Fitch warns of risks to Turkish economy amid political uncertainty

Fitch warns of risks to Turkish economy amid political uncertainty
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Fitch Ratings said that Turkey’s expansionary and inconsistent policy mix will maintain pressure on foreign currency demand, weaken international reserves, keep inflation at a high level, and create pressure on external financing needs and costs

International credit rating agency Fitch Ratings has confirmed Turkey's credit rating as "B" and outlook as "negative" and highlighted the risks in the Turkish economy, pressures on the Turkish lira, and the country's political and geopolitical risks ahead of the presidential and parliamentary elections set for May 14.

According to Fitch, Turkey's "B" rating reflects growing economic deterioration due to weak external financing and increasingly interventionist and unconventional policies, as well as political and geopolitical risks. These factors are against Turkey's large and diversified economy, relatively low levels of public debt, and manageable profile of public debt repayment, Fitch said.

Fitch stated that the negative outlook reflects their opinion that Turkey's expansionary and inconsistent policy mix, which includes negative real interest rates and the use of increasing regulatory measures and controls, will maintain pressure on foreign currency demand and the depreciation of the lira, weaken international reserves, keep inflation at a high level, and create pressure on external financing needs and costs.

Although the Central Bank of Turkey lowered its policy rate to 8.5% in February, officials are increasingly relying on targeted regulations to reduce domestic financing costs, manage the pace of credit allocation and demand for foreign currency, and reduce financial dollarization to mitigate the pressure on the lira.

Fitch also warned that this policy approach could create vulnerabilities in the banking sector, which has been resilient so far, by increasing risks from negative real interest rates on government bonds and negatively impacting profitability and asset quality. Moreover, the increasing number and frequency of measures could increase regulatory uncertainty, erode customers' confidence, and/or intensify liquidity risks by reducing access to external financing.

As for the inflation rate, Fitch expects it to average 56.5% in 2023, reflecting the government's focus on supporting growth and employment and reflecting inflation inertia. However, backward-looking indexation, high expectations, and additional depreciation of the lira continue to pose upward risks to inflation.

Regarding economic growth, Fitch stated that the negative impact of the earthquakes in February on economic activity would be partially offset by fiscal and credit stimulus before the May elections, with GDP growth forecasted to decline from 5.6% in 2022.