Pedestrians pass a digital sign advertising the latest rates for Turkish lira outside a currency exchange bureau in Istanbul, Turkey. Image Credit: Bloomberg

Dubai: A widening current account deficit, raging inflation, a plunging lira and the recent appointment of a new cabinet with more political appointees has added to the plunging international investor confidence in Turkey, according to rating agencies and analysts.

Ratings agency Fitch on Friday downgraded its already junk rating on Turkey’s sovereign debt, citing a widening current account deficit, a jump in inflation and the impact of the plunging lira. Fitch lowered Turkey’s Issuer Default Rating (IDR) to ‘BB’ from ‘BB+’ and attached a negative outlook.

Fitch is the latest among global credit rating agencies to downgrade Turkey’s ratings. “Economic policy credibility has deteriorated in recent months and initial policy actions following elections in June have heightened uncertainty. This environment will make it challenging to engineer a soft landing for the economy,” Fitch said in a statement.

In May this year, Standard & Poor’s cut sovereign debt rating on Turkey further into junk territory, citing widening concern about the outlook for inflation amid a sell-off in the Turkish lira.

S&P said the ratings decision, cutting Turkey to “BB-/B” from “BB/B,” was not part of its regularly scheduled reviews, reflecting what it said were growing concerns.

“The downgrade reflects our concerns over a deteriorating inflation outlook and the long-term depreciation and volatility of Turkey’s exchange rate,” S&P said in a statement at the time of rating downgrade.

Moody’s has placed the country on review for further downgrade just a few months after it lowered its rating on the country by one notch. The agency said that Turkey’s Ba2 ratings could be at risk due to a lack of clarity about what direction economic policy will take, given its external vulnerabilities.

Uncertainites

In a recent note, Moody’s has highlighted concerns about the independence of the Turkish central bank, saying that further challenges to its effectiveness would be negative for Turkey’s sovereign rating.

“Governance changes at Turkey’s central bank further challenge its strength and independence. Legislative changes announced on [last] Monday by Turkey [Ba2 review for downgrade] President Recep Tayyip Erdogan following his inauguration look set to further challenge the independence of Turkey’s central bank,” Moody’s said in a note.

The rating agency expressed its concern on the announced changes to shorten the term of the governor from a minimum of five years to an indicative four years, remove the requirement for deputy governors to have a minimum of 10 years of professional experience and place in the president’s hands sole responsibility for appointing the governor, deputy governor and other members of the country’s Monetary Policy Committee.

Analysts are also concerned that the recent political appointment of Erdogan’s son-in-law Berat Al Bayrak as treasury and finance minister, rather than more experienced figures, adding to investor concerns and further decline in the lira, which briefly fell as low as 5.97 against the dollar last week.

Turkey’s currency will continue to sink against the dollar, according to the UK’s Barclays bank. Barclays predict that, by the end of this year’s third quarter, the dollar/lira exchange rate will reach 4.95 and, by the end of the year, it will hit 5.10. Barclays expect the lira will continue to weaken against the dollar in 2019, reaching 5.25 by the end of the second quarter.

With the weakening of the lira against the dollar, the private sector will have a harder time repaying its foreign currency-denominated debt, analysts expect this would negatively impact government debt — 40 per cent of which is denominated in foreign currency. Numerous large Turkish companies have sought to restructure their debts.

Moody’s said the strongly expansionary fiscal and monetary policies implemented by Turkish authorities in recent months in pursuit of growth have fuelled those imbalances. The real growth rate doubled to 7.4 per cent last year from 3.6 per cent in 2016, substantially above the economy’s 3.5 per cent to 4.0 per cent potential growth rate. That has contributed to high and rising inflation that is widening the current account deficit and strongly undermining investor confidence — and with it the value of the Turkish lira.

“Although the central bank has gradually tightened monetary policy, most recently in May with a cumulative increase in the policy rate of 500 basis points to 17.75 per cent, monetary policy has ultimately proved ineffective in reining in inflation and inflation expectations,” Moody’s said in a note.