“The crisis has raised investors’ premium for holding Turkish financial assets, refocused attention on Turkey’s large current account deficit and pushed the Turkish lira down to record lows against the US dollar.
These developments have not affected Turkey’s ‘BBB-‘ sovereign rating. Reliance on net capital inflows and consequent vulnerability to investor sentiment are well-established key ratings weaknesses. As we said when we affirmed the rating in October, they are mitigated by declining government debt ratios, a robust banking system, a relatively deep domestic capital market and a dynamic private sector.
The current crisis remains very fluid and has not yet had a material adverse impact on the macroeconomic outlook, which we identified as a rating sensitivity in October. However, further political and social unrest is possible ahead of this year’s local and presidential elections. If the corruption scandal drags on, it could weaken the government and undermine its ability to take timely policy measures that would maintain economic stability.
The lira has fallen to almost TYR2.2/USD, a drop of over 7% since mid-December, when Turkish prosecutors unveiled a corruption investigation that prompted three government ministers to resign. It is likely the lira would have fallen further were it not for central bank intervention. The CBRT has pledged to spend USD6bn to end-January to support the lira, which could reduce gross FX reserves to around USD107bn. This would partly reverse the improvement since last July, when central bank intervention and portfolio capital outflows pushed reserves down to around USD103bn.
With market perceptions of political risk showing no sign of abating, the CBRT will remain under pressure to raise interest rates, even while the authorities aim to maintain growth at 4% in 2014. To date, macroprudential measures have been insufficient to restrain the current account deficit and inflation (7.4% at end-December, well above the CBRT’s 5% target).
A rate rise that forestalled significant shortfalls in net capital inflows would lower the risk of a harsher-than-expected current account deficit adjustment that badly dented economic growth, which we forecast to slow to 3.2% in 2014 from around 4% in 2013. Conversely, CBRT FX market intervention cannot continue indefinitely and currency weakness poses a threat to Turkish corporates, which have heavy exposure to FX risk. As we said in October, we think the authorities will adjust policy settings to avoid a more disruptive economic shock.
Low World Bank scores for political stability have long been a feature of Turkey’s sovereign credit profile, and political risk weighs on sovereign creditworthiness. Similarly, the tensions between the government and judiciary resulting from the corruption investigation have put strains on institutional integrity. These factors are not incompatible with a ‘BBB-‘ rating, but they have the capacity to weaken sovereign creditworthiness.