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Rating action

Scope Ratings has today affirmed Türkiye's foreign-currency long-term issuer and senior unsecured debt ratings of B-. Türkiye’s long-term issuer and senior unsecured debt ratings in local currency are affirmed at B. The Outlooks on Türkiye’s long-term ratings in both foreign and local currency have been revised to Stable from Negative. The short-term issuer ratings have been affirmed at S-4 in foreign and local currency, with Stable Outlooks.

Summary and Outlook

The revision of the Outlooks to Stable from Negative reflects Türkiye’s recent track record of a more conventional policy mix following general elections in May 2023. The recent policy measures taken by the governor of the central bank of the Republic of Türkiye (CBRT) and the Minister of Treasury and Finance have contributed to reduce the significant external and financial imbalances resulting from a protracted period of unorthodox monetary policy. Recent policy changes, including large and consistent policy rate hikes and the simplification of prudential regulations, have improved Scope’s assessment of the credibility, independence, and effectiveness of the CBRT. Still, even though President Recep Tayyip Erdoğan publicly supports the current policy stance, a sharper than expected economic slowdown may test the durability of the current economic management.

A sustained track record of orthodox economic and monetary policies before and after municipal elections scheduled for March 2024 will be central for the rating trajectory. Either a pause or an end to the monetary policy tightening cycle, while real policy rates remain deeply negative, inflation significantly above the CBRT’s target, and international reserves below adequacy ratios, would point to political interference in monetary decisions. Conversely, the sustained continuation of the policy normalisation process^1,2, which is Scope’s current working assumption, would be credit positive as it would support a gradual rebalancing of the economy, its resilience to external shocks, and thus lowers the likelihood of deeper balance-of-payments and/or financial crisis. In the near to medium term, external and financial risks remain prominent given high inflation, the CBRT’s negative net foreign assets position and the critical need for the banking sector to continue to finance the sovereign in foreign currency.

The affirmation of Türkiye’s credit ratings acknowledges multiple strengths supporting the sovereign’s credit profile, importantly reflecting comparatively moderate levels of central government debt, a resilient banking system able to supply liquidity to the sovereign, a large and diversified economy, as well as a comparatively strong medium-run growth potential.

The Stable Outlook represents Scope’s opinion that risks to the sovereign ratings are balanced over the next 12 to 18 months. Türkiye’s recent pivot towards a more conventional macroeconomic policy-mix following the 2023 general elections is balanced by the country’s record of policy reversals.

The ratings could be upgraded or the Outlook(s) revised to Positive if, individually or collectively: i) the current policy normalisation is continued in a consistent manner, durably enhancing the predictability and effectiveness of macro-economic policy making; and/or ii) external vulnerabilities are significantly reduced, due, for example, to a narrowing of current account deficits, improved capital inflows, and a sustained rise in net international reserves.

Conversely, the ratings could be downgraded or the Outlook(s) revised to Negative if, individually or collectively: i) the re-introduction of unconventional policies threatens the rebalancing of the economy; ii) macroeconomic stability is undermined by more severe balance of payment pressures and/or a curtailed financial strength of the banking system; and/or iii) severe domestic political pressure and/or an acute deterioration in security conditions and international relations adversely impact the economy.

Rating rationale

The revision of the Outlooks to Stable on Türkiye’s foreign-currency B- ratings reflects its recent monetary policy normalisation following the 2023 general elections, which has improved the inflation outlook, moderated external risks and lowered financial stability risks. Over time, a more restrictive monetary policy would support the gradual rebalancing of the economy and enhance Türkiye’s growth model.

Following President Recep Tayyip Erdoğan’s re-election in May 2023 for another five-year term, the CBRT has refocused on inflation targeting and raised the one-week repo auction rate by 3,400 basis points on a cumulative basis, from 8.5% in May 2023 to 42.5% as of end-December 2023,^3,4 its highest level since the early 2000s. The magnitude of policy rate hikes is materially above that observed between June and September 2018 (1,600 basis points) and between August 2020 and March 2021 (1,075 basis points). A larger than expected policy rate hike of 500 basis points in November 2023, compounded by selective credit and quantitative tightening, reflects the determination of the CBRT to initiate a disinflation course in the near term. It illustrates an adequate monetary policy response to soaring inflation, which rose from 39.5% year-on-year in May 2023 to 64.8% in December 2023 as the CBRT has relinquished control on the lira with no commitment to targeting a certain exchange rate level. Annual average inflation declined from 72% in 2022 to 55% in 2023, thanks to large base effects on energy prices, tighter funding conditions and an enhanced monetary policy transmission. Still, Scope projects inflation to reach 60% in 2024 as the lira depreciates. The policy rate is projected to stabilise at 45% as of end-2024 before moderately declining at 40% as of end-2025.

