(The following statement was released by the rating agency)
Aug 23 - Fitch Ratings says in a newly-published report that the Turkish economy is making solid progress in returning to a sustainable growth rate, while narrowing the current account deficit (CAD) and reducing inflation. However, its large external financing requirement still leaves it vulnerable to adverse shocks to the global financial environment.
The agency has previously identified achieving a soft landing of the economy - after it overheated and generated large macroeconomic imbalances in 2011 - as the main constraint on an upgrade to investment grade (see Full Rating Report on Turkey, dated 24 November 2011 at www.fitchratings.com.). Further progress in navigating a path back towards its potential growth rate, with inflation falling toward its target rate and the CAD narrowing to a more sustainable level could lead Fitch to upgrade Turkey’s Long-term Issuer Default Ratings to ‘BBB-‘ from ‘BB+’.
In Fitch’s view, the Turkish economy overheated in 2011: GDP growth was 10% in H111, the CAD hit 10% of GDP in 2011 and end-year inflation was in double digits, leaving it with a challenge of rebalancing, and vulnerable to a sharp correction (although this was not the agency’s base case).
GDP growth has slowed in each of the past five quarters and contracted by 0.4% in Q112 (qoq seasonally adjusted, though was still up 3.2% yoy). Fitch expects Turkey to avoid a formal recession as more timely activity indicators suggest an increase in GDP in Q212. Strong export growth is helping to offset a more abrupt slowdown in domestic demand, as well as narrowing the trade deficit. The agency forecasts GDP growth of 2.8% in 2012 and 4.5% in 2013.
A remarkable boom in exports to the Middle East and North Africa (up 48% in H112 yoy) raised their share of the total to 36% in June 2012, close to parity with the EU and more than offsetting a drop in exports to the EU (by 6%). Iran and Iraq alone accounted for nearly two-thirds of export growth, while gold exports surged by 600% (probably to a large extent to Iran, where international sanctions are biting). However, diversifying away from the EU to such a volatile region, particularly Iran, may be a risky strategy.
The sharp slowdown in domestic demand and strong export performance reduced the CAD to USD63.5bn in the 12 months to June 2012, from a peak of USD78.6bn in October 2011. This is reducing risks to Turkey’s creditworthiness. Fitch forecasts a CAD of USD60bn (7.5% of GDP) in 2012 and USD59bn (6.6%) in 2013.
Despite global uncertainty, capital inflows have been more than sufficient to finance the CAD and roll over Turkey’s external debt in 2012. Such resilience is especially impressive in light of the funding strains and increasing home bias in the EU, which is the source of 75% of the foreign direct investment stock and 83% of international bank lending. Furthermore, the mix of financing has improved since mid-2011, with lower dependence on short-term debt, portfolio inflows and the repatriation of overseas assets.
Recent outturns show a cooling in inflation pressures, with month-on-month declines in May, June and July. Fitch forecasts the 12-month inflation rate to decline from its high rate of 9.1% in July (core 7.5%) to 6.4% in December 2012 as large monthly price increases in H211 drop out of the calculation. Nonetheless, this would still be well above the central bank’s end-year inflation target of 5% and would be the fifth time in seven years that it would have exceeded its target, underlining the challenge of entrenching low inflation.
Notwithstanding the good progress towards a soft landing, Turkey’s CAD and external financing needs are still large, leaving it vulnerable to a sudden stop in international capital inflows for example, if there were material worsening in the eurozone crisis. Exporters’ exposure to Middle Eastern markets also carries risks. Over the medium term, Turkey needs to raise its domestic savings rate to help it to grow robustly without generating imbalances and reduce its vulnerability to shocks.
Link to Fitch Ratings’ Report: Turkeyâ€™s Soft Landing on Track, So Far