Fitch downgrades Turkey deeper into junk on 'spiralling inflation'

Increasingly interventionist policies to reduce the pace of rapid credit growth and tighter capital flow management measures do not reduce risks to macroeconomic and financial stability, rating agency says

Tourists inside the Grand Bazaar in Istanbul, Turkey. Despite a strong rebound in the country's tourism industry, Fitch estimates that higher energy prices and weaker external demand will result in a current account deficit of 5.1% of gross domestic product in 2022. Photo: Bloomberg
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Fitch Ratings cut Turkey’s sovereign debt rating deeper into junk territory citing the country's “spiralling inflation”, government and central bank policies that have increased macro and external risks as well as higher financing needs and limited capital inflows.

The agency slashed Turkey's rating to B from B+, five levels below investment grade, which indicates that material default risk is present, but a limited margin of safety remains, according to Fitch. Such a rating using makes it more difficult to access capital markets and raise financing. The outlook for Turkey is negative, Fitch said.

The rating decision comes after inflation in the country hit a 24-year high of 78.62 per cent in June, according to data from the Turkish Statistical Institute.

Surging energy and commodity prices as well as continued depreciation of Turkey's currency has contributed to rising costs with producer prices rising 138 per cent annually in the month of June, while food prices soared 93.93 per cent.

The lira lost 44 per cent of its value against the dollar last year and more than 20 per cent of its value against the greenback this year, while Turkey’s inflation has risen more than 42 per cent since December.

Fitch said it forecasts Turkey's annual inflation to average 71.4 per cent in 2022, which is the highest of any country rated by the agency.

"Its trajectory remains highly uncertain due to increased risks of backward indexation, rising expectations and additional lira depreciation, as the exchange rate pass-through has increased in both speed and magnitude," Fitch said.

Inflation is projected to slow to an average 57 per cent in 2023, according to Fitch due to accommodative policies that are expected until the 2023 elections.

“Despite rising inflation, we do not expect the Central Bank of the Republic of Turkey to hike interest rates given the political constraints and President [Recep Tayyip] Erdogan’s call for lower interest rates,” Abu Dhabi Commercial Bank economists Monica Malik and Thirumalai Nagesh said in a research note last week.

A food street vendor pushes his trolley in Istanbul, Turkey. Annual inflation in Turkey hit 78. 62% in June, the highest rate since 1998, according to official data. AP

Over much of the past five years, Turkey has remained focused on boosting economic growth and the country’s exports.

Mr Erdogan’s government has argued that high interest rates cause inflation rather than curb it, and has piled pressure on the central bank to keep borrowing costs low in the face of risks to the currency and prices.

The central bank kept rates unchanged at its June 23 meeting after ending last year with 500 basis points of cumulative easing. It has kept its key borrowing rate at 14 per cent over the past six meetings as it pursues policies aimed at widening the use of the local currency and making available long-term investment loans.

The central bank has been guided by "political considerations" and "the government's focus on maintaining high growth feeds foreign exchange demand, depreciation pressures on the lira, decline in international reserves and spiralling inflation, and discourages capital inflows to fund the higher current account deficit", Fitch said.

Fitch estimates that the higher energy prices and weaker external demand will result in a current account deficit of 5.1 per cent of gross domestic product in 2022 even with the recovery of the country's tourism industry. Tourism arrivals in the country surged 308 per cent year-on-year in May.

"Although net errors and omissions have supported the balance of payments in recent years, the limited visibility of their nature and resilience maintains the risk of additional pressure on international reserves ahead," the rating agency said.

The country has about $182 billion in external debt maturing over the next 12 months to the end of April 2023 and while access to external financing for the sovereign and private sector has been resilient it remains vulnerable to changes in investor sentiment, especially given tighter global financing conditions and Turkey's increased funding costs, Fitch said.

While Turkey's issuance of $5bn earlier this year and its existing foreign-currency cash buffers reduce near-term financing risks, its international reserves remain under pressure, Fitch said.

Fitch estimates Turkey's international reserves have declined to $101bn and that the central bank's net foreign exchange asset position turned "slightly negative" in June, falling to -$64bn when excluding FX swaps, similar to December 2021 levels.

The rating agency forecasts the country's international reserves will decline to $94bn by the end of 2022 and to $88 billion in 2023.

Updated: July 11, 2022, 9:07 AM
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