The erosion of Turkey’s institutional strength and rising economic and external imbalances drive the placement under review. High growth potential, exchange rate flexibility, sound public finances and banking sector resilience support the rating.
Scope Ratings GmbH has today placed the Republic of Turkey’s long-term local- and foreign-currency issuer and senior unsecured debt ratings of BB+, as well as the short-term issuer rating of S-3 in both local and foreign currency, under review for downgrade.
The placement under review for downgrade of Turkey’s sovereign ratings reflects the following two drivers:
- Deterioration in Turkey’s economic policy and governance framework both before and in following the June election, which weigh on the effectiveness and credibility of fiscal, monetary and structural economic policy management. Recent developments cast doubt on the authorities’ commitment to address the country’s fundamental macroeconomic weaknesses and raise questions on the long-term trajectory of Turkey’s creditworthiness.
- Increasing downside risks to Turkey’s macroeconomic stability stemming from external vulnerabilities caused by: i) a widened, largely debt-financed current account deficit; ii) steep depreciation of the Turkish lira against the US dollar and deterioration in the inflation outlook, with a to date incoherent policy response; iii) the negative impact of currency devaluations alongside more challenging global external financing conditions on the Turkish private sector, which has significant foreign-currency and external-debt exposures; and iv) the impact of balance of payments weaknesses on modest levels of international reserves.
The placement of Turkey’s sovereign ratings under review for downgrade reflects changes in Scope’s assessments in the ‘external economic risk’ and ‘domestic economic risk’ categories of its sovereign methodology. Turkey’s BB+ ratings remain supported, however, by the country’s high growth potential and large, diversified economy, flexible exchange rate regime, sound public finances, and aspects of resilience within the banking sector.
The first driver underpinning Scope’s decision to place Turkey’s sovereign ratings under review for downgrade is Scope’s view that Turkey’s economic policy predictability and credibility has deteriorated both before and following the presidential and parliamentary elections of 24 June, given governance changes and policy decisions that have raised questions on the direction of economic management and Turkey’s credit trajectory over a longer time window. President Tayyip Erdogan’s term and mandate to guide the economy now extends until 2023.
President Erdogan’s electoral victory has given him extremely broad powers in the new Executive Presidency. These capacities range from the ability to rule by decree to the means to stamp out dissent (evidenced in the July dismissals of more than 18,000 civil servants) to greater influence over monetary policy. Post-election economic governance reorganisations, including the appointment of Erdogan’s son-in-law as Minister of Treasury and Finance, departures of economic-moderates such as former Deputy Prime Minister Mehmet Simsek, and alterations in the appointment procedure for the central bank governor and monetary policy committee (MPC) members have cumulatively raised doubts in the administration’s resolve to rebalance the economy onto a more sustainable footing.
The Turkish central bank’s decision function, MPC governance changes, alongside the President’s statements on his greater role in setting monetary policy alongside a preference for lower rates, have increased concerns around the independence of monetary policy and increased uncertainty surrounding future rate decisions. For example, the market had priced in an interest rate hike of around 100 bps at the central bank’s MPC meeting on 24 July. The outcome of this meeting – to maintain the policy rate at 17.75% – has damaged investor confidence. In Scope’s view, the unpredictable and frequently overly reactionary monetary policy decision framework risk further bouts of market turbulence with increasing spill-over onto the real economy.
At the same time, fiscal performance has worsened in recent years, with a budget balance of -2.3% of GDP in 2017, down from -1.3% of GDP as of 2015. Pre-election spending caused further deterioration in the general government balance over the first six months of 2018. Scope anticipates the general government deficit to widen to 2.9% of GDP in 2018, reflecting partly the slowing economy’s impact on fiscal revenue growth. In addition, government bond yields have risen significantly, making debt financing more expensive. In general, in Scope’s view, a reorientation in Turkey’s economic agenda favouring lower but more sustainable economic growth, including via structural economic reform, is the most direct route to increasing the credibility of Turkey’s policy-making institutions, stabilising the lira, and, in turn, supporting a stabilisation in Turkey’s rating trajectory.
