London April 1 2023: On March 31, 2023, S&P Global Ratings revised its outlook on Turkiye to negative from stable. At the same time, we affirmed our ratings, including our unsolicited ‘B/B’ long- and short-term sovereign credit ratings and unsolicited ‘trA/trA-1’ national scale ratings, on Turkiye.
Our unsolicited transfer and convertibility assessment remains ‘B’, signifying that the risk the sovereign prevents private sector debtors from servicing foreign currency (FC)-denominated debt is about the same as the risk of a sovereign default.
Outlook
The negative outlook reflects risks to Turkiye’s creditworthiness from what we consider untenable monetary, financial, and economic policy settings. 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.
Downside scenario
We could lower the ratings if pressure on Turkiye’s financial stability or wider public finances were to increase further, potentially in connection with renewed currency depreciation.
Upside scenario
We could raise the ratings if the predictability and effectiveness of monetary and financial sector policies improved while the sovereign’s balance-of-payments position strengthened, particularly the Central Bank of the Republic of Turkiye’s (CBRT’s) net foreign currency reserves.
Rationale
Low policy rates, directed lending, and regulatory controls on FC 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, in our opinion.
Policy direction remains uncertain. Political pressure on the CBRT continues. Policy missteps could stem from the 2023 general elections with high food inflation, exchange rate volatility, and a hit to real incomes likely to be contributing factors. Ahead of elections, and in response to February’s devastating earthquakes, the incumbent government has provided additional fiscal support in the form of business tax deferrals and one-off social payments, which led to an increase in the cash deficit reported in the first two months of 2023. Reconstruction costs are likely to require external financing of as much as 12% of GDP (although a considerable portion of this could come from grants rather than debt).
But probably the greatest fiscal and economic risk to Turkiye comes from its large and increasingly pressured banking system, with total assets of 98% of GDP. An estimated 30% of the loan book, and 41% of deposits are denominated in FC. 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. Asset quality and financial strength are highly sensitive to exchange rate developments and risk management standards at individual commercial banks, both public and private.
Given Turkiye’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. Renewed currency depreciation would have negative implications for Turkiye’s financial stability and public finances, given the extensive dollarization of central government debt (65% was FC-denominated as of Jan. 31), as well as substantial Treasury guarantees (including on the debt of state-owned enterprise Botas and that on household and corporate foreign currency-linked deposits). Heterodox policy settings could also pose a refinancing risk to the economy’s stock of short-term external debt at $196 billion, or over 20% of GDP by remaining maturity.
Institutional and economic profile: Domestic credit conditions are tightening fast, even as fiscal and monetary settings continue to accommodate
- An elevated current account deficit and loose fiscal and monetary policy settings could undermine exchange-rate stability in the run-up to the May 14 elections.
- At the same time, credit conditions for firms are tightening fast.
- Turkiye’s institutional arrangements are weak, with limited checks and balances.
Turkiye’s economic policy settings remain ad hoc and interventionist. Since Sept. 23, 2021, the CBRT has lowered its key reference rate by a cumulative 1,000 basis points (bps) despite reported inflation of 55% versus the 5% medium-term target. At the same time, authorities have introduced reserve and collateral requirements that appear to be aimed at suppressing FC demand and lowering market interest rates, including government domestic yields to levels far below reported inflation. Despite low policy rates, the cost of deposit funding for banks has been rising rapidly. The resulting narrowed net interest margins have spurred banks to tighten underwriting standards for the corporate sector (and for consumer lending, although only recently).
The state of the Turkish economy is challenging to assess in light of unrestrained inflation (as evidenced by the 96% increase in the GDP deflator during 2022) and prominent swings in the inventory component of GDP.
TurkStat reported headline 5.6% GDP growth in 2022, following 11.4% growth in 2021. According to official data, at end-2022, Turkiye’s economy was nearly 20% larger in real terms than pre-pandemic (2019) figures, with private consumption 42% above 2019 levels. In nominal terms, Turkish GDP more than doubled last year. These figures are exceptional when compared with those of other major economies, raising doubts about the data’s reliability.
