Turkey Outlook Upgraded at S&P

S&P upgraded Turkey’s outlook from negative to stable with a maintain a credit rating of BB which is two notches below the investment grade, citing government policy gradually refocusing on measures to reduce external vulnerabilities. Here we list key takeaways from the report:

  • Accepting that it would have a minimal impact, mandatory enrollment of employees aged under 45 in the Private Pension System is considered as an indicator of positive intent.
  • Attempts to cut the bill for imported energy are important to the credit rating agency regarding the external balances.
  • S&P believes that the government’s reform agenda also targets improving educational standards, increasing labor market flexibility and female participation in the workforce, and reducing the size of Turkey’s sizable informal economy, however, the implementation of this ambitious program of reforms competes to some extent with the president’s intention to bring about constitutional change with the end goal of achieving an executive presidency
  • S&P has lowered its estimate of Turkey’s gross external financing requirement for 2016-2019 to close to 170% of current account receipts plus usable reserves, from close to 185%, largely due to the lengthening average maturity of Turkish external debt (which we believe is very important).
  • S&P views Turkey’s banking system as generally well capitalized and supervised, noting the size of state-owned banks being relatively large and foreign currency funding represent risks (if their hedges do not hold, due to counterparty risk, or because of the second-round effects of the large open foreign exchange position in the corporate sector on banks’ asset quality).
  • S&P could lower its ratings if Turkey’s fiscal performance and debt metrics deteriorate beyond expectations, or if political uncertainty contributed to further weakening in the investment environment or tightening global policy rates intensified balance-of-payment pressures.
  • S&P could raise its ratings if sustained rebalancing of the source of economic growth led to much lower external borrowing needs.

The following shows the changes in S&P Global’s estimates on Turkey for the 2016-2019 period.


Turkey: Debt on the Radar Again

In a widely expected and almost inevitable move, Moody’s downgraded Turkey’s sovereign rating by one notch to Ba1 (junk level) on Friday, quoting the increase in the risks related the country’s external funding requirements and the weakening in previously supportive credit fundamentals, particularly growth and institutional strength as the driver of the decision. Turkey is now only rated at IG only by Fitch, who already lowered the outlook on its rating to negative last month.

Rating downgrade marked the end of three years of EMBIG IG conclusion of Turkey which represented 7.4% of the EMBIGD IG. We will see more forced selling by the pension funds at the remainder of this year, however, based on experience, losing IG is not capable of being a market driver in the long-run, and still, global policy remains highly accommodative, keeping an adjustment a long way off. On the other hand, we do not believe that Turkey would regain its IG anytime soon. We are also of opinion that we are in the initial phase of a downgrade cycle in emerging economies as we expect to see cuts in South Africa, Philippines.

Not surprisingly, the decision will bring Turkey’s debt on the radar, again, which, in fact, has been the weak link of the economy. Turkey’s debt has been rising rapidly and now stands at more than 120% of GDP. In particular, the corporate sector is really concerning where debt has risen by $315 billion since 2007, or by more than 40 ppts of GDP. The corporate sector is where concerns lie as public sector debt is not the issue. The government managed to de-lever through this period while non-financial firms levered up rapid in the post-financial crisis period and borrowed heavily in hard currency, creating a large short-FX position. Also, when compared to the CEEMEA peers, Turkey cannot be considered as an under-levered economy.

Turning into banks, fortunately, Turkish lenders calculate risk-weighted assets in accordance with the ratings that Fitch provide who still rates Turkey at IG. But, another rating downgrade is also very likely there, which eventually increase risk weighted assets leading higher capital burden. Turkish banks will also face higher cost of external funding at around 40-60 bps which would also hit profitability systemwide.

But we’d like to put some emphasis on Turkish banks’ FX-denominated asset-liability management. According to the data released by the official regulator, Turkish banks have a net FX position deficit of $11.5 billion which is closed by derivatives. Compared to the deficit of $45 billion recorded in late 2014, the recent figure seems manageable. Thus, a FX mismatch for banks seems quite unlikely unless…


Still one big question remains as to how bank allocated their FX assets. The chart below shows that the share of loans increased from 58% to 73% in six years following the financial crisis, also demonstrates the funding source of Turkish corporates where the real concerns lies related to FX liabilities.


So the sentence left unfinished would end with worries about the asset quality. Turkish bank entered a period of deleveraging but NPL generation has still been strong, more than doubling the loan growth.

On the macroeconomic front, more specifically on the implications for CBRT’s monetary policy, we still continuation of rate cuts of 25 bps both on upper and lower parameters of the interest rate corridor which would end up with a symmetrical rate base (7%-7.5%-8%). This, we believe, should be the end of normalization process and easing cycle. In order to keep growth high, CBRT will use other tools such as RRR cuts. Also, some fiscal easing may be in place to support the economic activity.

Turkey: Outlook Revised to Stable at S&P

Standard & Poor’s revised its outlook Turkey to stable from negative and affirmed its BB+ FC and BBB- LC sovereign credit ratings after the close of the market on Friday. The action was a positive surprising as it came amid concerns around Turkey’s political outlook taken to a higher level with the ouster of PM Ahmet Davutoglu. The credit rating agency downgraded sovereigns such as Poland, citing risks related to institutional stability.

The change at the top of the government should not be a game changer for Turkish politics in the short-term since Davutoglu had mostly felt into line with President Erdogan during his tenure. Still, this would keep Turkey’s governance mechanism open to dispute and harm Turkey’s accession process to the European Union while negotiations over visa-free pass going on which was supposed to mark a milestone in the history of country. Also, one would expect that steps toward a constitutional reform are to be taken faster than expected.

Turning back to the upside revision of S&P, the action has been primarily driven by a change in S&P’s assessment for Turkey’s debt burden as the credit rating agency believes that risks to the roll-over of its external debt have moderated. Having said that, the economic performance of the country has proven to be resilient by posting a higher-than-expected GDP growth of 4% despite to a number of challenges including, the busy electoral calendar in 2015, the end of the peace process with the PKK, heightened regional instability, and weak investor sentiment toward emerging markets.

Interestingly, S&P does not see eventual constitutional reform leading significant policy changes such as intensification of intervention in the independence of Turkish central or nationalization of private sector banks. Since, we don’t even have any draft that frames a new constitution, it is hard to predict the implications for the economy. But for instance, in case of a completed transition towards a presidential system, most certainly only the President will be in charge of assigning the Central Bank Governor. This the most controversial point made in the S&P’s Turkey release.

Putting it in a nutshell, below is the comparison of the estimates of the credit rating agency in November 2015 and May 2016 which, in our view, is useful to understand the underlying dynamics of S&P’s rating process.

Turkey - S&P EstimatesThe next report will be released on November 4, 2016.