Rating action

Scope Ratings GmbH (Scope) has today upgraded Türkiye's foreign-currency long-term issuer and senior unsecured debt ratings to B, from B-. Türkiye’s long-term issuer and senior unsecured debt ratings in local currency have been upgraded to B+, from B. The Outlooks on Türkiye’s long-term ratings in both foreign and local currency have been maintained at Positive. The short-term issuer ratings have been affirmed at S-4 in foreign and local currency, with Stable Outlooks.

The upgrade of Türkiye’s long-term ratings reflects more effective economic policies driven by monetary policy tightening and stronger fiscal discipline. The current policy stance supports the gradual rebalancing of the economy, the narrowing of external gross financing needs, and the replenishment of net international reserves. In Scope’s opinion, this reduces the likelihood of balance-of-payments and/or financial crisis.

The maintenance of the Positive Outlooks is driven by Scope’s expectation that the current policy stance will be maintained over the forecast horizon to support a material decline in inflation, lower current account deficits, and a further increase in external liquidity buffers.

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Key rating drivers

Effective economic policies raise the prospects of a material decline in inflation. The Central Bank of the Republic of Türkiye (CBRT) has sustained monetary policy tightening, with cumulative policy rate hikes of 4,150 basis points since policy shift operated in 2023. The CBRT increased again policy rates in March 2024 (500 basis points to 50%)¹, which has been complemented by quantitative tightening decisions and the simplification of the macroprudential framework. The CBRT’s track record in inflation targeting supports an enhanced credibility, independence, and effectiveness of monetary policy, reducing the risk of policy reversal.

The forward guidance of the CBRT points to the maintenance of high rates until a significant and sustained decline in inflation is observed². Commitment to establish a disinflationary course raises confidence that inflation will start receding in the second half of this year³. Although inflation remains high (75.4% year-on-year in May 2024), it is projected to decline from a projected 56% in 2024 to 38% in 2025 based on stronger monetary transmission, favourable base effects, and enhanced coordination with fiscal policy.

Stronger fiscal discipline further supports confidence in the disinflation process. The central government deficit is projected at 5.4% of GDP in 2024, after 5.2% of GDP in 2023⁴, based on the budget surplus recorded in May 2024 (TRY 219bn, or around USD 7bn) and a potential tax reform considered by the authorities. This could include, among others, the removal of VAT exemptions, a tax on financial and real estate income, and a minimum corporate tax. Altogether, those measures could generate a substantial increase in revenue according to the Finance Ministry and the Revenue Administration. However, only part of those measures is expected to be introduced gradually. Even so, the government plans to lower current expenditures, while earthquake-related spending could be lower than expected because of limited absorption capacity. Assuming a durably more restrictive fiscal stance, the general government debt is set to moderately increase from 29.5% of GDP in 2023 to 31.3% in 2024 and around 33% by 2029⁵.

Overall, more effective monetary and fiscal policies support the gradual rebalancing of the economy. The domestic economic activity is expected to be increasingly led by net exports rather than domestic demand. Real GDP growth is projected at 3.0% in 2024, down from 4.5% in 2023, and 3.2% in 2025 as high inflation weighs on consumer demand. Even so, the economy has proven to be resilient to policy mix adjustments and external shocks. Real GDP growth is projected to hover around 3.5% over the forecast horizon.

Narrowing current account deficits support the replenishment of international reserves. Current account deficits are projected to decline from 4.0% of GDP in 2023 to around 2.5% in 2024 based on lower consumer and gold imports. This drives the decline of external gross financing needs, estimated at USD 250bn in 2024 (22.4% of GDP), down from USD 270bn in 2023 (24.3% of GDP). In the longer run, a durably more restrictive policy stance should enable current account deficits to decline further around 2% in 2025 and 2026, mitigating external funding needs. Moreover, the maintenance of high policy rates and projected decline in inflation supports a more favourable investor sentiment and net capital inflows.

Lower current accounts deficits raise the prospects for durably higher external liquidity buffers. The CBRT’s net foreign assets, after adjusting for foreign currency swaps, have continued to increase from a negative position of USD 52bn as of end-April 2024 to a positive of USD 4bn as of mid-June 2024, or its highest since early 2020. The enhanced external position of the CBRT is also reflected in gross international reserves, which have increased to USD 146.3bn as of mid-June 2024, or about 5 months of imports. Importantly, higher liquidity buffers lower the dependence of the CBRT to foreign-currency swap arrangements with domestic banks.

Finally, tight credit conditions and higher external liquidity buffers raise confidence into lira denominated assets and support the de-dollarisation⁶. The funding of the banking system has improved with a decline in currency swap transactions against the Turkish lira, reflecting higher domestic savings in local currency. The share of FX-protected deposits in total deposits have continued to decline (from around 20% as of end-2023 to about 13% as of mid-June 2024), alike the share of hard-currency deposits (from 40% to 37% over the period). Overall, the net FX position of the banking sector has improved (from minus TRY 19bn in February 2023 to TRY 95bn in April 2024), bolstering the resilience of domestic banks against external shocks and mitigating risk related to Türkiye’s external debt (USD 500bn, or about 45% of GDP).

Rating challenges: high inflation, lingering external and financial stability risks

Türkiye’s long-term ratings are constrained by persistently high inflation, materially above that of sovereign peers, increasing vulnerability to external shocks. The authorities may have limited room for maneuver to accommodate additional pressure on domestic prices. The inflation outlook is vulnerable to exchange rate depreciation as the CBRT’s intervention on foreign exchange market is constrained by moderate net international reserves relative to external gross financing needs. Pension and wage revalorisation, high dollarization, and a record of unconventional economic policies could also delay the disinflation process. Credit challenges are compounded by lingering external and financial risks, as well as institutional and geopolitical risks, and high regional instability.