The second driver underpinning the decision to place the ratings under review for downgrade is the increased risks to Turkey’s macroeconomic stability facilitated by external vulnerabilities.
Turkey’s current account deficit has widened this year, to 6.3% of GDP in the 12 months to May 2018 (from 3.3% of GDP in the 12 months to May 2016), on the back of energy price hikes alongside elevated economic growth and domestic demand. Scope expects that higher oil prices and higher interest payments will result in a current account deficit of 6.8% of GDP in the full year 2018 from 5.6% in 2017, before narrowing slightly to 6% of GDP in 2019. Moreover, the current account deficit is largely fuelled via less stable forms of external financing, exposing Turkey to greater vulnerabilities of capital account reversals in a more challenging global interest rate environment and wider emerging market stresses.
Next, the Turkish lira has devalued by 22% against the US dollar (to 4.9 at the time of this writing) and 19% on a nominal trade-weighted basis since the beginning of 2018. With the pass-through of currency declines, inflation reached 15.4% YoY in June—the highest level since December 2003 and well above the central bank target of 5%. This has forced a central bank tightening of 500 bps since December 2017. However, the inflation outlook is worsening, and Scope expects headline inflation to peak at around 17% in September 2018, reducing the real policy rate and risking a longer-lasting de-anchoring of inflation expectations.
The significant lira depreciation has meaningful implications on open net foreign exchange positions of the private sector, totalling USD 223bn in Q1 2018. High levels of foreign exchange liabilities increase the vulnerability of firms with insufficient foreign exchange income and assets or with maturity mismatches on balance sheets. Firms and households are also simultaneously stressed by tighter domestic borrowing conditions, with bank lending rates to commercial enterprises increasing to 23.5% in June, from 15.2% in January 2018.
Turkey’s gross external financing needs will remain around USD 240bn in 2018 and next year, up from around USD 220bn in 2017. Gross external debt totalled 52.8% of GDP in Q1 2018. In addition, modest gross international reserves of USD 130.9bn (106% of short-term external debt) as of May 2018 are at risk of further decline. Given Turkey’s sizeable external financing needs of approximately 30% of GDP per annum, declining reserves may exacerbate balance of payments stresses.
At the same time, Scope notes that Turkey’s BB+ credit ratings are underpinned by continued strength in public finances with a large tax base and strong tax revenue growth, moderate public-debt burden and resilient debt structure (though 42% of central government debt is in foreign currency), reducing to an extent Turkey’s vulnerability to shocks. Despite budgetary deterioration, Turkey’s deficit remains at manageable levels and the public-debt ratio stands at only 28.4% of GDP as of Q1 2018 – below that of ‘bb’-rated sovereign peers. Under Scope’s debt sustainability analysis, Turkey’s general government debt ratio is forecast to remain under 35% of GDP over the medium term, reflecting in part the low risk of crystallisation of modest though rising contingent liabilities, which are mostly in the form of PPP-infrastructure projects.
In addition, Turkey benefits from a large, diversified economy (with nominal GDP of USD 849bn in 2017), supported further by a flexible exchange rate. Real growth in the first quarter of 2018 was 7.4% year-over-year. Scope expects economic growth to remain strong at 4-5% in 2018 and 2019, assuming some rebalancing in the economy owing to tighter economic and financial conditions but boosted by external demand.
Bank profitability has been affected by the weaker economic environment. Despite higher financing costs, external-debt roll-over of banks has continued at a rate of above 100%. While restructuring of large corporate loans has seen a limited increase, mostly in the form of maturity extensions, the quality of loan portfolios has remained stable with the non-performing loan (NPL) ratio falling to below 3% of total loans. This reflects areas of resilience within the banking sector, including a favourable structure of external debt, enabling the sector to bridge short-lived market shutdowns. Moreover, banking sector capitalisation, supported by adequate NPL provisions, is sufficient to absorb moderate shocks, but remains sensitive to further lira depreciation given the high level of foreign currency loans on bank balance sheets and the risk of asset quality deterioration.
