We forecast that output in 2019 will contract by 0.5% in real terms amid tight financing conditions and elevated inflation.
  • In our view, Turkey's response to financial, and balance of payments, pressures has so far been largely ad hoc, focused more on relieving symptoms rather than on resolving the fundamental economic vulnerabilities.
  • Nevertheless, we believe the authorities still have fiscal room to maneuver given comparatively low net general government debt.
  • We are affirming the foreign currency ratings on Turkey at 'B+/B' and the local currency ratings at 'BB-/B'. The outlook is stable.
On Feb. 15, 2019, S&P Global Ratings affirmed its unsolicited long-term 
foreign currency sovereign credit rating on Turkey at 'B+' and its unsolicited 
long-term local currency sovereign credit rating at 'BB-'. The outlook is 

We affirmed the unsolicited short-term foreign and local currency sovereign 
credit ratings at 'B'.

We also affirmed the unsolicited Turkey national scale ratings at 

The stable outlook reflects balanced risks to our ratings on Turkey over the 
next 12 months.

We could lower our ratings on Turkey if we see an increasing likelihood of 
systemic banking distress with the potential to undermine Turkey's fiscal 
position. Key indicators of this could include a rise in corporate loan book 
default rates in excess of our current forecast, difficulties rolling over 
banks' foreign funding, or domestic deposit withdrawals.

We could also lower our ratings if Turkey's economic growth weakens materially 
beyond our projections, for example through a combination of persistently high 
inflation and tight domestic financing conditions.

We could consider an upgrade if the government successfully devises and 
implements a credible and transparent economic adjustment program that 
bolsters confidence in Turkey's banks and economy, while reducing 
balance-of-payments risks and bringing inflation under control.

Our ratings on Turkey remain constrained by its weak institutions. There are 
limited checks and balances between government bodies, raising questions about 
Turkey's ability to address the challenging environment for its financial 
sector and broader economy. Following the June 2018 elections, power remains 
firmly in the hands of the executive branch, with future policy responses 
difficult to predict.

As capital inflows into Turkey dried up last year, the lira weakened 
substantially and the historically high current account deficit was forced 
into surplus. Imports fell notably as domestic purchasing power reduced in 
foreign currency terms.

Despite the current account shifting into surplus, we believe Turkey's 
balance-of-payments risks remain elevated and therefore constrain the 
sovereign ratings. This is principally due to the need to refinance a high 
stock of external private sector debt, which we estimate amounts to about 40% 
of 2018 GDP. The repayment schedule for this debt is front-loaded with almost 
half maturing in the next 12 months. We consider this a risk given what we 
view as only limited foreign exchange reserves at the Central Bank of the 
Republic of Turkey (CBRT).

The ratings remain supported by Turkey's comparatively low net general 
government debt burden, thanks to past economic policies. We think the 
government still has some fiscal flexibility that should help absorb the 
consequences of an ongoing economic adjustment. Nevertheless, a combination of 
support for public-private partnerships, weaker economic growth, and possible 
external deleveraging in the private sector could rapidly erode what today 
appears to be a sound public balance sheet.

Institutional and Economic Profile: Turkey will feel the consequences of the 
2018 currency crisis with output contracting and high inflation this year
  • We expect the Turkish economy to contract by 0.5% this year, although there are major uncertainties surrounding this forecast.
  • Weak growth dynamics are mainly due to domestic demand. Both consumption and investments will reduce while net exports make a positive contribution to growth.
  • Turkey's institutional environment remains weak, with limited checks and balances. Turkey is gearing up for the March 2019 local elections and we don't expect any reform or policy initiatives until these are over.
Turkey has entered a period of stagflationary adjustment and we expect GDP to 
contract by 0.5% in real terms in 2019. This will mark the first full-year 
output contraction since 2009. It follows a period of overheating of the 
domestic economy, which abruptly ended with the currency crisis in August 
2018. Even though financial market sentiment has improved and the lira has 
regained some ground since then, we still expect the consequences will weigh 
on Turkey's economic prospects in the near to medium term.

