DBRS Downgrades Republic of Turkey to BB (high) Negative Trend

DBRS, Inc. has downgraded the Republic of Turkey’s long-term foreign currency issuer rating to BB (high) and long-term local currency issuer rating to BBB (low). DBRS has also downgraded the short-term foreign currency issuer rating to R-3 and the short-term local currency issuer rating to R-2 (middle). The trend on all ratings is Negative.

The one notch downgrade reflects the deterioration in the rule of law and rising geopolitical tensions, all in the context of Turkey’s large external financing needs. Reduced external funding poses clear risks to the macroeconomic outlook. Moreover, the failed coup attempt and its fallout could divert political attention from the much-needed structural reform agenda, which is important to boost national savings and reduce external imbalances. The Negative trend reflects DBRS’s view that risks remain skewed to the downside.

Turkey’s large external financing needs are a key source of vulnerability. Growth has been primarily driven by domestic demand, but with low national savings this has come at the expense of high current account deficits. Moreover, structural energy imbalances and dimming prospects for tourism are likely to keep the current account deficit elevated. Increasing external indebtedness by non-financial corporates has added to the buildup of imbalances. Gross external debt rose to US$412 billion (58% of GDP) in the first quarter of 2016. Consequently, Turkey faces a high annual external financing requirement of 27% of GDP. Despite demonstrated resilience in banking sector and non-financial institutions since 2011, given the low level of net foreign exchange reserves, sudden stops or a reversal in net capital inflows could have strong negative effects on the economy.

In this context, the deterioration in the rule of law and rising geopolitical tensions are a source of concern. Institutional checks and balances appear to have eroded with concerns about judicial independence and freedom of the press. The fallout of the attempted coup could accelerate these political trends.

In recent years, policymakers have acknowledged the need to rebalance the economy, increase domestic savings, and remove structural bottlenecks to boost productivity. Though the government has announced an Action Plan based on the 10th National Development Plan (2014-18) and some measures have been passed, attention to the reform agenda could be diverted by the recent political developments.

However, Turkey’s ratings are supported by several credit strengths, including the economy’s size and diversity. It is an upper-middle income country with nominal GDP of US$720 billion and a population of 78 million. Real GDP growth has averaged 4.8% since 2003, supported by favorable demographics and capital accumulation. Contributions from total factor productivity, on the other hand, have been comparatively weak.

Turkey has made significant progress in the area of fiscal management. Consistent primary surpluses have strengthened the public sector balance sheet. The public debt-to-GDP ratio has declined by more than one-half, from 77.9% of GDP in 2001 to 32.9% in 2015. Turkey has also improved its debt profile both in terms of composition and maturity, reducing the sensitivity of debt stock to liquidity, interest rate and exchange rate risks. However, Turkey remains vulnerable to risk appetite as 18.8% of government debt is held by non-residents at the end of May 2016.

Turkey’s banking system is well-capitalized despite bouts of market volatility over the last three years. The capital adequacy ratio for the sector is 15.5%, the quality of the capital is strong, and non-performing loans account for just 3.3% of total loans. Although banks’ external obligations have increased substantially, they have a neutral net foreign exchange position. However, banks are indirectly exposed to exchange rate risk through the corporate sector, which had a $192 billion net foreign exchange exposure in April 2016. In an adverse scenario of higher rates, currency depreciation and slower growth, bank profitability and asset quality could deteriorate.

RATING DRIVERS

The balance of risks is skewed to the downside. The ratings could be lowered if (1) our assessment of Turkey’s institutional quality continues to weaken, or (2) a sharp reduction in capital inflows has severe effects on the economy and financial system. On the other hand, the trend could change to Stable if institutional quality concerns subside, and policy actions are taken to facilitate a smooth macroeconomic rebalancing.

Notes:
All figures are in US dollars unless otherwise noted.

The principal applicable methodology is Rating Sovereign Governments, which can be found on the DBRS 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. These can be found on www.dbrs.com at:
http://www.dbrs.com/about/methodologies

The sources of information used for this rating include Central Bank of the Republic of Turkey, Ministry of Finance, Undersecretariat of Treasury, Turkish Statistical Institute, International Monetary Fund, World Bank, Haver Analytics, DBRS. DBRS considers the information available to it for the purposes of providing this rating was of satisfactory quality.

This rating was not initiated at the request of the rated entity.

The rated entity or its related entities did participate in the rating process. DBRS did not have access to the accounts and other relevant internal documents of the rated entity or its related entities.

Generally, the conditions that lead to the assignment of a Negative or Positive Trend are resolved within a twelve month period while reviews are generally resolved within 90 days. DBRS’s trends and ratings are under constant surveillance.

Lead Analyst: Rohini Malkani
Rating Committee Chair: Roger Lister
Initial Rating Date: 23 May 2013
Most Recent Rating Update: 21 July 2016

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