Fitch Downgrades Turkey to ‘B+’; Outlook Negative

Fitch Ratings

Feb. 11, 2022

Fitch Ratings - London - 11 Feb 2022: Fitch Ratings has downgraded
Turkey's Long-Term Foreign Currency Issuer Default Rating (IDR) to
'B+' from 'BB-'. The Outlook is Negative.

The downgrade of Turkey's IDRs and the Negative Outlook reflects the
following key rating drivers and their relative weights:


Policy-driven financial stress episodes of higher frequency and
intensity have increased Turkey's vulnerabilities in terms of high
inflation, low external liquidity and weak policy credibility. Fitch
does not expect the authorities' policy response to reduce inflation,
including FX-protected deposits, targeted credit and capital flow
measures, will sustainably ease macroeconomic and financial stability

Moreover, Turkey's expansionary policy mix (including deeply negative
real rates) could entrench inflation at high levels, increase the
exposure of public finances to exchange rate depreciation and
inflation, and eventually weigh on domestic confidence and reignite
pressures on international reserves. The risk of additional
destabilising monetary policy easing or stimulus policies ahead of the
2023 general elections is high, and there is an elevated degree of
uncertainty about the authorities' policy reaction function in the
event of another episode of financial stress, as political
considerations limit the central bank's ability to raise its policy

Authorities expect that the introduction of FX-protected deposits
combined with a broader strategy to encourage 'liraisation' of the
financial system will support exchange rate stability and in turn
facilitate a reduction in inflationary pressures. The new mechanism,
expanded from retail depositors to corporates, non-residents and
Turkish citizens abroad, will compensate term deposit holders if the
lira depreciation is greater than the nominal interest rate. As of 9
February, FX-protected deposits were TRY313 billion (5.8% of total
deposits), and corporates are expected to increase participation due
to tax benefits.

In Fitch's view, the new instrument's capacity to sustainably improve
confidence is limited in an environment of high and rising inflation,
as well as unanchored expectations. Moreover, if the instrument fails
to reduce domestic demand for FX, preserving a stable exchange rate
without the use of interest rates would require renewed FX
intervention or additional capital flow measures similar to those
recently introduced requiring the sale of 25% of exporters' revenues,
as well as tighter controls to monitor that credit allocations do not
add to FX demand. This policy response could in turn have a negative
effect on domestic confidence.

Inflation rose to 48% in January and price pressures remain high, with
PPI close to 94% (partly reflecting international commodity prices and
supply chain disruptions), continued exchange rate pass-through,
rising inflation expectations and utility price and wage hikes. We
forecast inflation to reach 38% by the end of the year and average 41%
in 2022 and 28% in 2023, the second highest among all Fitch-rated
sovereigns. Backward indexation, failure of the authorities to rein in
expectations and additional exchange rate volatility represent upside
risks to our inflation forecasts.


Turkish FX liquidity buffers are low relative to peers and risks
derived from high financial dollarisation, the vulnerable structure of
international reserves and significant exposure to changing investor
sentiment. After coming under pressures in November-December, recent
figures show an increase in gross (USD114.7 billion) and net (USD16.3
billion) reserves but the net foreign asset position of the central
bank (excluding FX swaps) remains negative.

We expect gross reserves to increase to USD118 billion in 2022 (4.2
months of current external payments), as export rediscount credits, FX
conversion of deposits, a new FX swap with the UAE (equivalent to USD5
billion) and EUR1 billion deposit from Azerbaijan's Sofaz at the
Central Bank will more than offset continued current account deficits
and domestic FX demand, and limited portfolio inflows.

Although we expect the current account deficit to narrow further to
1.7% of GDP in 2022 from an estimated 2.2% in 2021 and 4.9% in 2020,
external financing needs will remain high. External debt maturing over
the next 12 months (end-November) amounts to USD167 billion. Access to
external financing for the sovereign and private sector has been
resilient to previous episodes of stress, but is vulnerable to changes
in investor sentiment.

Reduced FX volatility in recent weeks and the introduction of the
FX-protected deposits have allowed lira deposits to partially recover
and driven some reversal in dollarisation. The scheme could mitigate
near-term risks to the stability of bank funding, improve sentiment in
the near term and alleviate pressure on capital ratios. Nevertheless,
the combination of deeply negative real policy rates and rising
inflation creates risks for financial stability, for example if
depositor confidence is shaken, and could potentially jeopardise the
until now resilient access of banks and corporates to external
financing. In this negative scenario, official international reserves
would come under pressure, as a significant portion of banks foreign
currency assets is held in the central bank including FX swaps and
reserve requirements.

