S&P Global Ratings has upgraded its credit rating on Turkey by one notch to BB- from B+, while assigning a stable outlook, the rating agency said on November 1 following a scheduled review on the country.

Turkey currently has a BB-/Stable rating (at three notches below investment grade) from Fitch Ratings, a B1/Positive (at four notches below investment grade) from Moody’s Investors Service and a BB-/Stable (at three notches below investment grade) from S&P Global Ratings.

In September 2023 and December 2023, S&P delivered two Turkey outlook upgrades. In May, it delivered a one-notch rating upgrade. Now, it has delivered a second upgrade.

In January, Moody’s delivered an outlook upgrade. In May, it delivered a two-notch upgrade.

In March, Fitch delivered a one-notch rating upgrade. In September, it delivered a second upgrade.

More upgrades will follow should Turkey’s monetary normalisation policy remain in effect. Fitch, Moody’s and S&P have no remaining scheduled Turkey reviews set for 2024.

No risk in debt service

The risk of the sovereign preventing private-sector debtors from servicing foreign currency-denominated debt is diminished in light of steps taken by authorities to re-build previously depleted external buffers amid a gradual removal of financial sector regulations hampering foreign currency liquidity management, S&P noted in its press release on its rating action.

The stable outlook balances S&P’s expectation that the current economic team will persevere with tight monetary policy against the implementation risks associated with the government's medium term program.

S&P could raise Turkey’s ratings should there be further progress on bringing inflation down closer to single-digit levels and restoring long-term confidence in the Turkish lira and more broadly domestic capital markets.

Evidence of this would include further de-dollarisation of the share of foreign currency deposits in the Turkish banking system and increased liquidity and depth of domestic capital markets, particularly for foreign exchange operations.

Rebalancing

S&P’s upgrade reflected the rebalancing of Turkey's external accounts, visible in the narrowing of the 12-month rolling current account deficit to about 1% of GDP in August, a reduction in foreign currency deposits and a concomitant increase in the central bank’s stock of net foreign currency reserves.

(Editor’s Note: For the improvement in the current account deficit, the shift of gold imports from the current account to the net errors and omissions via a gold import ban/limit along with the inflated tourism income figures should be taken into account.)

De-dollarisation

What has mattered most over the past 12 months is the success authorities have had in convincing domestic households and companies to shift their savings back into local currency.

That shift has been the largest contributor to the growth of foreign currency reserves this year.

At present, foreign currency and protected deposits (KKM) make up 45% of the total versus 58% at the end of 2023, with protected deposits (which are insured by the central bank against exchange losses beyond the rate at which they are remunerated) having declined from $89bn (9% of GDP) to $44bn (4% of GDP) over the same period.

A share of 45% of the total remains an elevated share for foreign currency savings in any economy and household confidence in the disinflation plan is still evolving.

The gap between household and market participants' expectations on 12-months forward inflation remains around 40 percentage points.

Higher external borrowing

Improved external financing conditions have led to an increase in external borrowing by companies and banks.

At the same time, domestic credit growth is not keeping up with inflation and private investment remains stagnant although there has been a rise in foreign currency borrowing by Turkish companies from domestic banks, reflecting the large gap between local currency and foreign currency interest rates.

Challenging inflation ahead

Bringing down inflation further is likely to prove challenging. In December, a tripartite commission that includes representatives from unions, employers and the government is scheduled to negotiate an agreement on a national minimum wage increase to take effect in January 2025.

One risk to the disinflation programme is that the increase, which is a benchmark for wage-setting across the Turkish economy, is backward-indexed to the 2024 rate of inflation of about 44% rather than to the government's year-end 2025 inflation target of 17%.

30% minimum wage hike

Given political realities and the still tight labour market, S&P’s operating assumption is that the agreement will settle on a figure somewhere between these two extremes.

Anything higher than 30%, however, would, in S&P’s view, almost certainly prolong an already protracted disinflation process and make single-digit inflation in 2027 a less attainable goal.

Anything lower could turn already ambivalent popular support against the "programme".

No elections until 2028 or not before 2026?

At present, no elections are scheduled through March 2028, reducing pressures on policymakers to agree to backward-indexed wage increases for 2025 and 2026.

Nevertheless, the next two years of below-inflation wage increases amid stubbornly high services inflation will weigh on consumer confidence and potentially raise questions about the sustainability of the "program".

Support within the governing Justice and Development Party (AKP) to revise the Constitution introduced in 2017 could eventually bring the general election forward, but not before 2026, in S&P’s view.

Some deputies within the senior party of the current AKP and Nationalist Movement Party (MHP) governing coalition are calling for President Recep Tayyip Erdogan to serve a fourth term.

Under the 2017 constitution, the president, who is both the head of state and the head of government, cannot serve more than two consecutive five-year terms in full.

By cutting short his current term, S&P understands that Erdogan would be eligible to run for a third term.

To do so, however, would require the support of 360 out of 600 members of parliament, which is 40 more than the number of governing coalition members of parliament.

(Editor’s note: Main opposition Republican People’s Party (CHP) chair Ozgur Ozel is ready to provide the required support to hold a snap election.)

Fiscal tightening, monetary easing

Fiscal policy tightening has yet to materialise while the central bank is likely to embark on cautious monetary easing early in 2025, according to S&P 

For 2024, S&P projects an accruals-based general government deficit of 5.1% of GDP versus the government's 4.9% of GDP objective as growth decelerates.

For 2025, it estimates the deficit narrows to 4% of GDP versus the government's target of 3.1% of GDP.