High-frequency indicators point to a pronounced slowdown in economic activity. 
According to Turkstat, the Turkish economy grew by 1.6% year-on-year in the 
third quarter of 2018, a major deceleration compared to 6.0% growth in the 
first half of the year. We estimate that the economy contracted by 2.5% in the 
final months of last year. Several indicators inform our view:
  • A decline in domestic orders of manufacturing firms in the fourth quarter of 2018;
  • Industrial production and PMI indices hitting multi-year lows;
  • Reduced consumer confidence; and
  • A substantial decline in imports.
We expect that domestic demand will remain weak and will be a major 
contributor to Turkey's weak growth performance this year. Following extreme 
currency volatility in 2018, inflation spiked--surpassing 25% in October 2018 
and marking a 15-year high. Even though it has now somewhat reduced, inflation 
remained above 20% in January 2019. As high inflation will erode incomes, we 
believe that consumption will likely decline by 2% this year. In our view, 
government initiatives to temporarily boost domestic demand through lower 
taxes will have only a limited effect. In addition, we believe that headline 
inflation likely underestimates the full impact on consumer purchasing power. 
For instance, food inflation exceeded 30% toward the end of 2018, straining 
the budgets of lower income households. 

We also forecast that investments--an important previous growth driver--will 
decline by 5% this year. The Turkish corporate sector remains in a short 
foreign-exchange position that the CBRT estimates at about 30% of GDP. 
Consequently, last year's pronounced exchange-rate weakening has increased the 
burden of servicing this debt. Combined with much tighter domestic financing 
conditions, partly due to CBRT interest rate hikes, there is limited scope for 
investment activity. Funding pressures are exacerbated by weak consumer 
demand, which limits firms' ability to pass higher prices to domestic 
consumers. Companies also face cost pressures, including a 26% hike in the 
minimum wage. 

Our base-case economic scenario, described above, is largely unchanged from 
six months ago and remains subject to considerable uncertainty. We currently 
project output contraction to be much milder than the 5% recession Turkey 
experienced in 2009. This is because, unlike 2009, external conditions are 
broadly favorable this time around with Turkey's trade partners forecast to 
continue growing. Net exports have so far supported economic dynamics, 
cushioning subdued domestic demand. Should growth in Europe decelerate or 
trade wars escalate materially, the adjustment for the Turkish economy could 
prove more painful. 

We also see some potential upside stemming from a more consistent government 
policy response to Turkey's economic challenges. This could happen after the 
March 2019 local elections. 

Beyond 2019, we believe Turkey's growth prospects could improve. We note that 
Turkey's economy is large and diverse, characterized by a highly flexible SME 
sector, a strategic geographic location, and a young and growing population. 
Some export-oriented sectors, particularly tourism, have been doing well 
recently because of competitiveness gains due to the weaker lira. 
Nevertheless, we expect recovery from the current downturn to be slower 
compared to pre-2018 growth rates. In our view, absent substantial reform 
momentum coupled with reduced political uncertainty, faster recovery will be 
difficult to achieve.

Turkey's institutional arrangements have eroded substantially in recent years 
and are a major constraint for the sovereign ratings. In last year's June 
presidential and parliamentary elections, the president and the Adalet ve 
Kalkinma Partisi (AKP)-led coalition secured a victory that was the final 
chapter in Turkey's transition to an executive presidential system. As a 
consequence, we expect the executive branch will dominate future 
decision-making, sidelining the few checks and balances that had remained in 
place, including, by potentially increasing, off-balance-sheet financial 

In our view, this high centralization of power has left Turkey ill-prepared to 
deal with the fallout from last year's balance-of-payments shock. We view the 
response so far to last year's currency crisis as ad hoc, rather than 
coordinated and consistent. The focus has been on addressing the symptoms, 
rather than the underlying causes, of Turkey's economic problems. The 
important exception to our assessment that the policy response has been 
reactive, rather than proactive, was the CBRT's decision to hike the one-week 
repurchase agreement (repo) rate by 6.25 percentage points on Sept. 13, 2018. 
We consider this move to have been instrumental in stabilizing the exchange 

Turkey has been in a constant electoral cycle over the last three years and 
remains so: local elections are coming up in March 2019. Given the likely 
tight race in at least some of the constituencies, including Ankara, we 
foresee possible further concessions to the electorate as the ruling AKP seeks 
to shore-up support. To this end, we note the government's decision to 
temporarily lower some taxes until the end of March 2019 alongside a hike in 
the minimum wage. We do not expect any major policy or structural reform 
initiatives until the local elections are over. We also do not anticipate that 
Turkey will sign up to an International Monetary Fund program, before or after 
the upcoming polls, except if far more difficult external financing conditions 

We continue to see risks stemming from Turkey's international relations. Even 
though interactions with the U.S. have improved following the earlier release 
of a detained U.S. citizen, multiple points of contention remain. U.S. policy 
toward Turkey has also become less predictable than in the past. Tensions 
between the two countries include Turkey's alleged role in allowing Iranian 
counterparties to evade American sanctions including by using state-owned 
financial institutions, the Turkish government's decision to purchase S-400 
surface-to-air missiles from Russia, and its open support of the regime of 
Venezuelan President Maduro, whom the U.S. has openly denounced.