Core Variable Scorecard (CVS) and Qualitative Scorecard (QS)
Scope’s Core Variable Scorecard (CVS), which is based on relative rankings of key sovereign credit fundamentals, signals an indicative “BB” (“bb”) rating range for the Republic of Turkey. This indicative rating range can be normally adjusted by the Qualitative Scorecard (QS) by up to three notches depending on the size of relative credit strengths or weaknesses versus peers based on qualitative analysis.
For the Republic of Turkey, the following relative credit strengths have been identified: i) the growth potential of the economy; ii) economic policy framework; iii) fiscal policy framework; iv) public-debt sustainability; v) market access and funding sources; and vi) banking sector oversight and governance. Relative credit weaknesses are: i) macro-economic stability and sustainability; ii) current account vulnerabilities; iii) vulnerability to short-term external shocks; iv) recent events and policy decisions; and v) geo-political risk.
The combined relative credit strengths and weaknesses indicate an upward adjustment and signal a sovereign rating of BB+ for Turkey. A rating committee has discussed and affirmed these results.
Outlook and rating-change drivers
Scope will use the review period to further assess the direction of policy-making and the extent of the administration’s commitment to address the country’s macroeconomic challenges.
The ratings could be downgraded if, individually or collectively: i) fiscal, monetary and economic policies remain inconsistent with a rebalancing in the economy in favour of lower, but more sustainable, economic growth, failing to reduce inflation and macroeconomic vulnerabilities; ii) macroeconomic instability is accentuated via further external deterioration and/or shocks, undermining Turkey’s modest international reserve levels and exacerbating the balance of payments crisis; and/or iii) further institutional degradation or renewed security concerns arose, sparking market turbulence and interfacing with Turkey’s external vulnerabilities.
Conversely, the ratings could be confirmed at BB+ if: i) credible fiscal, monetary and economic policies were to be adopted, suspending market volatility and providing enhanced clarity on policies that rebalance the economy towards more sustainable growth and lower inflation; ii) the country’s external vulnerabilities were reduced, including its reliance on volatile forms of capital inflows, resulting in a lower and more sustainably financed current account deficit; and/or iii) the deterioration in Turkey’s governance framework reversed, underpinning greater confidence in the nation’s economic policy framework.
In Scope’s view, an upgrade is highly unlikely in the near term.
Seven lessons from 2020
Rebeca Ehrnrooth, Equilibrium Capital and CEMS Alumni Association President
Attending a New Year’s luncheon on 31 December 2019, we played a game that involved predicting the world in 2020. Some of the questions included: would Uber become profitable? Would the three-decade bond rally finally come to an end? Would the US hit a recession?
Unlike any of our predictions based on a traditional approach to business and predicting, we now know that 2020 became the year where business, professional and personal plans were turned upside down, reshaped and put-on hold. The proverbial black swan had arrived.
As revealed in a new CEMS Guide to Leadership in a Post-COVID-19 World, to which I contributed, the COVID-19 pandemic has exposed deficiencies in the 20th Century vision of leadership, giving a rare opportunity to question the status quo.
So, what are the main lessons from 2020?
- Humans are enormously adaptive. This is not an extinction scenario. The world is getting used to dealing with global human disaster which may become a recurring event. Life continues guided by new parameters.
- No sector or country is immune to rapid change. Just as the leveraged finance and equity markets ground to a halt during the Global Financial Crisis, we have seen a disruption in the financial markets (including M&A) in 2020, including a significant redistribution of wealth between sectors; think tech vs airlines and the hospitality industry. When a market is disrupted it has secondary and tertiary effects such as less work for accountants, lawyers, financiers etc.
- Location is not as important anymore. The belief that finance staff need to be based in one of the financial capitals to be effective has been forever altered. Pursuing a career in finance from anywhere is becoming possible. However, it’s likely that over time, financial controls and human interaction will move the work model back towards the traditional office approach, as work is a critical sanctuary for people. While working from home may allow more time for family, chores and sports, it is mainly effective for people who already have their internal and external networks. For junior employees it presents a notable challenge as they may be forced to spend their formative years without a chance to really build their networks.
