S&P also kept unchanged Turkey's national scale ratings at 'trAA+/trA-1+', the ratings agency said in a statement on Friday.
"In our view, recent decisions to tighten monetary policy could signal a return to a more conventional policy rulebook, while Turkey's modest net general government debt of 35% of GDP at the end of 2020 also leaves room for maneuver," S&P said.
Last week, Turkey's central bank decided to hold its one-week repo rate at 17%, saying that additional monetary tightening will be delivered if needed.
The ratings agency estimates that despite the coronavirus pandemic, the Turkish economy grew 0.9% in 2020, propelled by a large policy-driven credit stimulus. "However, macroeconomic imbalances widened; the current account deficit increased to an estimated 5.4% of GDP, foreign exchange reserves weakened, and inflation remained high," S&P added.
Here's what else S&P Global Ratings said in the statement:
The stable outlook considers the lingering risks from Turkey's accumulated economic imbalances and the fallout from the pandemic over the next 12 months. These are balanced against the resilience of Turkey's private sector and the still-contained stock of net general government debt. We expect the Turkish economy will continue to recover while inflation moderates and current account deficits reduce.
We could lower the ratings if we saw heightened risks of banking system distress, implying potential contingent liabilities for the government. This could be the case, for example, if banks' access to foreign funding diminished or domestic residents persistently converted their savings to foreign currency, which is not our base-case scenario. Weakened asset quality following 2020's largescale credit stimulus could also put pressure on the banking system.
We could consider an upgrade if Turkey's balance of payments position strengthened beyond our current projection, particularly the net central bank foreign exchange reserves. This could happen if Turkey ran lower current account deficits, for example, as a result of stronger recovery in goods exports and tourism services receipts. It could also occur if domestic resident dollarization and elevated imports of non-monetary gold reversed.
We could also raise the rating if we observed a sustained enhanced public policy predictability and monetary policy effectiveness.
Like other countries, Turkey has been substantially hit by the coronavirus pandemic and experienced another notable increase in COVID-19 cases toward the end of 2020. The authorities did not adopt a full lockdown but instead opted for targeted regional restrictions--including selective business closures and curfews and restrictions for specific age groups--as they did during the first wave of infections earlier in 2020. The number of new cases has since been falling.
To cushion the economic effect of the pandemic, the government enacted a series of fiscal measures such as additional health care spending, tax deferrals, and labor market support programs. However, largescale credit stimulus was also deployed in the first half of 2020, with the stock of domestic credit expanding by 36% overall last year.
We consider that this credit stimulus underpinned stronger growth, which we now estimate at 0.9% in real terms in 2020. However, it also led to an accumulation of macroeconomic imbalances, including a wider current account deficit, a weakened foreign exchange reserve position, and sticky double-digit inflation, which reached 14.6% in year-on-year terms in December.
In response to the pressured Turkish lira, the government's policy approach shifted notably in the second half of 2020. It discontinued credit stimulus and the Central Bank of Turkey (CBRT) tightened monetary policy through raising the key one-week repo rate by a cumulative 875 basis points since the end of September. We consider that this apparent return to a more conventional policy toolkit should help moderate the accumulated imbalances, particularly external ones. There could still be risks of reversal, for example if growth momentum wanes sparking increased political pressure to revive it. This is not our baseline scenario, however, given the recent announcements from the Ministry of Finance and the central bank.
Positively, Turkish banks have maintained access to foreign funding even during difficult times and were able to rollover maturing loans throughout 2020, like they did in the aftermath of the August 2018 currency crisis. The government also demonstrated access to foreign capital markets, issuing Eurobonds in October and November. More recently, a dual-tranche Eurobond issuance took place in January 2021, which was several times oversubscribed. We estimate that Turkey's net general government debt totalled 35% of GDP at the end of 2020, providing fiscal headroom in the event of a further negative shock.
Our ratings on Turkey remain constrained by what we view as its weak institutions. We see limited checks and balances between government bodies, with power concentrated in the hands of the executive branch, which renders policy responses difficult to predict. Nevertheless, the outcome of local elections held in 2019 suggests that Turkey's political system retains a degree of competition.
Institutional and Economic Profile: Growth in 2021 will depend on the external environment and speed of vaccine rollout
We estimate that--bolstered by a large credit stimulus--the Turkish economy expanded by close to 1% last year. Besides China, Egypt, and Vietnam, Turkey is the only other major emerging market economy to have grown, by our estimates.
We expect continued economic recovery, which is nevertheless set to slow in quarterly terms.
Policy and institutional risks remain elevated.
