A new Fitch report on Turkey, issued on 3 July, comments that the FX reserves of Central Bank of Turkey are now too low to afford further intervention in the currency market. Dollar/TL climbed to 6.88 after the report, reaching a 1.5 month high on Friday.
Fitch: External Pressures Remain Turkey’s Main Credit Weakness
At our most recent rating review in February, when we affirmed Turkey’s sovereign rating at ‘BB-‘/Stable, one of the three qualitative notches deducted from the model-implied outcome was for weak external finances. This reflected low FX reserves and a large external financing requirement, wrote the credit rating agency.
An alarming decline in gross FX reserves
Since then, there have been sizeable FX interventions to support the Turkish lira. Gross FX reserves (including gold) fell to USD90 billion at 26 June from USD106 billion at end-2019. If we calculate gross reserves minus swaps, there has been a much sharper fall, from USD87 billion at end-December 2019 to USD33 billion. These trends highlight the underlying pressure on reserves, which has increased external vulnerability since February.
Recent policy on FX interventions suggests that Turkey’s prior, long-standing commitment to a flexible exchange rate has weakened. The marked increase in the proportion of reserves made up of FX swaps also creates a greater risk in the event of their large-scale withdrawal by banks.
However, the external financing positions of the banking and corporate sectors have been resilient. This resilience has been a supporting feature for Turkey’s sovereign credit profile since the mid-2018 lira crisis. Banks’ orderly foreign-currency deleveraging has continued and the rollover rate of 73% in April (on a rolling 12-month basis) was unchanged on 1Q20. Foreign-currency bank deposits are still growing. The corporate sector has also steadily deleveraged and its external debt rollover rate was 84% in April on a rolling 12-month basis, unchanged on March.
BoP stabilization main scenario, with significant downside risks
We forecast a stabilisation of Turkey’s balance of payments in 2H20, but there are sizeable downside risks. Given the low level of reserves, we do not anticipate further large net FX interventions by the central bank and we believe the policy interest rate easing cycle has neared its end. The resumption of government external debt issuance and a lighter redemption profile in 2H20 will have some stabilising effect on the external position.
But we still see a risk of further interest rate cuts contributing to renewed external pressure, even though the monetary policy committee held rates at 8.25% last week. We anticipate broad continuity in the policy response to managing balance of payments pressures. Should external pressures become much more acute, the policy response would be more uncertain.
Reuters: TL drops to 1.5 month low on Friday
Turkey’s lira slipped to its weakest since mid-May late on Friday after Fitch said the country still faces external financing risks and that its monetary easing cycle has neared an end, after inflation jumped more than expected.
The currency, which hit a record low on May 7, was worth 6.865 versus the dollar to close the week, after sliding to as far as 6.88 in late-day trading. The move broke it out of a very tight range over the last two weeks.
Data earlier on Friday showed inflation jumped more than expected to 12.6% year-over-year in June, drifting further from a central bank target and prompting analysts to predict interest-rate hikes were on the horizon.
Last week the bank unexpectedly halted a nearly year-long easing cycle in the face of a 13% drop this year in the lira, depleted FX reserves and the country’s relatively high external obligations.
Fitch, the ratings agency, said there are “sizeable downside risks” to its expectation that Turkey’s balance of payments will stabilise in the second half of the year. “External pressures remain Turkey’s main credit weakness,” it said.
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