Overview

  • In our view, less-buoyant external demand and worsening terms of trade could inhibit Turkey's economic rebalancing.
  • We are therefore revising our outlook on Turkey's long-term foreign and local currency sovereign credit ratings to stable from positive, reflecting our view that the ratings on Turkey are likely to stay at the current level during the next 12 months.
  • We are affirming our long- and short-term foreign currency sovereign credit ratings on Turkey at 'BB/B' and our long- and short-term local currency ratings at 'BBB-/A-3'.

Rating Action

On May 1, 2012, Standard & Poor's Ratings Services revised the outlook on 
Turkey's long-term foreign and local currency sovereign credit ratings to 
stable, from positive. At the same time, we affirmed our 'BB/B' foreign 
currency and 'BBB-/A-3' local currency long- and short-term sovereign credit 
ratings on Turkey. We also affirmed the Turkey long- and short-term national 
scale ratings at 'trAA+/trA-1'. The '3' recovery rating and 'BBB–' transfer 
and convertibility (T&C) assessment remain unchanged. (Watch the related 
CreditMatters TV segment titled "What's Behind Standard & Poor's Rating Action 
On The Republic Of Turkey?," dated May 1, 2012.)

Rationale

Less-buoyant external demand and worsening terms of trade (the price of 
exports compared to imports) have, in our view, made economic rebalancing more 
difficult, and have increased the risks to Turkey's creditworthiness given its 
high external debt and the state budget's reliance on indirect tax revenues. 
We have revised the outlook on Turkey's long-term sovereign credit ratings to 
stable from positive, reflecting our view that the ratings are likely to 
remain at the current level during the next 12 months.

Under our sovereign ratings criteria (see "Related Criteria And Research" 
below), the key constraints on Turkey's ratings are:
  • Its external vulnerability as measured by high net external debt and gross external financing needs relative to its capacity to generate foreign currency (measured by current account receipts [CARs]).
  • Modest income levels. We estimate Turkey's GDP per capita at $9,840 at end-2011, which is below the majority of its trading partners but compares well with similarly rated sovereigns. This reflects modest levels of absolute productivity, as well as low labor participation rates, especially among women.
  • Risks related to the 2010-2011 credit boom. Turkey's real GDP growth of more than 8% annually over the past two years was mostly driven by rapid domestic credit expansion, financed mainly by short-term external funding to banks. Domestic demand, particularly via import-intensive private consumption and investment in nontradable sectors, mainly contributed to this rapid GDP growth.
As a result of the above factors, Turkey's current account deficit (CAD) 
exceeded 40% of CARs in 2011 (about 10% of GDP) and the financial sector's net 
external debt rose to 40% of CARs at end-2011, versus 7% at end-2009. We 
estimate that Turkey's gross external financing needs (current account payment 
plus short-term external debt by residual maturity) will reach 142% of CARs 
plus usable reserves in 2012, one of the highest ratios for a rated sovereign. 
This heavy reliance on external savings exposes Turkey to shocks, either 
domestic--for example if recent high domestic credit growth were to result in 
future bad loans--or external, say if rising risk aversion were to deter 
foreign investors and banks and result in a net outflow of foreign capital. 
Such external shocks could lead to a rapid depreciation of the Turkish lira, 
with a significant pass-through to inflation. In turn this could increase 
domestic interest rates and have a potential negative secondary effect on 
government borrowing costs. In addition, we note that Turkish banks obtained 
about $14.8 billion (8% of CARs) of foreign currency funding through 
repurchase agreements of local currency securities with foreign banks at 
end-2011; this exposes banks to margin calls should bond prices fall or the 
Turkish lira depreciate.

