OREANDA-NEWS. September 22, 2015. Fitch Ratings has affirmed Turkey's Long-term foreign and local currency Issuer Default Ratings (IDR) at 'BBB-' and 'BBB', respectively. The Outlooks are Stable. The issue ratings on Turkey's senior unsecured foreign and local currency bonds have also been affirmed at 'BBB-' and 'BBB', respectively. The Country Ceiling has been affirmed at 'BBB' and the Short-term foreign currency IDR at 'F3'.

The rating on Turkey's Hazine Mustesarligi Varlik Kiralama Anonim Sirketi's (Hazine) USD1.5bn of global certificates (sukuk), due in March 2018, has also been affirmed at 'BBB-'.

KEY RATING DRIVERS
The affirmation of Turkey's IDRs and Stable Outlooks reflects the following rating drivers:

The general government balance sheet is strong, fiscal discipline has been maintained through the electoral period and the commitment to fiscal discipline appears to benefit from consensus across the political spectrum. Fitch forecasts a general government primary surplus of 1.1% of GDP in 2015, unchanged from 2014. General government debt to GDP is forecast to maintain its downward trend and is expected to hit 30% at end-2017, compared with a 'BBB' median of 43.1%.

The political environment has deteriorated, in Fitch's view. There is significant uncertainty around the outcome of legislative elections set for November, which were called after the failure to agree a coalition following the June elections, at which the ruling AKP lost its parliamentary majority. Opinion polls point to a similar result at the November elections. The Kurdish peace process has broken down and with the number of fatalitiess rising, there is a risk that the current outbreak of hostilities may be prolonged. Turkey has also become involved in the conflict in neighbouring Syria following a deadly ISIS attack.

Momentum in structural reform has slowed and prospects for revitalisation are uncertain. After a pause in reform, the AKP unveiled a detailed and comprehensive policy agenda in 2014, but implementation has been minimal and post-election reform appetite is unclear.

Notwithstanding the slow pace of reform, real GDP growth was 3.1% in 1H15, driven by consumption and partly reflecting a rebound in the agricultural sector following drought in 2014. Higher frequency indicators suggest that momentum slowed in 3Q due to political uncertainty and tightening financial conditions, with the August PMI below 50 and credit growth slowing. The falling lira has pulled down consumer confidence, which hit its lowest level since March 2009 in August. Growth remains above the peer median and is forecast to pick up, even in the absence of renewed reform. Political pressure on the central bank has been less overt, but still weighs on policy credibility .

External vulnerabilities remain a feature of Turkey's sovereign credit profile but have not weakened materially since our last review. Net external debt has continued to rise and is forecast to hit 37.6% of GDP at end-2015, compared with a peer median of 6.9%, reflecting large current account deficits and some revaluation effects. Fitch expects the current account deficit to narrow to 4.6% of GDP in 2015 from 5.8% of GDP in 2014, driven by lower oil prices. The are no indications of a structural improvement in the current account deficit or in the availability of non-debt creating financing sources.

Gross external financing requirements are very large, at an estimated USD213bn (including short-term debt) in 2015 and the international liquidity ratio at 70.3% is less than half the peer median, exposing Turkey to global financial market conditions. Reliance on short-term borrowing has declined due to macro-prudential policy and Fitch assesses that banks have sufficient sources of foreign exchange liquidity to withstand a severe financing shock.

Uncertainties over the foreign asset position of Turkish corporates and the impact of higher financing cost are a potential source of vulnerability. Sovereign buffers to volatility in investor sentiment have diminished. Foreign exchange reserves have fallen so far in 2015 and while still relatively large on a gross basis, at USD120.7bn in July 2015, they are around one-third of this in net terms. Nonetheless, external debt rollover rates continue to exceed 100%.

The central bank has embarked on a simplification of the monetary policy framework that could over time address concerns about policy coherence, although the timeline and process for the transmission to a more orthodox structure is unclear. Inflation and real effective exchange rate volatility are more than double the peer median. Fitch assumes that an on-going tightening of liquidity conditions will be followed by policy rate hikes. Inflation is forecast to average 7.1% in 2015 and is not expected to fall sustainably below the 5% target throughout our forecast period. In part, this will be driven by the lira, which has fallen by around 30% against the US dollar so far this year.

The banking system is consistent with Turkey's investment grade rating, with a 'bbb' on Fitch's Banking System Indicator. Banks are well regulated, profitable and non-performing loans were just 2.9% at end-June 2015.

RATING SENSITIVITIES
The Outlook is Stable. Consequently, Fitch's sensitivity analysis does not currently anticipate developments with a material likelihood, individually or collectively, of leading to a downgrade. However, the following risk factors individually, or collectively, could trigger negative rating action:
- A materialisation of stresses stemming from external financing vulnerabilities.
- Prolonged and deepened political instability that undermines economic performance and threatens economic policy credibility.
- A deterioration in fiscal discipline that reverses the declining trend in debt/GDP.

Conversely, the following factors, individually or collectively, could result in positive rating action:
- Implementation of structural reforms that would deliver higher gross domestic savings, a more flexible labour market and greater foreign direct investment to help address external imbalances.
- A more stable and predictable domestic political environment.
- A more coherent and predictable monetary policy framework that delivers lower and more stable inflation.

KEY ASSUMPTIONS
- Continued commitment to fiscal stability.
- Geopolitical tensions will not have a material impact on economic activity.
- Turkey's current account deficit will benefit from low oil prices (Fitch forecasts Brent crude to average USD55 in 2015 increasing gradually to USD70 by 2017) and economic recovery strengthening in the EU.