For 2023, growth is projected to decelerate to just over 2%, with household savings buffers eroded and export markets beginning to wane, and more exchange rate volatility amid persistent inflation, to drag on consumption (but strong household spending on consumer durables could act as a hedge against inflation). Post-election fiscal policy is likely to tighten, we believe, dragging on activity during second-half 2023.
Turkiye’s private sector is sophisticated, outward-looking, and flexible; it benefits from the country’s customs union with the EU, the destination for over 40% of merchandise exports and one quarter of services exports. The U.N.’s World Tourism Organization ranks Turkiye as the sixth-most visited nation globally, ahead of Mexico, the U.K., and Japan. In 2022, real exports increased 14.1% year over year, with services up 47% (and 29% higher than pre-pandemic figures). Some of the export figures’ strength probably captures reexports, including of hydrocarbons and refined energy products, to Asia and the Middle East as well as consumer durables and investment goods to Russia.
There is considerable storage, pipeline, and liquefied natural gas capacity within Turkiye’s energy sector. As a consequence, the risk of outright energy shortages appears to be low. This apparent supply resilience does not, however, immunize the country’s economy from the terms of trade shock of elevated hydrocarbon prices, given its dependency on oil and gas imports, which make up three-quarters of total gross energy supply (compared with about 50% in 1990). While gas and oil prices have softened since last summer, we cannot rule out future volatility.
We consider that the sovereign’s broader institutional arrangements are weak and continue to constrain the ratings. Following the 2017 constitutional referendum, the office of the prime minster was abolished, and decision-making (including control of the CBRT and the Supreme Electoral Council) is concentrated within the executive branch. Several opposition leaders, most notably Selahattin Demirtas of the People’s Democratic Party, remain in prison on terror-related charges. Nevertheless, some electoral competition remains. Following the 2018 parliamentary elections, the ruling Justice and Development Party lost its majority in the Grand National Assembly and entered a coalition with the Nationalist Movement Party. In May 2019’s local government elections, the Supreme Election Council, under apparent political pressure, annulled the outcome of the Istanbul municipal elections, which registered a victory for the opposition. The elections were rerun, and opposition candidate Ekrem Imamoglu of the Republican People’s Party won the vote by an estimated 10 percentage points.
Flexibility and performance profile: Economic imbalances are acute, with elevated inflation and vulnerable balance of payments
- We forecast that Turkiye’s inflation will remain high in 2023, averaging 45%.
- The headline 2022 budgetary result benefited from a doubling of nominal tax receipts. For 2023, we expect larger spending increases on wages, entitlements, subsidies, and capital projects ahead of the elections.
- Off-balance-sheet fiscal risks are rising, particularly from Botas and the Treasury’s guarantee to compensate FC-linked deposit holders against depreciation.
We expect that fiscal policy will remain accommodative until the elections in mid-2023, which could temporarily support growth. Temporary fiscal stimulus is likely to come through energy subsidies, a renewed credit guarantee scheme, higher capital expenditure, earthquake-related corporate tax deferrals and social payments, the recent doubling of pension expenditure, and broader eligibility for early retirement. Under most post-election scenarios, the fiscal stance is likely to tighten.
Turkiye’s fiscal profile can be divided in two:
- On the balance sheet, fiscal space looks substantial, although the dollarization of the state’s liabilities is a risk. We project a year-end 2023 general government debt-to-GDP ratio of 32%, although this figure is considerably more sensitive to exchange-rate effects than before given that 65% of the debt is denominated in foreign currency or about twice the FC debt before the 2018 currency crisis. Given that nominal GDP increased 107% in 2022 (the largest nominal increase since 1998), debt to GDP actually declined in 2022, with the local currency component significantly inflated away.
- Off-balance-sheet, there are several risks:
- –Foreign exchange risk: With the Treasury having guaranteed about 28% of system domestic currency deposits (Turkish lira [TRY] 1.7 trillion [$87 billion] as of March 23, 2023, according to financial regulator BDDK). We estimate that the direct fiscal cost of the Treasury’s FC protection scheme for 2022 was about 0.5% of GDP, but this could increase in 2023 depending on the exchange rate’s trajectory (and also because the stock of FC-linked deposits is now higher).