Moreover, the CBRT has pursued the simplification of prudential regulations,^5,6 boosting demand for lira-denominated assets. With the objective to transition from foreign currency protected savings accounts to conventional lira deposits, the CBRT decided, among others, to: i) introduce a reserve requirement ratio on foreign currency protected accounts⁷; ii) introduce a target for banks to convert maturing foreign-currency protected deposits into lira deposits⁸; and iii) increase the reserve requirement ratio for foreign-currency deposits.⁹ These adjustments led to: i) a 23% reduction in the outstanding balance of deposits under the foreign-currency protected scheme since August 2023, to TRY 2,626bn as of end-December 2023; ii) an increase in the share of lira deposits in total deposits by around 2.5 percentage points over the period; and iii) a reduction of financial distortions, with the weighted average rate on lira deposits (47.1% as of end-December 2023) falling below the weighted average interest rate paid on commercial loans (53.5%).

Monetary policy tightening and the simplification of prudential regulations have also improved the operating environment of Turkish banks, strengthened their resilience, and lowered external funding pressures. The net foreign exchange position of the banking sector recovered from USD 0.1bn as of end-May 2023 to USD 3.1bn as of end-December 2023. This reduces the probability that banks need to access foreign-currency liquidity parked at the CBRT, either to repay external liabilities or foreign-currency deposit withdrawals in a downside scenario. The improvement of the net foreign currency position of non-financial corporates further mitigates risks.

Furthermore, a more conventional monetary policy supports the reduction of external risks. This is reflected in: i) the moderation of the trade deficit (USD 99.9bn on a cumulative basis between January and November 2023, unchanged compared to the same period in 2022); ii) the stabilisation of the year-to-date current account deficit (USD 40.7bn in October 2023 vs USD 42.5bn in July 2023); and iii) the expected decline of external gross financing needs (estimated at USD 250bn in 2024 or about 19% of GDP vs USD 270bn in 2023 or 24% of GDP).

Moreover, the ability of Türkiye to fund external imbalances has been supported by a more favourable foreign investor sentiment including around local currency assets. Following the issuance of a 5-year dollar denominated sukuk of USD 2.5bn at 8.5% in November, Türkiye plans international bond issuance at USD 10bn in 2024, unchanged from 2023. Finally, the monetary policy pivot enabled Türkiye to start rebuilding external buffers, as seen by the rise in gross international reserves excluding gold (USD 92.8bn in December 2023 vs USD 55.7bn in May 2023) and in the net foreign asset position of the CBRT (positive USD 34.9bn as of end-December 2023 vs minus USD 4.4bn in May 2023).

Overall, monetary policy tightening and the simplification of prudential regulations support the progressive rebalancing of Türkiye’s economy, underpinning Scope’s decision to revise the Outlook to Stable. As credit growth slows, with banking sector loans in lira growing by 67% year-on-year on average between June and November 2023, vs 85% between January and May 2023, Scope expects Türkiye’s economy (nominal GDP of about USD 990bn in 2023) to gradually shift from being primarily led by private consumption towards more investment and exports. In this context, Scope expects an economic slowdown from 4.1% in 2023 to 3.3% in 2024 as private consumption adjusts to the more restrictive funding conditions.

Despite these recent improvements, Türkiye’s foreign-currency B- ratings remain anchored by persistent policy uncertainty amid still large external and financial vulnerabilities. A premature termination of the ongoing policy normalisation cycle and/or a policy reversal could compromise the reduction of economic and financial distortions.

Following years of unconventional policy, challenges remain significant as completing the current tightening cycle would require maintaining rates at their peak for a prolonged period. Despite significant rate hikes, real policy rates have only moderately increased from minus 31% in May 2023 to minus 22% in December 2023. The CBRT’s forward guidance points to the completion of the cycle in a short period of time, followed by the maintenance of restrictive funding conditions to ensure price stability. The CBRT projects that inflation will rise throughout the first half of 2024 – amid minimum wage increase (49% since July, 100% since January 2023), tax hikes and higher administrated prices – and that end-year inflation is set to decline from 65% in 2023 to 36% in 2024. On that basis, real policy rates are unlikely to return to positive territory before Q4 2024 or Q1 2025, almost two years after the start of monetary policy normalisation.