Regional security also remains a concern. Apart from geopolitical 
repercussions, any deterioration could decrease tourism flows. This could 
happen if tensions in Syria were to escalate or if there was an increased 
domestic terrorist threat, for instance, due to Turkish military operation 
against the YPG in Syria. 

Flexibility and Performance Profile: Despite a turnaround in the current 
account, balance-of-payments risks remain elevated, but the government still 
has fiscal room to maneuver 
  • Despite the turnaround in the current account, balance-of-payments risks persist due to the sizable stock of external debt with a front-loaded maturity schedule.
  • In our view, the authorities still command fiscal space given that net general government debt was 26% of GDP at end-2018, which is favorable in a global comparison.
  • We forecast inflation to remain at a 15-year high, averaging 16% in 2019.
Last year's currency crisis notably affected Turkey's balance of payments. 
Following years of sizable deficits (averaging 5% of GDP in 2013-2017), the 
current account switched to a surplus in a matter of weeks in August 2018. 
This primarily reflects the substantial depreciation of the lira, which saw 
imports collapse. It also reflects the reduced availability of external 

Rather than a rebalancing, we view this as a forced disruptive adjustment 
pointing to a major contraction in domestic economic activity. Although the 
lira exchange rate had recovered some ground by end-2018, imports remained 
depressed and the current account continued to post monthly surpluses through 
November (latest available data). We note that sudden and pronounced swings in 
external flows from deficit into surplus have historically been associated 
with major economic contractions, not only in Turkey, but also in other 
regions and countries (Eastern Europe, Iceland, and elsewhere). 

Despite imports providing the main impetus behind the current account 
turnaround, export performance was a bright spot in 2018 with volumes growing 
by an estimated 7%. In 2018, tourism arrivals hit an all-time high. One major 
question for 2019 is whether the pace of export growth can continue, 
particularly if the economies of Turkey's West European trade partners exhibit 
a sharper deceleration than we presently anticipate. 

Despite a significant turnaround in Turkey's external flows, we still view 
balance-of-payments risks as elevated. This is mainly because years of past 
external shortfalls have led to a substantial increase in private sector 
external debt to 40% of GDP at the end of last year, from 25% in 2010. This 
accumulated debt is characterized by a front-loaded repayment schedule, with 
almost half maturing over the next 12 months. Of this, close to 60% pertains 
to the country's banking system.

We previously highlighted downside risks to banks' foreign debt refinancing 
(see "Turkey Long-Term Foreign Currency Rating Lowered To 'B+' On Implications 
Of Extreme Lira Volatility; Outlook Stable," published Aug. 17, 2018). 
Positively, and in line with our base case, banks were able to roll over much 
of their external debt coming due last autumn, even though the cost has risen 
substantially. According to CBRT estimates, the rollover ratio declined to 80% 
by the end of last year. That said, we understand that some banks did not 
refinance maturing debt, not because they lost market access but because 
credit demand was rapidly declining and the outlook for lending was weakening. 

We currently expect some deleveraging in the banking sector in 2019 with an 
external debt rollover ratio of 80%-90% for the rest of the year. Downside 
risks remain, for example if domestic residents lose confidence in the 
financial system or if foreign financing dries up, significantly reducing 
rollover ratios. If this happens, Turkey's economic adjustment will likely be 
more pronounced than the 0.5% output contraction we are currently projecting. 
The exchange rate would then likely further correct, while consumption and 
investment would sharply decline.

We view the CBRT's buffers to counter a potential deterioration in balance of 
payments as limited. Although headline foreign exchange reserves amounted to 
US$93 billion at the end of 2018 (12% of GDP), a large proportion pertains to 
the CBRT's liabilities in foreign currency to the domestic banking system. 
This reflects the required reserves on banks' foreign-exchange deposits as 
well as liabilities under the reserve option mechanism. The latter allows 
commercial banks to maintain some of their required reserves related to 
Turkish lira deposits in foreign currency. Excluding these, we estimate the 
CBRT's net reserves are a much smaller, US$40 billion (5% of GDP).

