A landmark return by Turkey to investment grade territory following an 18-year hiatus has brought fresh confidence to the country and could pave the way for a new era of investment.
In early November, London-based Fitch Ratings upgraded Turkey’s long-term foreign currency issuer default rating (IDR) to BBB- from BB+, and its long-term local currency IDR to BBB from BB+. Fitch set the outlooks on both ratings as stable, while also raising the short-term foreign currency IDR to F3 from B, and its country ceiling to BBB from BBB-.
The upgrade reflects the fact that after two years of fluctuating growth rates, Turkey’s fundamentals are expected to pave the way for steady, long-term growth of 4-5%. Some analysts, however, remain cautious on Turkey’s outlook, warning that key factors which contributed to the country’s lengthy sub-investment rating still posed risks to its economy.
Turkey lost its investment grade in 1994 when Moody’s Investor Service became the last of the major three agencies to downgrade the country.
Both Moody’s and fellow ratings giant Standard & Poor’s (S&P) to date remain more circumspect than Fitch on Turkey’s prospects. In October, Moody’s said Turkey should do more to ward off the risk of balance of payments shocks to justify investment grade, while S&P lowered the country’s sovereign debt outlook in May from positive to stable.
However, Fitch’s upgrade was not altogether unexpected, given Turkey’s macroeconomic performance of late and, despite their words of caution, expectations are rising that other agencies will follow suit.
“Analysts had been expecting this positive ratings action, therefore the upgrade was already priced into the stock market to a certain extent, Özgür Güneri, the CEO of Finans Asset Management, told OBG. “However, over the medium to long-term, the upgrade will support asset values and market liquidity, and possibly lead to a more growth-friendly interest rate environment.”
Turkey’s leaders have welcomed the upgrade, with Finance Minister Mehmet Şimşek saying the decision signalled confidence in the country and could help bolster economic growth. The move is also likely to open the gates for investment from funds and institutions that select only investment-grade assets.
Fitch said that its sovereign rating decision was based on a number of factors which it detailed as “...an easing in near-term macro-financial risks as the economy heads for a soft landing and underlying credit strengths including a moderate and declining government debt burden, a sound banking system, favourable medium-term growth prospects and a relatively wealthy and diverse economy”. Within days of its initial announcement, Fitch also upgraded nine Turkish banks.
Fitch has forecast steady GDP expansion in Turkey of 3% this year, rising to 3.8% in 2013 and 4.5% in 2014. The agency added that while Turkey’s long-term potential growth rate of 4-5% may not be as high as emerging markets, it was arguably more manageable, and considerably more than that expected in most of Europe.
It added that both public finances and the private financial sector were sound, with Turkey bucking the trend of rising government debt seen elsewhere. The financial sector was increasingly deep and well capitalised, while a non-performing loan ratio of 2.8% was viewed favourably for a country that had witnessed rapid credit growth. Fitch added that pro-business reforms, including openness to foreign investment, and a culture of entrepreneurship were also important factors.
While acknowledging that the upgrade marks an important step forward for Turkey, analysts have been quick to point out that the country’s debt remains just one notch above non-investment grade. They also highlight some of the factors that still pose a threat to both the economy and the rating.
Fitch considers external imbalances to be the single biggest risk, with the current account deficit (CAD) expected to be $58bn, or 7.3% of GDP, this year, and $63bn (7.2%) in 2013. Progress has been made in reducing the CAD from $77bn (10%) two years ago, partly through efforts to realign the economy towards higher exports. The agency warned, however, that given the volatile international environment “at some point, an external financing shock and a recession are likely”.
Questions are also being asked about how Turkey will continue to tackle inflation, which hit double figures in 2011 due to a combination of rapid growth and international factors. The IMF has forecast a rate of 8.7% for 2012, and inflation creates a challenge for Turkey’s central bank as it looks to find a balance between containing prices and bringing down interest rates over time to lower financing costs for businesses and households.
Turkey’s shift to investment grade status may mark a significant milestone for the country. But, with key questions remaining unanswered, even if the other agencies follow Fitch’s vote of confidence, their approach is likely to be one of qualified caution rather than unreserved endorsement.