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.