In contrast to the balance of payments, Turkey's fiscal position remains 
supportive of the sovereign ratings. Historically, the government ran 
recurrent fiscal deficits, but these have been contained, averaging only 
slightly higher than 1% of GDP over the last five years. We estimate that last 
year's deficit was 2.5% of GDP, lower than we previously forecast. We expect a 
mild widening of the deficit this year, mainly due to weaker economic growth. 
Nevertheless, shortfalls will remain contained at below 3% of GDP over the 
forecast horizon. Consequently, net general government debt should hover 
around 25% of GDP, which compares well globally. 

Beyond the headline figures, Turkey's underlying fiscal position has somewhat 
deteriorated in our view. We note that last year's stronger fiscal outturn was 
bolstered by a series of one-off revenue measures including the tax amnesty 
and the introduction of permission for citizens to opt out of military 
service, for a fee. This trend has continued in 2019. For example, the CBRT 
decided to bring forward the payment of a large dividend (1% of GDP). The CBRT 
made a profit in 2018 because foreign-exchange reserves were revalued in local 
currency terms, owing to the lira's depreciation. We also see risks from 
various potential government off-balance-sheet commitments, such as those 
stemming from public-private partnerships (PPPs). We understand the PPPs are 
administered by different government bodies and there are no consolidated 
published statistics. It is, however, unlikely that the maximum theoretical 
government exposure to PPPs and guarantees extended exceeds 10% of GDP. 

Despite the aforementioned risks, the government still has policy space to 
leverage the public balance sheet if needed, in our view. Such a need could 
arise, for example, if the government were called to support parts of the 
banking system through recapitalizing individual institutions or undertaking a 
broader sector clean-up by moving nonperforming assets to a "bad bank." In our 
view, risks to the stability of the Turkish banking system have risen 
substantially over the last 12 months. These stem from more difficult domestic 
and foreign financing conditions, and a likely deterioration in asset quality. 
We revised our assessment of contingent liability risks to the state from the 
banking system to moderate from limited in August 2018.

So far the authorities have not provided any concrete plans as to how they 
might deal with a deterioration in bank asset quality, although we understand 
that the "bad bank" option has not been ruled out. The New Economy Program 
published in September 2018 lacked specific details on resolving banking 
sector problems bar a reference to an asset quality review. Such a review was 
undertaken by Turkey's Banking Regulation and Supervision Agency (BRSA) in 
December, but the details have not been made public. Official nonperforming 
loans are around 4.5% of system loans, which we think underestimates existing 
credit risk. We forecast that problem loans will increase, rising to double 
digits over the next two years. 

In our view, Turkey's monetary policy has been historically ineffective in 
managing inflation. The CBRT has never met the 5% medium-term target that was 
introduced in 2012, while the real effective exchange rate has shown 
substantial swings. The CBRT has faced increasing political pressure in recent 
years, which in our view is impairing its effectiveness, often by delaying 
timely responses to rising inflation, which soared to 25% in October 2018 and 
has remained above 20% since then.

Although the CBRT has maintained the key repo at a very high 24% since 
September, questions remain over its future policy direction. We expect the 
CBRT to start reducing interest rates this year as inflation declines, but 
long before it approaches the target rate. In our view, political pressure for 
doing so will likely persist, particularly amid a slump in economic activity. 
We also note that the CBRT declared an extraordinary early dividend of Turkish 
lira (TRY) 33.7 billion (around 1% of GDP) payable to the Treasury. It remains 
unclear whether this payment could help fund additional short-term fiscal 
stimulus, but we anticipate that it could flatter headline fiscal data this 

The long-term local currency rating on Turkey is one notch higher than the 
long-term foreign currency rating. In our view, the floating exchange rate 
regime, comparatively developed local currency capital markets, and the fact 
that about 50% of government debt is denominated in local currency and almost 
entirely held domestically imply a lower default risk on Turkey's 
lira-denominated sovereign commercial debt compared to its foreign 
currency-denominated debt. This is also premised on our expectation that 
Turkey will continue to fund a large share of its financing needs in the local 
currency debt capital markets and that the process will be transparent and 
driven by market forces. 
We work across the world

From London to San Francisco, to our home base in (Saint Helier) Jersey, we’re looking for extraordinary and creative scientists to help us drive the field forward.

Disclaimers: AC Investment Inc. currently does not act as an equities executing broker or route orders containing equities securities. All data and information is provided “as is” for personal informational purposes only, and is not intended for trading purposes or advice. Please consult your broker or financial representative to verify pricing before executing any trade.

77 Massachusetts Avenue Cambridge, MA 02139 617-253-1000 pr@ademcetinkaya.com