Fitch on Friday affirmed its BB rating on Turkey’s debt and maintained a negative outlook, citing low foreign reserves and political risks.
The Fitch decision comes as Turkey grapples with its first recession in a decade following a currency crisis last year that has unleashed sky-high inflation and slashed 40 per cent off the value of the lira in the past year.
Nationwide mayoral elections on March 31 saw voters punish the ruling Justice and Development party (AKP) for its handling of the economy, electing opposition candidates in the commercial hub of Istanbul, the capital Ankara and 10 other provincial cities. The AKP has refused to concede defeat in Istanbul and is pushing to rerun the elections, possibly in June.
The spectre of political instability has unnerved investors who fret about Turkey’s commitment to democratic standards under its powerful president, Recep Tayyip Erdogan. A new election is also likely to further delay pledges from Mr Erdogan’s economic team to reduce government spending and continue to adhere to tight monetary policy to reduce inflation that is hovering at 20 per cent.
The possibility of “repeat elections in Istanbul just seem set to create more political flux and risk, and months more of economic policy drift — hardly conducive to much-needed policy reform and . . . rebalancing,” Timothy Ash, a strategist at BlueBay Asset Management in London, wrote in a research note on Friday.
Before the March vote, the government not only stepped up spending and tax breaks, but introduced unorthodox measures such as opening state-subsidised food stalls to rein in inflation, reportedly pressuring private banks to keep deposit rates low and boosting lending through state-controlled banks. Investors also began worrying that the central bank was using its foreign currency reserves to prop up the lira in the weeks before the election.
The bank said last week that it had bolstered its foreign currency reserves ahead of the election by borrowing billions of dollars, confirming a Financial Times report that showed it had bulked up its reserves by $9.6bn through swaps with a maturity of up to one month. Such short-term borrowing has raised questions about the central bank’s ability to defend the currency should it face another major sell-off.
In its report, Fitch noted foreign exchange reserves may have fallen because of efforts to stabilise the lira ahead of the elections. It also said market concerns over Turkey’s reserves position appeared to contribute to a renewed fall in the lira, “which could add to dollarisation pressures”.
Fitch added the Turkish economy “seems to have bottomed” amid a deep recession. It expects the economy to contract by 1.1 per cent this year, and estimated average growth of 1.5 per cent for 2018 to 2020 will fall short of the 6.8 per cent expansion seen from 2010 to 2017. The rating agency added that credibility in Turkey’s monetary policy is “weak”.
Fitch forecast inflation to average 14.2 per cent this year, the highest of any sovereign rated above the B category.
The lira was little changed after the report, trading at TL5.9609 per dollar.
Fitch last cut Turkey’s rating to BB and its outlook to “negative” in July 2018 in the weeks before a full-blown currency crisis unleashed sky-high inflation and tipped the $850bn economy into recession.
The other two major agencies also rate Turkish debt as junk. Standard & Poor’s rating is B+ with a stable outlook, and Moody’s is set at Ba3 with a negative outlook.