Turkish banks are vulnerable to FX volatility due to high external
debt payments, the impact on asset quality (41% of loans denominated
in foreign currency) and high deposit dollarisation (61.5%). In
addition, Fitch estimates that 10% depreciation erodes the sector
common equity Tier 1 ratio by about 50bp, although the regulator has
extended regulatory forbearance to cushion the impact of depreciation
on capital ratios.

Turkey's 'B+' IDRs also reflect the following key rating drivers:

Turkey's ratings reflect weak policy credibility and predictability,
high inflation, low external liquidity relative to high external
financing requirements and dollarisation, and geopolitical risks.
These credit weaknesses are set against low government debt and
deficits, manageable sovereign financing needs, high growth and
structural indicators, such as GDP per capita and Human Development,
relative to rating peers.

Public finances are a strength relative to peers. Fitch estimates that
general government debt increased to 42% of GDP at end-2021, below the
'B' median of 68%, as the depreciation of the lira was balanced by
lower financing needs and net repayments of domestic foreign currency
debt. Debt dynamics will remain vulnerable to increased currency
risks, as 66% of central government debt was foreign currency-linked
or denominated at end-2021, up from 39% in 2017.

Fitch estimates that Turkey's fiscal deficit declined to 3% of GDP at
the general government level and 2.9% at the central government level
in 2021, the latter below the revised 3.5% fiscal target. We forecast
that the general government deficit will widen to 4.2% in 2022 and
4.5% in 2023. Fiscal risks stem from potential payments related to the
FX protected deposit scheme, fiscal measures to cushion the impact of
inflation on the economy, rising interest payments and expenditure
linked to inflation such as wages and pension transfers. Government
debt amortisations are manageable, averaging 3.5% of GDP in 2022-2023
and our baseline assumption is that the sovereign will maintain access
to external markets based on the record of regular external bond
issuance, despite repeated periods of stress in recent years.

We expect the Turkish economy to slow to 3.2% in 2022 from 11% in
2021, balancing still favourable external demand dynamics, recovery in
the tourism sector and an accommodative policy stance against tighter
financing conditions, deterioration in consumer sentiment, and the
negative impact of a weaker exchange rate and high inflation. Despite
growth resilience, GDP per capita in US dollar terms has deteriorated
since 2013, falling by almost USD4,000 to an estimated USD8,633 in
2021, due to the multi-year weakening of the currency.

On the domestic front, the support for the government continues to be
under pressure as a result of rising inflation and the sharp
depreciation of the lira in 2021. We expect the proximity of general
elections, due by June 2023, to heavily influence policy in the
direction of supporting growth.

Geopolitical tensions have eased over the past year and Turkey has
sought to rebuild relations with countries in the region.
Nevertheless, key foreign policy issues remain unresolved such as
Turkey's 2019 purchase of the S-400 Russian missile system, US
cooperation with the Kurdish People's Protection Units (YPG) in Syria
or the maritime disputes in the Eastern Mediterranean. The evolution
of relations with Russia is uncertain due to Turkey's support and arms
sales to Ukraine.

ESG - Governance: Turkey has an ESG Relevance Score (RS) of '5' for
both Political Stability and Rights and for the Rule of Law,
Institutional and Regulatory Quality and Control of Corruption. Theses
scores reflect the high weight that the World Bank Governance
Indicators (WBGI) have in our proprietary Sovereign Rating Model.
Turkey has a medium WBGI ranking at 37 reflecting a recent track
record of peaceful political transitions, a moderate level of rights
for participation in the political process, moderate but deteriorating
institutional capacity due to increased centralisation of power in the
office of the president and weakened checks and balances, uneven
application of the rule of law and a moderate level of corruption.


Factors that could, individually or collectively, lead to negative
rating action/downgrade:

-Macro: Policy initiatives that exacerbate macroeconomic and financial
stability risks, for example an inflation-exchange rate depreciation
spiral or weaker depositor confidence.

-External Finances: Signs of reduced access to external financing for
the sovereign or the private sector, for example due to further
deterioration of investor confidence, that would lead to balance of
payments pressures including sustained reduction in international

-Structural features: A serious deterioration in the domestic
political or security situation or international relations that
severely affects the economy and external finances.
Factors that could, individually or collectively, lead to positive
rating action/upgrade:

- Macro: A credible and consistent policy mix that stabilises
confidence and reduces macroeconomic and financial stability risks,
for example by reigning in inflationary pressures.