- –Broader public sector deficit pressure: State company Botas, which imports 95% of the natural gas consumed in Turkiye, has been borrowing domestically and externally to finance the difference between what households and small enterprises pay and the actual cost of imports. The Treasury made transfers to Botas from the central government budget of 0.7% of GDP in 2022 to partially offset these losses, but these are made with a lag, and do not compensate for upfront exchange-rate and market-price-related losses. In addition, the cost to state-owned enterprises of FC debt payments and payouts on public-private partnerships have increased in tandem with the weakening currency, while the state has had to provide additional capital support to some state-owned enterprises. Nevertheless, even under a worst-case scenario, we do not think the cost to the state of buying out the eight principal PPP projects as exceeding $14.3 billion, or 1.8% of GDP.
- –Quasifiscal activity by state banks, which is a much larger fiscal worry: Loan book quality risks are particularly pertinent for public banks, in our view, given that they have been heavily involved in episodes of rapid credit expansion at low rates. Financial stability risks could in turn present a contingent liability risk to the government if it had to rescue a bank, either because of lost domestic depositor confidence or foreign creditors’ appetite for rolling over Turkish banks’ foreign debt decreasing. The government has already contributed capital to public banks several times, with another capitalization set to take place in March 2023 worth 0.6% of GDP, but these amounts have so far been relatively modest. The broader financial sector continues to be subject to notable liquidity risks via the provision of FC swaps with the CBRT, and high short-term external debt. Bank asset quality could face further pressure because about 32% of loans were denominated in FC (as of Jan. 31, 2023, although this was notably lower than the 37% proportion recorded four months before), effectively making this debt more expensive to service as the lira depreciates.
Turkiye’s current account deficits remain large, at an estimated $51.7 billion or 6% of GDP on a 12-month rolling basis as of January 2023. More than anything else, these elevated external deficits reflect policymakers prioritizing demand stimulus over other objectives, as well as the economy’s young demographics, and relatively low propensity to save. Since 2018, debt has superseded equity as the largest source of financing for these deficits, although the economy has generally grown as fast or faster than net (if not gross) external debt accumulation since then (according to official National Accounts data published by TurkStat).
We focus on the net foreign reserves number because the CBRT’s gross foreign currency reserves of about $117 billion (14% of GDP) as of Feb. 28 are largely encumbered. Excluding the institution’s FC obligations to domestic residents, usable reserves–which represent the CBRT’s effective capacity to intervene–were about $37.7 billion (equivalent to one-fifth of short-term external debt by remaining maturity). To calculate usable reserves, we only exclude FC liabilities to domestic residents. Therefore, our figures include an estimated $28 billion in swap lines from the central banks of Qatar, the United Arab Emirates, South Korea, and China (we understand that as of early March, Turkiye’s usable reserves will also reflect a $5 billion deposit from the Saudi Fund for Development).
The external stock position is also a risk. External debt maturing over the next 12 months remains significant, at $196 billion (24% of GDP) as of January 2022, according to CBRT estimates.
Monetary policy in Turkiye is sui generis: a combination of low nominal policy rates and patchwork of macroprudential regulations intended to suppress FC demand by tightening domestic liquidity conditions. Since March 2021, the CBRT has lowered the policy rate (one-week repurchase rate) 1,000 bps even with inflation hitting multiyear highs and while nearly all major global central banks were moving to raise rates and tighten monetary settings. A consequence of this has been a weak and volatile exchange rate.
Absent positive real interest rates or significant useable FC reserves, and in light of the recent weakening inflows of savings into FC-linked deposits, policymakers have resorted to other measures to contain lira depreciation. These include the use of financial and capital controls. Turkiye’s monetary authority and financial regulator continue to impose FC surrender requirements on exporters, press banks to lend to the government and the corporate sector at steeply negative real interest rates, and curtail firms’ preference to accumulate FC buffers against currency depreciation by restricting access to credit whenever their FC positions exceed regulatory ceilings.
