Fitch downgraded Turkey’s sovereign debt and issued a scathing verdict on president Recep Tayyip Erdogan’s plan to tackle soaring inflation.
The international rating agency pushed the long-term debt rating deeper into junk territory, lowering it from BB- to B+ — putting G20 country on a par with Benin, Egypt, Turkmenistan, Rwanda and Kenya.
Fitch issued a negative outlook for Turkey’s debt, meaning that it could face further downgrades, and said that the financial system had been made more vulnerable by frequent and intense episodes of financial stress that it said were driven by policymakers.
It said that the centrepiece of Erdogan’s plan to stabilise the country’s crisis prone economy — a series of exchange rate linked savings schemes — would not “sustainably ease macroeconomic and financial stability risks”.
The Turkish lira lost more than 40 per cent of its value against the dollar in 2021 after Erdogan ordered the country’s central bank to cut interest rates four times in the final months of the year, despite soaring inflation and a shift towards rate rises by global central banks.
The Turkish president, who has consolidated his grip over the country’s institutions in recent years, rejects the economic orthodoxy that raising interest rates helps to restore price stability.
He has argued that he is presiding over a “new economic model” that he says will address the country’s structural economic imbalances by capitalising on a weaker, more competitive lira to boost exports, investments and employment.
Turkish officials say that a set of state-backed deposits schemes, which seek to lure Turks to save in lira by promising to protect them against exchange rate loses, will reverse a long-term trend of “dollarisation” and help to bring down inflation by stabilising the local currency. They argue that, in a country that is heavily reliant on imports, price instability is largely driven by lira weakness.
Turkey’s finance minister has predicted that inflation will fall to single digits by May next year. But Fitch said that it forecast average inflation of 41 per cent in 2022 and 28 per cent in 2023 — a rate that it said was the second highest level of any country in its coverage.
The rating agency said that the country’s expansionary policy mix — including real interest rates that currently stand at almost -35 per cent — “could entrench inflation at high levels, increase the exposure of public finances to exchange rate depreciation and inflation”. That could eventually hit domestic confidence and reignite pressures on the country’s already low foreign currency reserves, it said.
Fitch said that the capacity of the new savings schemes to “sustainably improve confidence” was limited. It warned that, if the measures failed to curb domestic demand for foreign currency, authorities could be forced to resort either to burning through more of the country’s central bank reserves or further capital controls. “This policy response could in turn have a negative effect on domestic confidence,” it said.
Turkey lost its investment grade status from Fitch in January 2017, and has been further downgraded three times since then. The latest downgrade will further raise the cost of international borrowing for the country, which is heavily reliant on foreign financing to fund its economy.