DBRS Assigns Long Term Foreign Currency Rating of BBB low Stable to the Republic of Turkey

DBRS Ratings Limited (DBRS) has assigned BBB (low) to the Republic of Turkey’s long-term foreign currency issuer rating and BBB to the long-term local currency issuer rating. The trend on both ratings is Stable. DBRS has also assigned a short-term foreign currency rating of R-2 (middle) and a short-term local currency rating of R-2 (high), both with a Stable trend.

Turkey’s ratings are underpinned by the country’s large and diversified economy with positive growth prospects, well managed public finances with moderate debt ratios, and relatively low household indebtedness. The ratings also reflect the flexibility provided by a floating exchange rate regime, deepening local capital markets and a sound banking system. However, the ratings are constrained by a large and persistent current account deficit and a high external debt which exposes the country to capital outflows. Furthermore, political and geopolitical uncertainties have the potential to generate instability.

From 2004 to 2012, the economy expanded at an average annual rate of 5.0%. After growing well above trend in 2010 and 2011 at 9.2% and 8.8%, respectively, the Turkish economy decelerated to a more moderate growth rate of 2.2% in 2012. Growth became more balanced, as domestic demand and imports decelerated on the back of tighter monetary and macro-prudential policies implemented in 2011- 2012, while exports continued to perform well thanks to successful diversification towards new markets.

It is DBRS’s view that the successful macroeconomic adjustment accomplished without a recession whilst maintaining a robust trade performance is a demonstration of Turkey’s improved economic resilience. GDP is set to grow 3.4% in 2013 and 3.8% in 2014, supported primarily by domestic demand offsetting a slowdown in net exports.

Turkey's sound public finances underpin the ratings. Budgetary restraint has led to a reduction of the government budget deficit to 2.0% of GDP in 2012 from 5.5% in 2009 and lowered the debt burden to moderate levels with government debt as a percentage of GDP declining to 36.1% in 2012, down from 46.1% in 2009. As per the government latest forecasts for 2013 and 2014, DBRS expects the moderately expansionary fiscal stance to continue with budget deficits averaging 2.5% of GDP before narrowing to about 2% in 2014-15, reflecting a pick-up in economic growth and fiscal easing prior to the 2014 elections. Government debt to GDP is forecast to decline to 34% by 2017.

Sound debt management practices have reduced vulnerabilities including refinancing and exchange rate risk. The government has extended the domestic yield curve to 10 years, lengthened the average maturity of domestic borrowing to 5 years, and reduced the foreign currency denominated share of debt to 27%. Lower budget deficits have led to a lower projected total borrowing of 10.5% of GDP in 2013 from 15.8% in 2010. A well-functioning and deepening domestic capital market provides funding flexibility.

In addition, the rating is supported by the strength of the banking sector, thanks to reforms achieved following the 2001 crisis. Turkish banks had no direct exposure to the global mortgage markets during the 2008-09 global financial crisis. Turkey’s banking sector is well capitalized, with a capital adequacy ratio of 17.9% in 2012, strong profitability, and non-performing loans near historic lows. Although household debt increased during the rapid credit growth in 2011, it remains low at only 21.2% of GDP in 2012 and is held exclusively in local currency.

Despite these strengths, Turkey faces challenges stemming from its external finances. The current account deficit, albeit declining, remains high at 6% of GDP in 2012. The overall quality of the funding of the current account remains low, with foreign direct investment and long term inflows covering only 26.6% in March 2013 of the deficit and the rest being financed predominantly by portfolio inflows. The current account deficit is expected to widen to about 7% of GDP in 2013 which, together with maturing external debt payments, exposes the country to external shocks and resulting capital outflows, particularly given a rising short-term external debt burden.

DBRS believes however that the country's sound public finances, robust bank and household balance sheets, as well as policy flexibility provide important buffers against the propagation of shocks. Moreover Turkey did not suffer a sudden stop of capital during the 2008-09 financial crisis and was able to roll over debt and attract net inflows despite volatile external conditions. Structural reforms recently undertaken to channel existing savings into more productive uses, boost the savings rate and encourage domestic energy sources, such as the private pension reform and energy sector reforms, should also help reduce external imbalances over the medium to long term.

The Turkish economy is sensitive to developments on the global financial markets and has a track record of volatile GDP growth and inflation, due to its low savings rate and reliance on external funding. Inflation declined to 6.1% in April 2013, from 11.14% a year earlier, but remains above the central bank's inflation target of 5%. However, the floating exchange rate provides flexibility and monetary and macro-prudential policies have been effective in managing credit growth, helping the economy to adjust under challenging conditions of volatile capital flows and low interest rates in advanced economies.

Political risks weigh on the ratings. The upcoming local elections in March 2014 and presidential elections in the summer of 2014 could weaken the underlying fiscal stance if the economy were to slow more than projected. DBRS believes that overall increasingly stable domestic political conditions, particularly the possibility of a resolution of the ongoing Kurdish question, could reduce political risk. The Syrian civil war, which is having a negative economic and security impact on the border regions, remains however a key source of concern. So far the impact on the Turkish economy has been relatively contained with approximately 193,767 refugees, fleeing to Turkey at a cost of 0.08% of GDP to the budget and exports to Syria accounting for 1.5% of total exports in 2011.

The Stable trend reflects the sovereign’s improved resilience to economic, financial and political vulnerabilities. DBRS could raise the ratings if: (1) there is a sustained reduction of external imbalances while maintaining a stable macroeconomic environment, and (2) a reduction in political risk as a result of further progress on the resolution process of the Kurdish question leading to improved trade and fiscal performance. Conversely, potential risk factors that could result in a negative ratings action include: (1) rapid credit growth resulting in a further widening of the current account deficit, (2) a hard landing if capital inflows were to slow or reverse, and (3) a political shock with a substantial negative impact on the macroeconomic and fiscal outlook.

Notes:
All figures are in U.S dollars (USD) unless otherwise noted.

The principal applicable methodology is Rating Sovereign Governments, which can be found on our website under Methodologies. The principal applicable rating policies are Commercial Paper and Short-Term Debt, and Short-Term and Long-Term Rating Relationships, which can be found on our website under Rating Scales.

The sources of information used for this rating include the Central Bank of Turkey, Ministry of Finance, Turkstat, IMF and Haver Analytics. DBRS considers the information available to it for the purposes of providing this rating was of satisfactory quality.

Ratings assigned by DBRS Ratings Limited are subject to EU regulations only.

Lead Analyst: Giacomo Barisone
Rating Committee Chair: Alan G. Reid
Initial Rating Date: 23 May 2013
Most Recent Rating Update: 23 May 2013

For additional information on this rating, please refer to the linking document under Related Research.