Our ratings on Turkey are supported by our view of its generally effective 
policymaking and institutions, its moderate and declining public debt burden, 
and its monetary policy flexibility. In our view, a floating exchange rate 
regime can work as a channel of nominal adjustment for economies like Turkey 
that are exposed to potentially volatile capital inflows. As the Turkish lira 
has weakened since the second half of 2011, we expect domestic demand for 
imports to moderate and Turkish exports to become more competitive. However, 
we believe the competitiveness gain from weaker exchange rates will probably 
be partly offset by wage inflation through indexation. During fourth-quarter 
2011, credit growth decelerated as the cost of external funding increased. The 
Banking Regulation and Supervisory Agency of Turkey has also implemented 
macroprudential measures that have helped manage credit growth. In our view, 
however, Turkey's central bank's monetary policy--with stable policy repo 
rates but frequently adjusted and diverging overnight rates--has been less 
effective in influencing monetary conditions or narrowing Turkey's sizable 
external deficit. This has been partly due to the highly accommodative 
monetary policies of global central banks in advanced economies.

We believe that the government will aim to stabilize net general government 
debt to GDP at around 35% by 2015, despite our expectation that GDP will slow 
to 2% in 2012 as credit growth decelerates. We estimate that the general 
government primary surplus will likely have reached 1% of GDP in 2011 before 
deteriorating mildly over the ratings horizon (2012-2015) due to our forecast 
of economic slowdown. In our opinion, much of 2011's expected fiscal 
outperformance is due to temporary factors, including what we view to have 
been an unsustainable, credit-driven, year-on-year expansion of nominal GDP by 
some 15%, as well as the government's success in raising funds by tax 
amnesties. While Turkey's large and resilient economy benefits from a young 
and rapidly growing population, the social security deficit continues to be 
the major driver of headline general government deficit, highlighting the need 
for social security reform.

Outlook

The stable outlook reflects our view that the key risks to the Turkish economy 
will likely remain in balance in the next 12 months.

If external demand is stronger than we have assumed in our base case scenario, 
and the Turkish economy continues to shift toward net-export-driven growth, 
its external imbalances could unwind without the fiscal accounts significantly 
weakening or banks destabilizing. As of April 2012, the banking sector 
continued to report a loan-to-deposit ratio of just under 100%, compared with 
less than 80% at end-2009. As Turkey moves toward more-balanced and 
sustainable growth, its sovereign credit standing could improve.

We could consider a positive rating action if we see that structural reforms 
to the social security and energy sectors, and to education and labor policy, 
have boosted foreign direct investment and GDP growth. Creditworthiness could 
also improve, in our view, were the Turkish government to rationalize public 
spending and reduce budgetary vulnerabilities in the medium-to-long term.

On the other hand, if external demand is weaker than our baseline assumption, 
or Turkey's oil import price rises further and external financing costs 
increase, economic adjustment would be seen in a sharper contraction in 
domestic demand. In our view, this could adversely affect Turkey's fiscal 
account as well as Turkish banks' credit quality, thus potentially weakening 
Turkey's creditworthiness and placing pressure on the ratings.

Moreover, a continued abundant supply of liquidity, globally, could exacerbate 
imbalances in Turkey. In our view, a delayed correction would increase the 
risk of reduced access to external funding and could also weaken the 
government's fiscal accounts beyond our current expectations, which could 
place downward pressure on the ratings.

Related Criteria And Research

Ratings List

Ratings Affirmed; CreditWatch/Outlook Action
                                        To                 From
Turkey (Republic of)
 Sovereign Credit Rating
  Foreign Currency                      BB/Stable/B        BB/Positive/B
  National Scale Rating                 trAA+/--/trA-1     
  Transfer & Convertibility Assessment  BBB-               
 Senior Unsecured                       BB                 
  Recovery Rating                       3

Turkey (Republic of)
 Sovereign Credit Rating
 Local Currency                         BBB-/Stable/A-3    BBB-/Positive/A-3
 Senior Unsecured                       BBB-               


Complete ratings information is available to subscribers of RatingsDirect on 
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Primary Credit Analyst:Eileen X Zhang, CFA, London (44) 20-7176-7105;
eileen_zhang@standardandpoors.com
Secondary Contact:Frank Gill, London (44) 20-7176-7129;
frank_gill@standardandpoors.com
Additional Contact:Sovereign Ratings;
SovereignLondon@standardandpoors.com

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