We estimate that the Turkish economy expanded by 0.9% in 2020, which represents a significant upward revision to the 3.3% contraction we projected in July. Apart from China, Egypt, and Vietnam, we believe Turkey is the only other major emerging market economy to have registered growth, despite being hit hard by the coronavirus pandemic.
This unusually strong outturn is largely explained by the sizable credit stimulus the authorities engineered during the first half of 2020. Although Turkey has previously undergone several rapid credit extension episodes, we estimate that the stock of domestic credit increased by a total 36% in 2020, the highest level in over a decade. The expansion appears significant even taking into account the foreign exchange (FX) rate effect: Since about one third of loans are denominated in FX, the stock inflates when the lira depreciates.
The credit stimulus was fairly broad; corporate and household loans rose rapidly--including housing loans, automobile loans, and, to a lesser degree, credit card lines. This propelled private consumption and investments. We estimate that both actually rose last year, contrary to our prior expectations of contraction.
Despite providing short-term support to the economy, the credit boom has widened Turkey's macroeconomic imbalances. Specifically, stronger domestic demand kept imports elevated, which we estimate grew by 6% in real terms last year (remaining flat in U.S. dollar terms). This contributed to a current account deficit of 5.4% of GDP last year, the highest level since 2013. Concurrently, the central bank foreign exchange reserves fell and deteriorated in quality while inflation reached 14.6% in year-on-year terms by the end of 2020.
We consider that it will take time to unwind the accumulated imbalances, but the authorities have already taken steps toward a more conventional economic policy. In October 2020, the president replaced the leadership of the ministry of finance and the central bank. Since then, the CBRT has taken decisive steps to tighten monetary policy amid a continued slide in the exchange rate. Policy rates were raised by a cumulative 675 basis points over the last three months of 2020 while previous regulations incentivizing banks to lend are being abolished.
In our view, the adopted measures should ultimately help Turkey control inflation, while also reducing balance of payments risks and replenishing FX reserves. At the same time, as previous policy stimulus is withdrawn, the pace of recovery is set to slow in quarterly terms. It remains to be seen whether lower growth for a potentially prolonged period would be palatable politically.
Beyond government policy direction, we consider that the shape of Turkish economic growth in the short term will depend on the external environment and the vaccine rollout in Turkey. Although we expect international tourism to recover, the process will likely be only gradual, which could continue to constrain domestic economic prospects. Turkey has also announced plans for a vaccine rollout with a strong initial uptake, but it remains to be seen whether this is sustained. That would, in turn, largely depend on the availability of sufficient supplies and population's willingness to get vaccinated.
Overall, our medium-term growth projections are unchanged, with real GDP projected to expand by an average of 3.4% annually over the medium term. We note, however, that Turkey's economy is large and diverse, characterized by a highly flexible SME sector, a strategic geographic location, and a young and growing population. Consequently, economic recovery could ultimately prove stronger than we currently project, particularly beyond 2021.
We consider that Turkey's institutional arrangements remain comparatively weak and continue to constrain the sovereign credit ratings. In the June 2018 presidential and parliamentary elections, the president and the Adalet ve Kalkinma Partisi-led coalition secured a victory that marked the final chapter in Turkey's transition to an executive presidential system. We see limited checks and balances between government bodies. Because power is concentrated in the hands of the executive branch, it is difficult to predict policy responses.
Nevertheless, a degree of domestic political competition remains, as highlighted by the local election results in 2019, when opposition parties secured the mayorships of several large cities--including Istanbul, Ankara, and Izmir--and the electoral authorities acknowledged these results.
Turkey's international relations remain complex. The country has lately been involved in a series of military conflicts, including in Libya, Syria, and more recently in the Nagorno-Karabakh war between Armenia and Azerbaijan. Tensions with the EU and the U.S. remain, even though immediate prospects of international sanctions have subsided. The U.S. imposed limited CAATSA (Countering America's Adversaries Through Sanctions Act) sanctions against several defense industry officials over Turkey's purchases of S-400 anti-aircraft systems from Russia. This has had a limited impact so far. Disagreements also remain with the EU over Turkey's continued drilling activities in the Eastern Mediterranean in search for gas.
Flexibility and Performance Profile: Recent policy steps suggest a return to a more conventional macroeconomic rulebook
The CBRT has decisively tightened interest rates in recent months and signaled inflation control as a primary monetary policy objective.
Nevertheless, imbalances remain high, particularly for balance of payments, with high short-term external debt and limited foreign exchange reserve firepower.
Positively, Turkey's fiscal indicators remain strong, boasting one of the smallest increases in debt to GDP ratios globally as a result of the pandemic.
Turkey's monetary policy has historically been ineffective at managing inflation. The CBRT has never met the 5% medium-term target introduced in 2012, while Turkey's real effective exchange rate has fluctuated substantially. The CBRT has faced increasing political pressure in recent years, which frequently delayed timely responses to rising inflation.
