S&P changes Turkey's outlook to negative on public sector risks and reconstruction costs

The view reflects risks to creditworthiness from 'untenable' monetary, financial and economic policy settings

Ruins in Hatay, Turkey. Reconstruction costs as a result of the earthquakes may require external financing of as much as 12 per cent of gross domestic product, S&P Global said. Bloomberg

S&P Global Ratings has revised its outlook on Turkey to negative from stable, citing an increase in broader public sector risks and increased reconstruction costs after the earthquakes in February.

Turkey's long- and short-term sovereign credit ratings were affirmed at “B”, which is two levels below investment grade on S&P's scale, the New York-based ratings agency said in a statement on Friday.

The negative outlook reflects risks to Turkey's creditworthiness from “untenable” monetary, financial and economic policy settings, S&P said.

“Our unsolicited transfer and convertibility assessment remains 'B', signifying that the risk the sovereign prevents private sector debtors from servicing foreign currency-denominated debt is about the same as the risk of a sovereign default,” it said.

“As a consequence of intensifying external, monetary, fiscal and banking system pressures, we revised our outlook on Turkey to negative from stable and affirmed our unsolicited 'B/B' long- and short-term sovereign credit ratings on the sovereign.”

Regulatory pressure is on the rise, while usable foreign currency reserves are modest at an estimated $37.7 billion as of February 28, equivalent to one-fifth of short-term external debt by remaining maturity, S&P said.

“In our view, contingent liabilities from state banks and public enterprises are large and growing, while balance-of-payments and exchange-rate vulnerabilities remain elevated.”

Up until the February earthquake, Turkey's economy had been performing well: its economy posted the third highest growth among G20 countries in 2022, rising 5.6 per cent, trailing India and Saudi Arabia, the Organisation for Economic Co-operation and Development reported last month. This follows an 11.4 per cent growth in 2021.

The country's economy was nearly 20 per cent larger in real terms than pre-pandemic figures in 2019, official data from the TurkStat agency shows. Private consumption was 42 per cent above 2019 levels.

But the February earthquakes damaged Turkey's economy and society. Damage from the tremors — which also struck Syria — is estimated to exceed $100 billion, the United Nations said last month.

Reconstruction costs as a result of the earthquakes, meanwhile, are seen to require external financing of as much as 12 per cent of gross domestic product, although a considerable portion of this could come from grants rather than debt, it said.

“Unrestrained inflation complicates our fiscal, economic and monetary analysis,” S&P said.

However, the “greatest” fiscal and economic risk to Turkey stems from its large and increasingly pressured banking system, with total assets are 98 per cent of GDP, it said. About 30 per cent of its loan book and 41 per cent of deposits are denominated in foreign currency.

“As a consequence, asset quality and financial strength are highly sensitive to exchange rate developments and risk management standards at individual commercial banks, both public and private,” S&P said.

S&P said it could raise its ratings on Turkey if the effectiveness of policies in the country's monetary and financial sectors improve, and its balance of payments position strengthened, specifically the central bank's net foreign currency reserves.

However, it could also lower the ratings if the pressure on Turkey's financial stability or wider public finances were to increase further, it said.

“Low policy rates, directed lending and regulatory controls on foreign currency positions and interest rates render the Turkish economy and banking system more vulnerable to external shocks, against a backdrop of slowing global growth and difficult market conditions,” it said.

Policy direction, meanwhile, remains uncertain, as political pressure on the central bank continues, S&P said.

Missteps in policy could arise from the 2023 general elections, which are scheduled for May, with high food inflation, exchange rate volatility and a hit to real incomes likely to be contributing factors, it said.

S&P did acknowledge that Ankara has provided additional fiscal support in the form of business tax deferrals and one-off social payments in response to the earthquakes, leading to an increase in the cash deficit reported in the first two months of 2023.

“Given Turkey's elevated current account deficits, limited usable reserves, high inflation and reliance on occasional capital inflows, the outlook for the exchange rate remains, at best, uncertain,” S&P said.