This period of higher rates could be contractionary for the economy and increases the risks of political interference. The authorities could pause or prematurely end monetary policy normalisation if the economic slowdown is sharper than anticipated, or even take policy actions contradicting the policy stance introduced after general elections if the economy falls into recession. Those adverse scenarios would make the 5% inflation target less achievable, undermine the gradual rebalancing of the economy and maintain pressure on international reserves. Although not Scope’s baseline, downside risks remain on the durability of the current policy pivot given Türkiye’s track record of policy reversals, highly centralised decision-making and politicisation of independent institutions.

Furthermore, reducing external gross financing needs while rebuilding adequate buffers will require time and a consistent conventional policy mix. External vulnerabilities are still large, as reflected in: i) the surge in gold imports (+75% between January and October 2023 compared to the same period in 2022), pointing to low confidence in the lira; ii) the uncertain trajectory of the current account balance amid high import dependence and large errors and omissions, highlighting risks related to exports to Russia and/or highly volatile foreign capital flows; and iii) limited gross international reserves excluding gold (USD 92.8bn in December 2023) compared to gross financing needs (estimated at USD 250bn in 2024). In addition, swap-corrected net foreign assets, including the government’s short-term foreign-currency swap liabilities with domestic banks, which are excluded from central bank foreign-currency liability data, remain negative at minus USD 38bn as of end-December 2023, a moderate improvement since minus USD 59bn in May 2023. The negative net reserves of the CBRT point to high dependence on continued forex supply and roll-over of existing foreign-currency swap arrangements with the banking sector. Swaps increased by about USD 17bn between May and December 2023, and the CBRT will continue to conduct transactions in 2024. On that basis, Türkiye remains vulnerable to further tensions on its balance of payments resulting from potential inappropriate policy actions and/or external shocks, including heightened geopolitical tensions.

Financial stability risks are also likely to remain significant until the successful completion of the process to simplify prudential regulations. Unwinding unconventional policy measures is challenging in the context of higher interest rates and inadequate international reserves, which raise risks of mistakes in the calibration and/or sequencing of policy actions.¹⁰ The economy remains highly dollarised, with around 30% of loans and 40% of deposits denominated in foreign currency, and the outstanding balance of foreign-currency protected accounts remains high – about two times that of December 2022 in nominal terms (or about 18% of 2022 GDP). This reflects low confidence in lira-denominated assets, with the local currency depreciating continuously between early May 2023 and end-December 2023 (34% against USD, 34% against EUR) and the real effective exchange rate decreasing by 5%. Moreover, the operating environment remains challenging for local banks due to: i) the economic slowdown induced by more restrictive funding conditions that could weigh on asset quality; and ii) the lira depreciation eroding capital buffers given the mismatch between loans and deposits in foreign currency, as well as large short-term external debt. In Scope’s opinion, there remain risks to the sovereign balance sheet given regular recapitalisation of public banks, as operated in March 2023.

Finally, fiscal pressures are likely to persist due to reconstruction spending following the February 2023 earthquake, although the government’s low debt and broadly stable debt trajectory is a key credit strength. Despite tax hikes introduced after general elections, the central government deficit is projected at 6.4% of GDP in 2023 and 2024, driven by reconstruction spending estimated at 2.5% of GDP in 2024. The deficit is projected at 3.4% of GDP in 2025. Türkiye’s debt trajectory is challenged by: i) sustained fiscal deficits; ii) valuation effects triggered by the lira depreciation, with 65% of central government debt denominated in foreign currency as of November 2023; iii) high inflation, with 6.9% of debt indexed to the consumer price index; and iv) higher refinancing rates. Even so, Scope expects the central government debt-to-GDP to moderate to 31% by 2028 thanks to high nominal growth rates.

Core Variable Scorecard (CVS) and Qualitative Scorecard (QS)

Scope’s Core Variable Scorecard (CVS), which is based on the relative rankings of key sovereign credit fundamentals, provides a first indicative rating of ‘bbb-’ for the Republic of Türkiye. Türkiye receives no positive adjustment under the reserve currency adjustment. As such, a ‘bbb-’ indicative rating can be adjusted by the Qualitative Scorecard (QS) by up to three notches depending on the size of relative qualitative credit strengths or weaknesses against a peer group of countries.

