Fitch executives, who revised Turkey’s credit rating outlook to “stable”, gave important messages to EKONOMİ daily newspaper about the Turkish economy.
Credit rating agency Fitch, which revised Turkey’s rating outlook from negative to stable with an upward revision after a gap of two years, sent important messages regarding the Turkish economy. Fitch executives pointed out that the normalization steps have started to gain confidence in the CBRT in the eyes of foreign investors, but it remains unclear whether traditional policies will be maintained.
Paul Gamble, Country Ratings Director at Fitch Ratings, said that the CBRT has started to gain the confidence of foreign investors following the policy shift under the new economic management, as evidenced by moderate foreign inflows into bond and equity markets.
Gamble said they believe that Turkey’s post-election policy shift has mitigated short-term macro-financial stability risks and balance of payments pressures, but that there are still significant challenges that require confidence in the durability of the policy adjustment, inflation remains very high (not expected to peak until Q2 2024), and the external position remains very weak despite the recent improvement.
“Gross international reserves are rising, but in net terms, and especially when swaps are included, low reserves are a major source of vulnerability,” Gamble said. Noting that it will take some time to rebuild reserves and sustainably lower inflation expectations, Gamble said that various possible obstacles could threaten the permanence of the recent normalization steps in 2024, adding that “The challenges to normalization initiatives and the risk of unintended consequences could weaken the resolve of the Turkish authorities.”
Fitch Senior Director and Turkey Analyst Erich Arispe also said that Turkey’s history of politically intervened policy reversals and a premature shift back to monetary easing put pressure on expectations for the longevity of the current policy direction. “In our view, local elections in March 2024 could test the government’s resolve to maintain the current tightening cycle,” Arispe said. Reducing large-scale macroeconomic distortions will likely require a difficult adjustment period due to higher real interest rates and weaker GDP growth, while President Erdogan’s patience could be tested if negative shocks delay positive outcomes, Arispe said.
In an environment where the tightening cycles of major central banks have largely come to an end, what awaits emerging economies such as Turkey in 2024, when a global shift to looser monetary policies is expected to take place? What risks do you think developments in the global economy may pose for Turkey in 2024?
Paul Gamble: The monetary tightening cycle in leading economies is indeed nearing its end, but the lagged effects of monetary tightening will keep global economic growth weak. Fitch expects global growth to slow from 2.4% in 2023 to 1.2% in 2024. Higher interest rates will weigh on US growth next year as credit slows, investment weakens and household income and profit growth decline. The eurozone economy will recover only slightly in 2024 as headline inflation falls and real wage growth picks up, helping consumption. China’s economy will slow down due to a downturn in services. Our baseline scenario shows growth above 4.5% in 2024, but there are downside risks due to the continued slump in the real estate sector. Weak global growth creates a challenging environment for all emerging markets. Weak growth in the euro area, Turkey’s main trading and investment partner, for the second consecutive year will impact economic activity in Turkey. Falling global interest rates should ease funding conditions for emerging markets, but the improvement will not be significant as we expect rates to remain historically high. Financial inflows to Turkey will be mostly influenced by domestic economic policy. The key external risks to Turkey are geopolitical. This year has shown that geopolitical events can be large and unpredictable. The economic effects of geopolitical uncertainty continue to evolve. In particular, Turkey continues to be exposed to high energy prices.
CBRT started to gain the trust of foreign investors
Although the new economic administration that took office after the elections in Turkey has taken many steps towards normalization, what kind of repercussions did the unconventional monetary policy implemented before the elections have on the balance sheets of Turkish banks? Some of the practices of that period are still in place, and restrictions on some types of loans such as KKM are still in place. Do you think the CBRT has gained the confidence of foreign investors regarding returning to orthodox policies?
Paul Gamble: The CBRT has begun to gain the confidence of foreign investors following the policy shift that began with the new economic administration, as evidenced by moderate foreign inflows into bond and equity markets. We believe that the post-election policy shift in Turkey has reduced short-term macro-financial stability risks and balance of payments pressures. Monetary tightening, including selective credit and quantitative tightening (sterilization of excess liquidity) as well as the 31.5 percentage point increase in the policy rate to 40% since June 2023, has been larger and faster than we expected. The cooling of domestic demand is contributing to halting the deterioration in inflation expectations by easing the pressure on the lira and thus supporting the recovery in international reserves. However, there are still significant challenges to confidence in the durability of the policy change. Inflation is still too high (it is not expected to peak until Q2 2024) and inflation expectations have deteriorated. Moreover, despite the recent improvement, the external position remains very weak. Gross international reserves are rising, but low reserves in net terms, especially when swaps are included, are a major source of vulnerability. Rebuilding reserves and sustainably lowering inflation expectations will take some time. Potential obstacles could threaten the durability of the recent policy in 2024. Local elections are due in March and the ruling party will be looking to win back mayorships in major cities, with potential implications for a tighter policy stance. At Fitch, we assume that the policy shift will lead to a period of below-trend growth, with limited political tolerance shown previously. Finally, challenges to normalization initiatives and the risk of unintended consequences could weaken the Turkish authorities’ resolve.
Foreign investors have recently started to include Turkish assets in their portfolios, albeit in small amounts. What other steps does Turkey need to take in order for these small amounts to reach larger numbers?
Erich Arispe: Monetary tightening has been larger and more front-loaded than markets expected, as the central bank tries to rebuild policy credibility and predictability. In addition, President Erdoğan has publicly endorsed the new policy orientation. However, Turkey’s history of politically intervened policy reversals and premature resumption of quantitative easing weighs on expectations for the longevity of the current policy. However, our focus, probably in line with market participants, is on the effectiveness of the policy adjustment to sustainably reduce large-scale macroeconomic imbalances, including rising inflation (61% y/y in November) and the still high current account deficit. (USD 41 billion, first 10 months of the year).
President Erdoğan’s patience may be tested
Will foreign investors wait until after the local elections in March to increase their holdings of Turkish assets? Are there still hesitations about Turkey’s move towards orthodox policies?
Erich Arispe: Local elections in March 2024 could test the government’s resolve to maintain the current tightening cycle, avoiding electoral stimulus measures that undermine policy change. However, after March and despite the absence of scheduled elections in the next few years, reducing the large-scale macroeconomic distortions discussed earlier will likely require a challenging adjustment period with higher real interest rates and weaker GDP growth. Negative shocks could delay positive outcomes and test President Erdoğan’s patience. On the other hand, the announced bilateral agreements and the realization of external financing from portfolio inflows could support FX reserves and mitigate some of the impact of policy tightening on the economy.
Given the geopolitical tensions around Turkey (Ukraine to the north and Gaza to the south) and the slowdown in Europe (Turkey’s main trading partner), what are your key macroeconomic forecasts for Turkey in 2024?
Erich Arispe: With a tighter policy mix and weaker growth in its main trading partners (we forecast Eurozone growth of 0.5% and 0.7% in 2023 and 2024, respectively), we expect the Turkish economy to slow from the previously projected 4.3% to 2.5% in 2024. We expect inflation to reach 65% by the end of 2023 and decline to 38% by the end of 2024. Although we have not yet seen the direct impact of the Gaza conflict on the Turkish economy, uncertainty over geopolitical developments (including the course of the war in Ukraine) continues to pose risks to the growth prospects of the global economy and the course of international financing costs. Adverse developments in these external factors could increase the difficulty and cost of rebalancing the Turkish economy.
