Turkey’s credit rating was cut deeper into junk by S&P Global Ratings on May 1 as the rating agency responded to the risk of its overheating economy experiencing a hard landing.

S&P highlighted the country’s deteriorating inflation outlook and the long-term depreciation and volatility of the Turkish lira (TRY) as well as signs of corporate debt distress.

S&P reduced Turkey’s foreign currency rating from ‘BB/B’ to ‘BB-/B’, on par with Brazil and Vietnam. The local currency sovereign rating was lowered from 'BB+/B' to 'BB/B', while the outlook was given as stable. The rating agency's move was not part of its regularly scheduled review programme for Turkey. That will heighten concerns about the state of the country's economy, with investors still dumping the TRY despite a rate hike.

"There is a risk of a hard landing for Turkey’s overheating, credit-fueled economy," S&P said in the statement. "This is reflected in the rising imbalances in Turkey’s economy, most notably in its widening debt-financed current account deficit and high inflation."

The TRY has fallen 7.4% in 2018, making it the third-worst performing emerging market currency. The benchmark BIST-100 index of the Istanbul stock exchange, meanwhile, has declined 9.6% to date in the year so far.

S&P said it did not believe the central bank’s hiking of its late-liquidity window rate last week by 75 basis points would be sufficient to bring down inflation, currently running at 10.2%, to the national lender’s 5% target or curb the volatility in Turkey’s real effective exchange rate (REER). Turkey’s CPI-based REER fell to a record low in March. Although the rate hike temporarily lifted the TRY, the lira bears were soon stomping back into the picture. The TRY stood at 4.1522 to the dollar as of around 15:05 Istanbul time on May 2, compared to its all-time low of 4.1944 recorded on April 11

The central bank’s sluggish response to strong market calls for aggressive tightening has intensified investor concern that it is under pressure from Turkish President Tayyip Erdogan, who regularly calls for cheaper money to help investors and drive headline growth. S&P noted that the lender has been “facing increasing political pressure.”

Erdogan is bidding for re-election in snap polls called for June 24. Opponents claim he brought forward the elections from November 2019 because if he waits much longer he runs the risk of voters going to the polls amid clear economic distress. His ruling AKP party says a new mandate is needed to deliver the political stability required to speed up economic reforms.

The rating agencies themselves have also been targeted with strong rhetoric from the outspoken Erdogan, who on March 9, two days after Moody’s Investors Service cut Turkey further into junk, claimed they were preoccupied with trying to drive the country into a corner and that the financial markets should not take them seriously.

Warning sounded on problem loans
On April 16, Moody’s issued a note saying that the prolonged weakness of the TRY combined with high inflation would likely increase problem loans for Turkey’s banks as the private sector would have a tougher job on its hands to repay its foreign currency-denominated debt. S&P backed up this point, adding that the devaluation would negatively impact government debt. Some 40% of that debt is foreign currency-denominated.

It is known that several large Turkish conglomerates are attempting to restructure their debts. In April, it was reported that Turkish food giant Yildiz Holding is to restructure $6.5bn of its $8.5bn in debt. Turkey’s Dogus Holding, with outstanding loans that stood at TRY23.5bn ($5.73bn) at end-2017, is also in talks with banks on debt restructuring, according to sources familiar with the matter who spoke to Reuters.

In further comments on its downgrade, S&P said: “Macroeconomic imbalances, mainly a deteriorating current account and fiscal deficit, as well as high inflation, are building up… Exchange-rate depreciation and volatility are a risk to Turkey's financial stability.”

It also noted: “The composition of external financing has shifted toward short-term debt. Signs of distress in the private sector are starting to show, and capital outflows and the lira's depreciation may accelerate this trend.”

S&P made the case that Turkey's economy is certainly overheating, noting: “Real GDP grew by 7.4% in 2017, and we have now revised our 2018 growth forecast slightly upward to 4.4%. Yet, despite very rapid GDP growth rates, in US dollar terms Turkey's 2017 GDP was 10.5% below its 2013 level, which gives a better indication for Turkey's ability to service foreign currency debt.”

In making the downgrade, S&P also cited Turkey’s state of emergency—described in March by the UN human rights office as having a “chilling effect” on Turkish society—which has been in place since July 2016 following the failed coup and which will remain in place at least until after the late June elections.

Escalating tensions in Syria, as well as Turkey’s military moves in Kurdish-controlled areas of its neighbour, threaten to undermine Turkey’s strong export performance, it added.