Toward the end of 2020, Turkey's monetary policy appears to have shifted significantly, reversing the previous easing cycle implemented between mid-2019 and mid-2020. The president replaced the central bank governor in October and since then, the CBRT has more firmly communicated its focus on the 5% inflation target and a commitment to a market-determined exchange rate. Specific policy steps included:
Decisive interest rate hikes in November and December of a cumulative 675 basis points, bringing the nominal rate to 17% and real rates into positive territory, considering inflation of 14%-15%;
Communicating a plan to withdraw forbearance measures applicable to the banking sector, which would expire in mid-2021; and
Abolishing the so-called asset ratio rule calculation, which previously effectively pushed banks to lend more.
In our view, these steps, if sustained, should help control elevated inflation. Consumer price index growth measured 14.6% year-on-year in December 2020 or almost 3x the CBRT's 5% target. It remains unclear whether the tight monetary policy will be sustained over a longer period, allowing the CBRT to regain credibility. We consider that as tighter policy fully feeds into the domestic economy, political pressure to loosen it could resurface, like it did in 2019.
We also believe that recent monetary policy steps should help address Turkey's weakened balance of payments position. In 2020, we estimate that Turkey's current account registered a 5.4% of GDP deficit, the highest since 2013. The widening has largely been underpinned by the effect of the credit stimulus, which contributed to higher imports. A loss of exports, including in the tourism sector due to the pandemic, also had an impact. Another major contributor to the wider current account deficit was the import of non-monetary gold, which totalled close to $20 billion compared with the historical average of about $10 billion annually. It effectively represents dollarization, with Turkish residents shifting away from the lira to preserve purchasing power amid the volatile exchange rate.
In parallel, the CBRT's FX reserves have declined and deteriorated in quality as its borrowing has picked up via swap lines on the liability side in foreign currency. After subtracting these obligations, we estimate that usable FX reserves dropped close to zero last year, from around $47 billion in 2019. In our view, this limits the CBRT's firepower to counteract further exchange rate volatility or to meet unexpected external financing requirements.
The central bank has communicated that it plans to replenish its depleted reserves, although we consider that, absent a current account surplus, achieving this would be challenging. The CBRT's FX reserves could benefit from portfolio flows to emerging markets, including Turkey, but this would result in borrowed as opposed to own reserves. Reserves could also strengthen if domestic residents were to de-dollarize, which has not happened so far. Subscribing to an IMF program could be yet another avenue, but we understand this is not currently a policy option.
In our view, Turkey's fiscal position remains comparatively strong and continues to support the sovereign ratings. We estimate that--as a result of the implemented support measures and the pandemic's effect on growth last year--the general government deficit widened to 4.0% of GDP in 2020, from 3.2% in 2019. However, the increase in public leverage was higher, primarily because of Turkish lira depreciation. Close to half of government debt is denominated in foreign currencies. In addition, back in May 2020, the government injected capital worth 0.5% of GDP into state banks via the Sovereign Wealth Fund. We estimate net general government debt totaled 35% of GDP at the end of 2020, which leaves the government fiscal policy space to maneuver. The government also issued Eurobonds in October and November, demonstrating a ready access to capital markets. A more recent dual-tranche Eurobond issuance in January 2021 was several times oversubscribed.
Although fiscal leverage remains low, we note risks from contingent liabilities. We estimate that direct government guarantees and commitments under public-private partnership agreements remain limited, at below 10% of GDP. That said, in an adverse scenario, we anticipate that the government may have to extend support to the financial sector, particularly the public banks. We note that two cases of recapitalization have already occurred over the past 18 months (0.7% of GDP in April 2019 and 0.5% of GDP in May 2020). Additional support may be required because of the rapid loan growth combined with the effects of the COVID-19 pandemic on Turkish households and the corporate sector.
Bank asset quality is likely to deteriorate in the coming months. Last year's Turkish lira 20% depreciation and the recent increases in domestic interest rates would weigh on the corporate sector. This could become more apparent once the forbearance measures are withdrawn, particularly the extended period to classify loans as nonperforming. Positively, Turkish banks have been consistently able to rollover their external debt, even amid very difficult markets, such as throughout 2020 and in the aftermath of the 2018 currency crisis.
The long-term local currency rating on Turkey is one notch higher than the long-term foreign currency rating. We consider that Turkey has a managed-float exchange rate regime and comparatively developed local currency capital markets, while about 50% of government debt is denominated in local currency and almost entirely held domestically. In our view, these factors imply lower default risk on Turkey's lira-denominated sovereign commercial debt than on its foreign currency-denominated debt."