Key Statistics
Table 1
Turkiye–Selected Indicators
2017 | 2018 | 2019 | 2020 | 2021 | 2022 | 2023 | 2024 | 2025 | 2026 | |
ECONOMIC INDICATORS (%) | ||||||||||
Nominal GDP (bil. LC) | 3,134 | 3,759 | 4,312 | 5,048 | 7,249 | 15,007 | 17,627 | 20,807 | 22,845 | 25,352 |
Nominal GDP (bil. $) | 858 | 780 | 761 | 720 | 815 | 906 | 816 | 867 | 827 | 886 |
GDP per capita (000s $) | 10.6 | 9.5 | 9.1 | 8.6 | 9.6 | 10.6 | 9.4 | 9.9 | 9.3 | 9.9 |
Real GDP growth | 7.5 | 3.0 | 0.8 | 1.9 | 11.4 | 5.6 | 2.1 | 2.8 | 3.4 | 3.2 |
Real GDP per capita growth | 6.2 | 1.5 | (0.6) | 1.4 | 10.0 | 4.8 | 0.8 | 1.5 | 2.1 | 1.9 |
Real investment growth | 8.3 | (0.2) | (12.5) | 7.4 | 7.4 | 2.8 | 1.9 | 3.3 | 4.0 | 3.4 |
Investment/GDP | 30.7 | 29.4 | 25.0 | 31.5 | 31.9 | 35.1 | 35.2 | 34.5 | 34.9 | 34.9 |
Savings/GDP | 26.0 | 26.8 | 26.5 | 27.1 | 31.0 | 29.7 | 31.3 | 32.2 | 31.5 | 31.6 |
Exports/GDP | 26.0 | 31.2 | 32.6 | 28.7 | 35.3 | 37.9 | 36.5 | 32.6 | 32.0 | 31.9 |
Real exports growth | 12.4 | 8.8 | 4.2 | (14.4) | 24.9 | 9.1 | 0.3 | 2.3 | 2.8 | 3.2 |
Unemployment rate | 10.9 | 10.9 | 13.7 | 13.1 | 12.0 | 10.4 | 11.5 | 10.4 | 10.2 | 10.0 |
EXTERNAL INDICATORS (%) | ||||||||||
Current account balance/GDP | (4.7) | (2.5) | 1.4 | (4.4) | (0.9) | (5.4) | (3.9) | (2.3) | (3.4) | (3.3) |
Current account balance/CARs | (17.3) | (8.2) | 4.2 | (15.0) | (2.5) | (13.8) | (10.2) | (6.6) | (9.9) | (9.8) |
CARs/GDP | 26.9 | 31.4 | 33.7 | 29.6 | 36.0 | 38.9 | 38.2 | 34.6 | 34.1 | 33.8 |
Trade balance/GDP | (6.8) | (5.2) | (2.2) | (5.3) | (3.6) | (9.9) | (8.1) | (6.5) | (7.2) | (7.2) |
Net FDI/GDP | 1.0 | 1.1 | 0.9 | 0.6 | 0.8 | 0.9 | 0.9 | 1.0 | 1.0 | 1.0 |
Net portfolio equity inflow/GDP | 0.3 | (0.1) | 0.0 | (0.6) | (0.2) | (0.4) | (0.5) | 0.0 | 0.0 | 0.0 |
Gross external financing needs/CARs plus usable reserves | 152.8 | 154.3 | 130.3 | 147.2 | 156.2 | 154.8 | 154.8 | 164.6 | 164.2 | 162.1 |
Narrow net external debt/CARs | 125.6 | 105.8 | 86.2 | 111.4 | 69.8 | 56.5 | 74.5 | 73.1 | 80.6 | 78.7 |
Narrow net external debt/CAPs | 107.0 | 97.8 | 90.0 | 96.9 | 68.1 | 49.7 | 67.6 | 68.5 | 73.4 | 71.7 |
Net external liabilities/CARs | 191.2 | 136.6 | 120.2 | 180.9 | 84.5 | 77.1 | 98.1 | 103.6 | 116.1 | 115.1 |
Net external liabilities/CAPs | 163.0 | 126.2 | 125.5 | 157.3 | 82.4 | 67.8 | 89.0 | 97.2 | 105.6 | 104.8 |
Short-term external debt by remaining maturity/CARs | 70.6 | 73.6 | 66.4 | 74.4 | 58.9 | 50.5 | 63.7 | 63.6 | 67.8 | 64.7 |