- Change is likely to be lasting. The opportunity for alternative finance and tech focused providers is enormous and 2020 will accelerate this shift. For example, many retail banks are providing rather poor customer service, blaming the pandemic. Even the most loyal customers will be heading elsewhere. For recent graduates and current students this is a major shift; future winners and key employers may not be names we are used to seeing in the headlines.
- There will be a spotlight on leaders with visionary strategy and understanding of the operations. 2020 showed many politicians and business leaders behaving like they were playing a game of snakes and ladders, rather than executing a thought-out strategy. The next wave of thoughtful leadership is urgently required.
- Collaboration leads to success. The definition of a pandemic is an infectious disease prevalent worldwide. A global problem requires a collaborative solution rather than each country and industry on their own. Quoting Steven Riley, professor of infectious disease dynamics at Imperial College London: “Once you have the knowledge and you share the knowledge, then you are able to take measures to push transmission much lower”. This principle is transferable to management education. In a world more complex than ever, investing in a degree is hard currency. Combined with the full global alumni network, corporate partners and schools, CEMS is capital that doesn’t depreciate.
- Resilience has become a watch word. Saint-Exupéry’s quote resonates with me: “If you want to build a ship, don’t drum up people to collect wood and don’t assign them tasks and work, but rather teach them to long for the endless immensity of the sea.” We are in a new paradigm – so prepare for the next change. For COVID-19, while we hope that the vaccine will soon upon us, the broader long-term positive challenge remains.
Data after Brexit: How does the end of the transition affect GDPR?
By John Flynn, Principal Security Consultant at Conosco
The UK has officially left the European Union now that the transition period has ended on January 1st 2021. But this could raise issues with one of the biggest bugbears for many companies – the international transfer of personal data.
Businesses can relax, somewhat – GDPR, which took businesses months to get their heads around, is not being replaced. It will continue as the UK GDPR 2018, and will still be based on the criteria of the Data Protection Act of 2018. However, the UK will retain the right to change the UK GDPR as it sees fit in the future.
The main changes apply to those who receive data coming into the UK from Europe. Transfers from the UK to other countries can continue under existing arrangements.
We know it can be difficult to cut through the legal jargon, so we have simplified what you need to know to protect yourself and your data:
1 – Update your privacy notice
Most businesses do not have the correct clauses in place ahead of January 1st, potentially exposing their liability, should something happen to their data. All company privacy notices online will need to be updated to specifically state ‘UK GDPR’, as opposed to ‘EU GDPR’. You will also need standard contractual clauses in place, which cover both parties – those transferring and those receiving the data.
The Information Commissioner’s Office (ICO) has a list of what needs to be included in the standard contractual clause here. The ICO will remain the UK regulator for data protection, regularly liaising with each EU member state.
This also applies to Multi Corporate Groups who operate in multiple countries, who need to update their documentation and privacy notice to expressly cover the data transfers. The UK has applied for an adequacy assessment, which would negate the need for contractual clauses, however this has not yet been approved by the EU.
2 – Data privacy assessments
Any company which runs applications and software should always perform a Data Privacy Impact Assessment. This was also in the guidelines before, but these assessments are now more important for those who outsource their IT operations internationally.
For example, when using a service such as a cloud-based system, the company must be sure that its service provider adheres to UK GDPR and stores the data within the European Economic Area (EEA), or has a binding corporate agreement with the company, where data is stored outside of the EEA. You should also, as mentioned above, make sure that a contractual clause is in place.
3 – Review local legislation
Contracts should now have contractual clauses that specify the responsibilities of the data controller and the data processor. If you are receiving personal data from a country territory or sector covered by a European Commission adequacy decision, the sender of the data will need to consider how to comply with its local laws on international transfers. You should check local legislation and guidance in this case.
4 – Cyber Security health check
The ICO is increasing its capacity and efforts to crack down on data breaches, post-Brexit. Now is a great time for all companies to have a health check to understand their Information Security posture and GDPR compliance. Nobody wants to be caught handling data improperly and fined when it could have been prevented with education and training.