Outlook and rating sensitivities

The Positive Outlook reflects Scope’s view that risks to the ratings are titled to the upside over the coming 12 to 18 months.

Upside scenarios for the ratings and Outlooks are (individually or collectively):

1. Current monetary policy normalisation is continued in a consistent manner, durably enhancing the credibility, independence, and effectiveness of the central bank, leading to a decline in inflation;
    
2. Fiscal discipline is pursued in a consistent manner, supporting enhanced coordination of the policy mix and enabling to gradually reduce the budget deficit;
    
3. External vulnerabilities are reduced, due, for example, to a narrowing of current account deficits, an increase in capital inflows, a de-dollarisation of the economy, and durably higher international reserves;

Downside scenarios for the ratings and Outlooks are (individually or collectively):

1. Failure to maintain a restrictive monetary policy stance and fiscal discipline threatens the disinflation process and the gradual rebalancing of the economy;
    
2. External vulnerabilities increase significantly, due, for example, to a sharp decline in international reserves, increasing the likelihood of balance-of-payments and/or financial crisis;
    
3. Severe domestic political pressure and/or an acute deterioration in security conditions and international relations adversely impact the economy.

Sovereign Quantitative Model (SQM) and Qualitative Scorecard (QS)

Scope’s SQM, which assesses core sovereign credit fundamentals, signals a first indicative credit rating of ‘bbb+’ for Türkiye. Under Scope’s methodology, the indicative rating receives 1) no positive adjustment from the methodological reserve-currency adjustment; and 2) two-notch negative adjustment from the methodological political-risk quantitative adjustment. On this basis, a final SQM quantitative rating of ‘bbb-’ is reviewed by the Qualitative Scorecard (QS) and can be changed by up to three notches depending on the size of the Türkiye’s qualitative credit strengths or weaknesses compared against a peer group of sovereign states.

Scope has not identified QS relative credit strength for Türkiye. Conversely, the following credit weaknesses have been identified in the QS: i) macro-economic stability and sustainability; ii) long-term debt trajectory; iii) debt profile and market access; iv) current account resilience; v) external debt structure; vi) resilience to short-term external shocks; vii) financial sector oversight and governance; viii) financial imbalances; ix) environmental factors; and x) governance factors.

On aggregate, the QS generates a three-notch negative adjustment for Türkiye’s credit ratings. An extraordinary one-notch downside adjustment is applied across foreign- and local-currency long-term ratings to account for years of significant weaknesses in macro-financial management, which are balanced by a gradual unwinding of economic imbalances. A further one-notch downside adjustment is applied for foreign-currency issuer and senior unsecured long-term ratings to account for lower albeit still high balance-of-payments risks. Together these adjustments indicate final B / B+ long-term foreign- and local-currency ratings for Türkiye.

A rating committee has discussed and confirmed these results.

Environment, social and governance (ESG) factors

Scope explicitly factors in ESG issues in its ratings process vis-à-vis the sovereign-rating methodology’s stand-alone ESG sovereign-risk pillar, which holds a significant 25% weighting under the quantitative model (SQM) and 20% weight under the methodology’s qualitative overlay (QS).

Environmental factors are explicitly considered in the ratings process via an environment sub-category of the ESG sovereign risk pillar. Türkiye’s exposure to natural disasters is considered high as the country is exposed to earthquakes and landslides. Although Türkiye issued its first green bond in April 2023, the country faces 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 SQM via accounting for the economy’s comparatively low rate of labour force participation and a comparatively high level of income inequality. Although the unemployment rate is high, the old-age dependency ratio compares favourably against that of indicative peers, and demographic growth is positive. Together with the reduction of absolute poverty and the improvement of education, this 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 SQM. Performance on voice and accountability, rule of law, control of corruption, regulatory quality, and government effectiveness having declined over the last decade. This supports Scope’s ‘weak’ qualitative assessment relative to sovereign 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, Press Release on Interest Rates, 23 May 2024
2. Central Bank of the Republic of Türkiye, Speech at the Briefing on Inflation Report 2024-II, May 2024
3. Central Bank of the Republic of Türkiye, Inflation Report, 2024-II Inflation Report, 9 May 2024
4. Republic of Türkiye, Ministry of Treasury and Finance, Turkish economy, 15 April 2024
5. Republic of Türkiye, The Medium Term Program (2024-2026), September 2023
6. Central Bank of the Republic of Türkiye, Financial Stability Report, May 2024

Methodology
The methodology used for these Credit Ratings and/or Outlooks, (Sovereign Rating Methodology, 29 January 2024), is available on https://scoperatings.com/governance-and-policies/rating-governance/methodologies.
The model used for these Credit Ratings and/or Outlooks is (Sovereign Quantitative Model Version 3.0), 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     NO
With access to internal documents                                  NO
With access to management                                           NO
The following substantially material sources of information were used to prepare the Credit Ratings: 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/or Outlooks and the principal grounds on which the Credit Ratings and/or Outlooks are based. Following that review, the Credit Ratings were not amended before being issued.

Regulatory disclosures
These Credit Ratings and/or Outlooks are issued by Scope Ratings GmbH, Lennéstraße 5, D-10785 Berlin, Tel +49 30 27891-0. The Credit Ratings and/or Outlooks are UK-endorsed.
Lead analyst: Thomas Gillet, Director
Person responsible for approval of the Credit Ratings: Giacomo Barisone, Managing Director
The Credit Ratings/Outlooks were first released by Scope Ratings in January 2003. The Credit Ratings/Outlooks were last updated on 26 April 2024.

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, as well as a list of Ancillary Services and certain non-Credit Rating Agency services provided to Rated Entities and/or Related Third Parties.

Conditions of use / exclusion of liability
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