Turkish Central Bank Governor Speech, Fitch downgrade and S&P action

Central Bank Governor Murat Cetinkaya will present the bank’s new quarterly inflation report at a press conference tomorrow. The press conference will start at 7:30am London time. The bank will have to raise its previous end-2016 inflation forecast of 6.5% considerably higher given the sharp depreciation of the lira since the end-October inflation report. Cetinkaya is likely to maintain the monetary policy committee’s (MPC) hawkish stance in its post-meeting statement on 24 January which kept the door open for further monetary policy tightening. Cetinkaya’s comments on the lira’s exchange rate and the central bank’s liquidity policy will also be closely watched by the market.

The central bank’s effective funding rate was 10.27% on Friday (27 January), up from 8.28% on 6 January before the sharp sell-off in the lira started. The central bank released on Friday (27 January) the calendar of its MPC meetings this year. The central bank reduced the number of its meetings to 8 from 12 previously. Following the first meeting of the year which has already taken place on 24 January, the MPC will hold meetings on 16 March, 26 April, 15 June, 27 July, 14 September, 26 October and 14 December.

The Statistics Office will release the December foreign trade data tomorrow and the January inflation data on Friday (3 February).  We forecast that the foreign trade deficit was $5.6bn in December, in line with the preliminary estimate and the Bloomberg consensus forecast.  We forecast that the January CPI inflation was 1.4% mom, compared to the Bloomberg consensus forecast of 1.8% mom. If January CPI inflation turns out to be less than 1.8% mom, the year-on-year headline will decline from 8.5% in December due to favorable base effects. We think the margin of error around the January forecast is quite large given the uncertainty around the extent of the pass-through from the lira’s rapid (and somewhat unexpected) depreciation in early January.

Fitch downgraded on Friday Turkey’s long-term foreign currency issuer default rating to BB+ from BBB- and assigned a “stable” outlook to it. Turkey’s previous BBB- rating – the lowest investment grade rating – was placed on “negative” outlook following the failed coup attempt in July 2016, and Friday’s downgrade was widely expected by the market. The main driver for the rating decision was Fitch’s assessment that “political and security developments have undermined economic performance and institutional independence” and that “while the political environment may stabilize, significant security challenges are set to remain.” The rating agency also opined that if the constitutional reform is approved in a referendum, it “would entrench a system in which checks and balances have been eroded.” Fitch also noted that the scope of the “purge of the public sector of the supporters of the group that the government considers responsible for the coup attempt in July” has “extended to the media and other groups” and has “unnerved some participants in the economy.” Additionally, the rating agency said that “high-profile terrorist attacks have continued, damaging consumer confidence and the tourism sector.”

As a secondary driver, Fitch noted that “the failure to address long-standing external vulnerabilities has been manifest in a sharp fall in the currency” and that although the rating agency “does not expect systemic problems that would jeopardize financial stability or trigger a balance of payments crisis,” it “does assume a detrimental impact on the private sector.” Fitch noted that “evolving domestic and external conditions bring the potential for further tests of Turkey’s ongoing resilience in external financing.” The rating agency expects real GDP growth “to average 2.3% between 2016 and 2018, compared with an average of 7.1% over the five years ending 2015 (based on new data after a credible GDP revision).” As for the banking sector, Fitch noted that “sector capitalization, supported by adequate NPL reserve coverage, is sufficient to absorb moderate shocks, but sensitive to further lira depreciation and NPL growth” and added that “refinancing risks have increased, although foreign currency liquidity remains broadly adequate to cover short-term sector wholesale funding liabilities due within one year.”

As for possible rating actions in the future: Fitch said that the country’s sovereign credit rating could see further negative action if, individually or collectively, it observes “heightened stress stemming from external financing vulnerabilities”, “weaker public finances reflected by a deterioration in the government debt/GDP ratio” and “a deterioration in the political and security situation”. For the possibility of a positive rating action, the rating agency has to observe, individually or collectively, “implementation of reforms that address structural deficiencies and reduce external vulnerabilities” and “a political and security environment that supports a pronounced improvement in key macroeconomic data.”

Also on Friday, S&P revised its outlook on Turkey’s unsolicited sovereign credit ratings to “negative” from “stable”. The rating agency affirmed Turkey’s BB long-term foreign currency sovereign rating. S&P said that since it last revised Turkey’s rating on 4 November 2016, “the lira has depreciated by 18% against the US dollar and 15% against the euro”, and that “the monetary policy response to currency and inflationary pressures of Turkey’s central bank may prove insufficient to anchor its inflation-targeting regime.” According to S&P, “given the large-scale dollarization of Turkey’s economy, a weaker exchange rate erodes corporate balance sheets, financial sector asset quality, and growth. “ The rating agency said that the decision reflects “what we consider to be rising constraints on policy makers’ ability to tame inflationary and currency pressures, which could weaken the financial strength of Turkey’s companies and banks, undermining growth, and fiscal outcomes, during a period of rising global interest rates.”