Usable reserves/CAPs (months) | 2.4 | 2.0 | 3.1 | 3.0 | 0.4 | 0.6 | 1.3 | 0.4 | 0.9 | 0.8 |
Usable reserves (mil. $) | 43,606 | 62,844 | 61,043 | 9,610 | 21,681 | 38,581 | 10,242 | 23,082 | 23,017 | 23,232 |
FISCAL INDICATORS (GENERAL GOVERNMENT; %) | ||||||||||
Balance/GDP | (2.0) | (2.8) | (3.2) | (2.9) | (2.3) | (1.7) | (3.8) | (3.6) | (3.5) | (3.5) |
Change in net debt/GDP | 3.5 | 7.1 | 5.4 | 10.1 | 11.0 | 8.2 | 8.2 | 5.8 | 4.2 | 4.2 |
Primary balance/GDP | (0.0) | (0.7) | (0.7) | (0.1) | 0.3 | 0.5 | (1.0) | (0.6) | (0.2) | (0.1) |
Revenue/GDP | 29.9 | 29.8 | 29.8 | 29.6 | 28.0 | 27.0 | 29.0 | 29.0 | 29.0 | 29.0 |
Expenditures/GDP | 31.9 | 32.5 | 32.9 | 32.5 | 30.3 | 28.7 | 32.8 | 32.6 | 32.5 | 32.5 |
Interest/revenues | 6.4 | 7.1 | 8.4 | 9.5 | 9.3 | 8.2 | 9.6 | 10.4 | 11.5 | 11.8 |
Debt/GDP | 27.9 | 30.1 | 32.6 | 39.7 | 41.8 | 28.4 | 32.4 | 33.3 | 34.5 | 35.3 |
Debt/revenues | 93.4 | 101.0 | 109.4 | 133.8 | 148.9 | 105.2 | 111.7 | 114.8 | 119.1 | 121.9 |
Net debt/GDP | 23.8 | 26.9 | 28.8 | 34.7 | 35.2 | 25.2 | 29.7 | 31.0 | 32.4 | 33.5 |
Liquid assets/GDP | 4.2 | 3.1 | 3.8 | 4.9 | 6.5 | 3.2 | 2.7 | 2.3 | 2.1 | 1.9 |
MONETARY INDICATORS (%) | ||||||||||
CPI growth | 11.1 | 16.3 | 15.2 | 12.3 | 19.6 | 72.3 | 44.6 | 22.4 | 12.0 | 10.1 |
GDP deflator growth | 11.0 | 16.5 | 13.8 | 14.9 | 29.0 | 96.1 | 15.0 | 14.8 | 6.2 | 7.5 |
Exchange rate, year-end (LC/$) | 3.81 | 5.27 | 5.95 | 7.35 | 12.99 | 18.73 | 24.00 | 27.00 | 28.00 | 29.00 |
Banks’ claims on resident non-gov’t sector growth | 21.1 | 12.3 | 10.4 | 35.9 | 35.5 | 53.4 | 25.0 | 20.0 | 20.0 | 20.0 |
Banks’ claims on resident non-gov’t sector/GDP | 62.9 | 58.9 | 56.6 | 65.8 | 62.1 | 46.0 | 49.0 | 49.8 | 54.4 | 58.8 |
Foreign currency share of claims by banks on residents | 29.6 | 36.2 | 34.7 | 30.7 | 38.6 | 28.7 | N/A | N/A | N/A | N/A |
Foreign currency share of residents’ bank deposits | 39.5 | 43.9 | 45.3 | 44.9 | 54.9 | 37.2 | N/A | N/A | N/A | N/A |
Real effective exchange rate growth | (17.4) | (15.9) | 1.9 | (16.8) | (10.2) | N/A | N/A | N/A | N/A | N/A |
Sources: Turkish Statistical Institute (Economic indicators), Banking Regulation and Supervision Agency, Central Bank of the Republic of Turkey, International Monetary Fund (Monetary indicators), Ministry of Treasury and Finance (Fiscal and Debt indicators), Central Bank of the Republic of Turkiye (External indicators).