A gap analysis performed by an expert is money well-spent. It’s also a fact that companies that have cybersecurity and Information Security controls are not only able to better defend against attacks but are also far better placed to recover from an attack.
It’s important that all businesses – large and small – are properly preparing their data storage and transferring for the 1st January. ICO has been busy setting examples by fining large, high-profile companies for failing to keep millions of customers’ personal data safe.
It will continue to come down hard on the data breaches of personal identifiable information and special categories of data. The saying ‘prevention is better than a cure’ rings truer than ever this year, and you will thank yourself if you make the efforts to properly store your data now, and not when it’s too late.
2020 reflections and 2021 outlook
By John Hunter, Head of Banking and Fiduciaries, Finance Isle of Man
Reflections on the most surreal year
The Covid-19 pandemic has completely changed the world as we knew it, resulting in catastrophic loss of life and fears of a downturn hang over global economies like a sword of Damocles. In the UK, the new strain has further exacerbated the situation. As I am sure many have already said we are living in what could be called the most surreal times. People have been trying to cope with this “new normal”, by changing their lifestyles and evolving behaviours.
The Isle of Man responded swiftly to the pandemic by closing its borders and enforcing social restrictions which everyone respected and adhered to. Socially and culturally the Island demonstrated all the good things that come from living on a relatively small Island where community still means so much.
The Isle of Man’s financial services sector adapted quickly, seamlessly transitioning to working from home. The banks too adopted flexible remote working practices and continued to support clients around the world helping them navigate the challenging situation and making the most of any opportunities that arose.
Although there is no substitute for face-to-face interactions, we all embraced web-conferencing platforms like Microsoft Teams and Zoom to stay connected with contacts around the world and build and nurture business relationships, whether it was with financial services firms or high net worth individuals looking to relocate to the Island.
Furthermore, a priority for the Isle of Man has been to reinvigorate the business and cultural ties with South Africa. In a normal world, we would have travelled to the country, held in-person meetings with businesses and industry representatives and talked about building on our wonderful historic ties. However, because of the scale and breadth of disruption we had to change all our plans! We hosted a virtual roadshow which comprised a series of webinars exploring why it has never been more important for South African businesses and individuals to choose the right jurisdiction for long term financial planning.
Looking ahead to the future
We are all hoping that the global rollout of vaccines will provide the pathway to some form of return to normality and all the things people are missing will be back. Like amidst all periods of immense turmoil, interesting, new possibilities have emerged such as the revolution in work culture and a renewed importance of being close to nature and green spaces is. And these possibilities can help reshape society for the better.
The global economic recovery and rebuild might seem further away in the current environment especially amidst the new lockdowns. But we are confident in the resilience of economies and are hopeful that different industrial sectors and governments working together would result in green shoots.
The financial services industry has an important role to play in getting the world economy back on its feet. It is a core component of the solution to continue facilitating the financing of corporates, as well as to develop sustainable finance and nurture digital technologies which have proven to be vital during the pandemic. The sector should continue its cooperation and collaboration with governments and regulators to ensure efficient capital flows and financial stability for businesses and individuals.
Banks too have a crucial role to play as they are instrumental to the effective transmission of monetary policies and stimulus packages. As mentioned in a report by EY: “Financial insecurity in the wake of COVID-19 will require banks to boost consumer confidence and help build a more resilient working world.”
We expect the Isle of Man’s financial services sector and banks to continue navigating the situation with resilience as they have been doing thus far and contributing to the global recovery process. Also, we truly hope this will be our busiest year ever (subject to our ability to travel), with an extensive global schedule of planned activity to promote the Island as an international financial centre of excellence and innovation. Personally, I had planned to be in South Africa for the British & Irish Lions tour, but regrettably, it might not take place and as such we will look forward to catching up with friends there as and when we can.
No doubt, there are significant challenges for the world ahead but as Albert Einstein said: “in the midst of every crisis lies great opportunity”. And it is this opportunity that we all need to work together to identify and make the most of. We are confident that in 2021 the Isle of Man will continue to support financial services businesses help their clients, employees, and the wider society through these surreal times. We are all in this together.
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Seven lessons from 2020
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