For Türkiye, no relative credit strength has been identified. The following relative credit weaknesses are signalled: i) monetary policy framework; ii) macroeconomic stability and sustainability; iii) fiscal policy framework; iv) debt sustainability; v) debt profile and market access; vi) current account resilience; vii) external debt structure; viii) resilience to short-term external shocks; ix) banking sector oversight; x) financial imbalances; xi) environmental factors; and xii) governance factors.

Combined relative credit strengths and weaknesses generate a three-notch downside adjustment. An extraordinary two-notch downside adjustment is applied across foreign- and local-currency long-term ratings to account for years of significant weaknesses in macro-financial management and high economic imbalances. A further one-notch downside adjustment is applied for foreign-currency issuer and senior unsecured long-term ratings to account for high balance of payments risks. Together these adjustments indicate B- / B long-term foreign- and local-currency ratings for Türkiye.

A rating committee has discussed and confirmed these results.

Factoring of Environment, Social and Governance (ESG)

Scope explicitly factors in ESG sustainability issues during the ratings process via the sovereign methodology’s stand-alone ESG sovereign risk pillar, with a significant 25% weighting in the quantitative model (CVS).

Environmental factors are explicitly considered in the ratings process via an environment sub-category of the ESG sovereign risk pillar. The CVS considers Türkiye’s level of carbon intensity per unit of output that is consistent with the peer average. Nevertheless, exposure to natural disasters is considered high as the country is exposed to earthquakes and landslides. Moreover, Türkiye has middle-of-the-range scoring as compared with ratings peers on an ecological footprint of consumption compared with available biocapacity. Although Türkiye issued its first green bond in April 2023, the country ranks 172 of 180 nations on the 2022 Environmental Performance Index of Yale University, among the lowest in Eastern Europe, reflecting deep challenges on natural resources protection and climate change mitigation. This drives Scope’s ‘weak’ qualitative assessment.

Socially related factors are captured under the sovereign methodology in the CVS via accounting for the economy’s comparatively low rate of labour force participation, especially among women and youth, and a comparatively high level of income inequality. Unemployment rates are high although in line with that of some rating peers. However, the old-age dependency ratio compares favourably against that of indicative peers, and demographic growth is positive. Progress has also been made in the reduction of absolute poverty and improvement of education, which supports Scope’s ‘neutral’ qualitative assessment. 

Under governance-related factors, Türkiye scores weakly relative to rating peers according to the World Bank’s Worldwide Governance Indicators under the CVS – with performance on voice and accountability, rule of law, control of corruption, regulatory quality, and government effectiveness having declined over the last decade. Scope evaluates ‘governance factors’ as ‘weak’ against indicative peers. 

Rating committee
The main points discussed by the rating committee were: i) domestic economic risk; ii) public finance risk; iii) external economic risk; iv) financial stability risk; v) ESG-related risk; and vi) rating peers.

Rating driver references
1. Central Bank of the Republic of Türkiye, Monetary Policy for 2024, December 2023 
2. Presidency of the Republic of Türkiye, The Medium Term Program (2024-2026), September 2023 
3. Central Bank of the Republic of Türkiye, Press Release, December 2023 
4. Central Bank of the Republic of Türkiye, Inflation Report 2023-IV, November 2023 
5. Central Bank of the Republic of Türkiye, Financial Stability Report, November 2023 
6. Central Bank of the Republic of Türkiye, Press Release on the Simplification of the Macroprudential Framework, November 2023 
7. Central Bank of the Republic of Türkiye, Press Release on Selective Credit and Quantitative Tightening Decision, July 2023 
8. Central Bank of the Republic of Türkiye, Press Release on FX-Protected Accounts, August 2023 
9. Presidency of the Republic of Türkiye, Official Newspaper, August 2023 
10. IMF Staff Concludes Staff Visit to Türkiye, October 2023

