Turkish bank shares rally on Moody's outlook revision and monetary policy shift

Operating conditions still 'volatile', weighed down by anticipated slowdown in Turkey’s economic growth and persistently high inflation, global credit rating agency says

A street market in Istanbul. Inflation in Turkey is expected to hit 58 per cent this year. AP

Moody's Investors Service revised the outlook for Turkey's banking sector to stable, but operating conditions are still “volatile”, weighed down by an anticipated slowdown in the country’s economy and high inflation.

The operating environment for banks in Turkey remains challenging but recent government steps to move away from unconventional policymaking could ease headwinds for lenders in the country, the rating agency said in a report on Tuesday

“Following the elections in May 2023, the government’s initial steps towards orthodoxy are supportive of operating conditions and we expect the unorthodox measures introduced in the period building up to the elections will be gradually unwound during our outlook horizon,” Moody’s analysts said.

“Although banks should benefit from a return to orthodox policy, we believe the potential for sequencing missteps in the process of unwinding macroprudential measures presents risks to baseline expectations for the operating environment, particularly GDP [gross domestic product] growth and exchange rate depreciation.”

The outlook revision by Moody's boosted shares of the nation’s lenders to all-time highs.

The Borsa Istanbul Banking Sector Index, a gauge that tracks shares of Turkey’s listed banks, reversed losses and rose as much as 4.1 per cent to the highest level on a closing basis on Tuesday.

Investors Service raised the Turkish banking system’s outlook to stable from negative, boosting the nation’s lenders to all-time highs.

Despite headwinds, the country’s B3 stable rating and Turkey’s strong exports and tourism sectors will continue to support growth despite the moderate slowdown in the first half of 2023, the rating agency said.

Moody’s expects Turkey’s economic growth to slow down, with real GDP expanding at 4.2 per cent in 2023, down from 5.6 per cent growth in 2022.

It expects inflation to stay high at 51 per cent in 2023, although down from 72 per cent recorded in 2022.

In July, Turkey’s new central bank governor Hafize Gaye Erkan pledged to stick with a “gradual” cycle of monetary tightening despite more than doubling the forecast for consumer price inflation to 58 per cent.

Her remit is to restore the credibility of the central bank in the eyes of the markets after years of unconventional measures championed by President Recep Tayyip Erdogan.

Last month, Turkey increased its policy rate by 250 basis points to 17.5 per cent, continuing to reverse Mr Erdogan's low-rates policy as it promised more tightening.

For the banking sector, however, asset quality risks will remain elevated, driven by lower consumer spending and weakened repayment capacity of borrowers amid high inflation, Moody’s said.

Turkish central bank governor Hafize Gaye Erkan is working to restore market confidence in its monetary policy. EPA

Banks’ profitability measured by return on average assets has cooled to 3 per cent in the first half of 2023, down from 3.7 per cent for the same period in 2022, as pressure on the sector’s core margin continues to build. However, overall profitability of banks is still strong.

“The cooling off is driven by the unwinding of the previous macroprudential measures and lower income from inflation-linked securities,” Moody’s analysts said.

The funding profile of Turkish lenders has also improved amid strong liquidity, however, downside risks remain.

“Despite economic volatility, Turkish banks' funding and liquidity positions improved markedly, particularly in foreign currency,” Moody’s said.

The loan-to-deposit ratio improved to 93 per cent in December 2022 from 97 per cent a year earlier, building on a trend running since 2018.

“Banks have also reduced their reliance on short-term wholesale foreign funding to $56 billion in February 2023 from $75 billion in December 2018 while maintaining foreign currency liquid assets at around $100 billion.”