-External Finances: A reduction in external vulnerabilities, for
example due to a sustained improvement in terms of the level and
composition of international reserves, reduced dollarisation and
sustained improvement in the current account balance.

Sovereign Rating Model (SRM) and Qualitative Overlay (QO)

Fitch's proprietary SRM assigns Turkey a score equivalent to a rating
of 'BB+' on the Long-Term Foreign-Currency (LT FC) IDR scale.

Fitch's sovereign rating committee adjusted the output from the SRM to
arrive at the final LT FC IDR by applying its QO, relative to SRM data
and output, as follows:

- Structural: -1 notch, to reflect vulnerabilities in the banking
sector due to the significant reliance on foreign financing and high
financial dollarization, and the risk that developments in geopolitics
and foreign relations, including sanctions, could impact economic

- Macro: -1 notch, to reflect that risks to macroeconomic and
financial stability are not fully captured by the SRM, as the current
policy mix and potential reaction to shocks could further weaken
domestic confidence, reduce reserves and lead to external financing
and domestic liquidity pressures. Policy uncertainty also remains
elevated due to the risk of additional monetary policy easing and
other stimulus measures due the proximity of general elections due by
June 2023.

- External Finances: -1 notch, to reflect a very high gross external
financing requirement, low international liquidity ratio, a weak
central bank net foreign asset position, and risks of renewed balance
of payments pressure in the event of changes in investor sentiment.

Fitch's SRM is the agency's proprietary multiple regression rating
model that employs 18 variables based on three-year centred averages,
including one year of forecasts, to produce a score equivalent to a LT
FC IDR. Fitch's QO is a forward-looking qualitative framework designed
to allow for adjustment to the SRM output to assign the final rating,
reflecting factors within our criteria that are not fully quantifiable
and/or not fully reflected in the SRM.
Best/Worst Case Rating Scenario

International scale credit ratings of Sovereigns, Public Finance and
Infrastructure issuers have a best-case rating upgrade scenario
(defined as the 99th percentile of rating transitions, measured in a
positive direction) of three notches over a three-year rating horizon;
and a worst-case rating downgrade scenario (defined as the 99th
percentile of rating transitions, measured in a negative direction) of
three notches over three years. The complete span of best- and
worst-case scenario credit ratings for all rating categories ranges
from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are
based on historical performance. For more information about the
methodology used to determine sector-specific best- and worst-case
scenario credit ratings, visit;!!LIr3w8kk_Xxm!4eiIFZT-VzLgUEsuT3MjAxEYeR_OeY7wSFaNwFCkpWQtzwKPs7HR-row9omF4A$


The principal sources of information used in the analysis are
described in the Applicable Criteria.
ESG Considerations

Turkey has an ESG Relevance Score of '5' for Political Stability and
Rights as World Bank Governance Indicators have the highest weight in
Fitch's SRM and are therefore highly relevant to the rating and a key
rating driver with a high weight. As Turkey has a percentile rank
below 50 for the respective Governance Indicator, this has a negative
impact on the credit profile.

Turkey has an ESG Relevance Score of '5' for Rule of Law,
Institutional & Regulatory Quality and Control of Corruption as World
Bank Governance Indicators have the highest weight in Fitch's SRM and
are therefore highly relevant to the rating and are a key rating
driver with a high weight. As Turkey has a percentile rank below 50
for the respective Governance Indicators, this has a negative impact
on the credit profile.

Turkey has an ESG Relevance Score of '4' for Human Rights and
Political Freedoms as the Voice and Accountability pillar of the World
Bank Governance Indicators is relevant to the rating and a rating
driver. As Turkey has a percentile rank below 50 for the respective
Governance Indicator, this has a negative impact on the credit

Turkey has an ESG Relevance Score of '4[+]' for Creditor Rights as
willingness to service and repay debt is relevant to the rating and is
a rating driver for Turkey, as for all sovereigns. As Turkey has track
record of 20+ years without a restructuring of public debt and
captured in our SRM variable, this has a positive impact on the credit

Except for the matters discussed above, the highest level of ESG
credit relevance, if present, is a score of '3'. This means ESG issues
are credit-neutral or have only a minimal credit impact on the entity,
either due to their nature or to the way in which they are being
managed by the entity.