Methodology
The methodology used for these Credit Ratings and Outlooks, (Sovereign Rating Methodology, 27 September 2023) is available on https://scoperatings.com/governance-and-policies/rating-governance/methodologies.
The model used for these Credit Ratings and Outlooks is (Sovereign CVS Model Version 2.1), available in Scope Ratings’ list of models, published under https://scoperatings.com/governance-and-policies/rating-governance/methodologies.
Information on the meaning of each Credit Rating category, including definitions of default, recoveries, Outlooks and Under Review, can be viewed in ‘Rating Definitions – Credit Ratings, Ancillary and Other Services’, published on https://www.scoperatings.com/governance-and-policies/rating-governance/definitions-and-scales.Historical default rates of the entities rated by Scope Ratings can be viewed in the Credit Rating performance report at https://scoperatings.com/governance-and-policies/regulatory/eu-regulation. Also refer to the central platform (CEREP) of the European Securities and Markets Authority (ESMA): http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml. A comprehensive clarification of Scope Ratings’ definitions of default and Credit Rating notations can be found at https://www.scoperatings.com/governance-and-policies/rating-governance/definitions-and-scales. Guidance and information on how environmental, social or governance factors (ESG factors) are incorporated into the Credit Rating can be found in the respective sections of the methodologies or guidance documents provided on https://scoperatings.com/governance-and-policies/rating-governance/methodologies.
The Outlook indicates the most likely direction of the Credit Ratings if the Credit Ratings were to change within the next 12 to 18 months.

Solicitation, key sources and quality of information
The Credit Ratings were not requested by the Rated Entity or its Related Third Parties. The Credit Rating process was conducted:
With Rated Entity or Related Third Party Participation   YES
With Access to Internal Documents                               NO
With Access to Management                                        YES
The following substantially material sources of information were used to prepare the Credit Ratings: the Rated Entity and public domain.
Scope Ratings considers the quality of information available to Scope Ratings on the Rated Entity or instrument to be satisfactory. The information and data supporting these Credit Ratings originate from sources Scope Ratings considers to be reliable and accurate. Scope Ratings does not, however, independently verify the reliability and accuracy of the information and data.
Prior to the issuance of the Credit Rating action, the Rated Entity was given the opportunity to review the Credit Ratings and Outlooks and the principal grounds on which the Credit Ratings and Outlooks are based. Following that review, the Credit Ratings and Outlooks were not amended before being issued.

Regulatory disclosures
These Credit Ratings and Outlooks are issued by Scope Ratings GmbH, Lennéstraße 5, D-10785 Berlin, Tel +49 30 27891-0. The Credit Ratings and Outlooks are UK-endorsed.
Lead analyst: Thomas Gillet, Director
Person responsible for approval of the Credit Ratings: Alvise Lennkh-Yunus, Managing Director
The Credit Ratings/Outlooks were first released by Scope Ratings in January 2003. The Credit Ratings/Outlooks were last updated on 4 August 2023.

Potential conflicts
See www.scoperatings.com under Governance & Policies/Regulatory for a list of potential conflicts of interest disclosures related to the issuance of Credit Ratings.

Conditions of use / exclusion of liability
© 2024 Scope SE & Co. KGaA and all its subsidiaries including Scope Ratings GmbH, Scope Ratings UK Limited, Scope Fund Analysis GmbH, and Scope ESG Analysis GmbH (collectively, Scope). All rights reserved. The information and data supporting Scope’s ratings, rating reports, rating opinions and related research and credit opinions originate from sources Scope considers to be reliable and accurate. Scope does not, however, independently verify the reliability and accuracy of the information and data. Scope’s ratings, rating reports, rating opinions, or related research and credit opinions are provided ‘as is’ without any representation or warranty of any kind. In no circumstance shall Scope or its directors, officers, employees and other representatives be liable to any party for any direct, indirect, incidental or other damages, expenses of any kind, or losses arising from any use of Scope’s ratings, rating reports, rating opinions, related research or credit opinions. Ratings and other related credit opinions issued by Scope are, and have to be viewed by any party as, opinions on relative credit risk and not a statement of fact or recommendation to purchase, hold or sell securities. Past performance does not necessarily predict future results. Any report issued by Scope is not a prospectus or similar document related to a debt security or issuing entity. Scope issues credit ratings and related research and opinions with the understanding and expectation that parties using them will assess independently the suitability of each security for investment or transaction purposes. Scope’s credit ratings address relative credit risk, they do not address other risks such as market, liquidity, legal, or volatility. The information and data included herein is protected by copyright and other laws. To reproduce, transmit, transfer, disseminate, translate, resell, or store for subsequent use for any such purpose the information and data contained herein, contact Scope Ratings GmbH at Lennéstraße 5 D-10785 Berlin.