Fitch Ratings-London/Istanbul-13 January 2005: Fitch Ratings, the international rating agency, has today upgraded the Republic of Turkey's Long-term foreign currency and local currency ratings and the country ceiling rating to 'BB-' (BB Minus) from 'B+'. At the same time the agency affirmed the Short-term rating at 'B'. The Outlook has been revised to Stable from Positive.
The upgrade is driven by strong prospects for continued policy discipline, underpinned by domestic political stability, the adoption of a new IMF programme and the approach of EU accession talks, scheduled for October 2005.
"Government commitment to structural reforms and fiscal consolidation will help cement the macroeconomic improvements of the past two years, encouraging more predictable and sustainable growth, but there are formidable hurdles ahead and the government will have to make tough decisions," said Nick Eisinger, Director in Fitch's Sovereign Group. "Meeting the conditions to allow EU accession talks to commence in 2005, including the Cyprus issue might also be controversial. On balance, however, Fitch expects the government to overcome these challenges."
The IMF programme and the EU accession agenda should also support market confidence, providing ample financing for the large current account deficit and underpinning the exchange rate. The general government budget deficit is expected to fall further in 2005 to around 6% of GNP against an estimated 8% GNP in 2004. This will be assisted by tight fiscal policy, which aims for continued primary budget surpluses equivalent to 6.5% of GNP, and solid economic growth which Fitch forecasts at 6.8%. General government debt should continue to fall in 2005, to approximately 70% of GDP from an estimated 74% of GDP at the end of 2004. Public debt dynamics remain vulnerable to interest rate and exchange rate shocks, but this vulnerability is lower than two years ago and should continue to fall in 2005-2006. It would take a sizeable economic shock to rekindle the explosive rise in public debt dynamics that occurred during 2000-2002.
The rating upgrade is further supported by the success of the central bank in bringing down inflation, which ended the year at 9.3%, below the official target for the third year in a row. The 8% inflation target for 2005 is challenging, but achievable. Continued progress on disinflation will allow for further falls in interest rates. It should also help support improvements in debt management as the authorities are able to issue longer-dated domestic debt, thus raising the average maturity of domestic government debt. Over time, this will reduce the very large public financing burden, which Fitch estimates at close to 45% of GDP in 2005 and which represents one of the key vulnerabilities of the sovereign credit.
A by-product of Turkey's strong economic growth has been a widening of the current account deficit, which Fitch estimates at 5.1% of GDP in 2004 and expects to narrow only marginally in 2005, to around 4.8% of GDP. Although the balance of payments is showing a small surplus, the quality of the financing has been weak, characterised by sizeable short-term and partly speculative flows. This contrasts with other 'second wave' EU accession candidates, whose sizeable current account deficits are being financed with long term foreign direct investment. Turkey's large and relatively unfavourable external financing mix leaves the balance of payments exposed to shocks and possible rises in global interest rates. A sudden outflow of short term funds could place pressure on the exchange rate, with possible implications for fiscal sustainability and disinflation efforts. However, Fitch expects short term capital inflows to remain relatively buoyant in 2005. Meanwhile, balance of payments risks are partly offset by a floating exchange rate, an improving financial system, low and falling inflation and the important anchor to expectations provided by EU accession. The start of EU accession talks should help bolster direct investment flows to Turkey, but this could take some time.