Turkey: Risk Assessment
Country Risk Rating
Business Climate Rating
- Deceleration of inflation, lower interest rates supporting domestic demand
- Lower external vulnerability on narrower current account deficit
- Low public deficit to GDP ratio, but some contingent liabilities
- Large industrial production tissue and tourism industry, competitive export base
- Customs union with the EU
- Strategic location
- Still fragile consumer and business confidence
- Economy largely dependent on short-term capital inflows, high private external debt
- Industrial dependence on imported inputs, exposure to lira volatility
- Elevated regional geopolitical risks
- Informality (27% in 2017) and inequality
Rebalancing of the economy continues yet vulnerabilities persist
After hitting 25%, annual inflation declined as low as 8.6% end-2019 on the back of favorable base effects and mainly declining food prices. Thanks to lower inflation and supportive monetary policies from major central banks (US Fed, ECB, BOJ etc.), Turkey’s central bank was able to reduce its policy rate by around 10 percentage points in the second half of 2019. Lower inflation and interest rates, as well as further credit provision from state banks, are expected to sustain domestic demand in 2020, which would push up the growth performance, as domestic demand accounts for nearly 60% of GDP. Except in the event of another currency shock, industrial production will continue to recover in line with improving domestic consumption and continuous external demand. Low volatility of the lira will be important for the sustainable recovery of the economic dynamics. Due to its depreciation, the lira now supports the competitiveness of Turkish exports. Despite this rebalancing, corporate payment behavior will need more time to improve due to the high level of debt and deteriorated cash flows. During the economic contraction, and despite granted restructurings, non-performing loans rose to 6% compared to 3% mid-2018. Coupled with elevated risk perception, this has deterred banks to provide new loans. As a result, Turkish corporates, which rely largely on bank loans to maintain their cash flow and operating capital, started to struggle because of the lack and high cost of financing, as well as lower turnovers. Although lower interest rates are expected to feed credit channel in 2020, payment terms, especially for small and medium enterprises, particularly in domestic-oriented sectors, will not shorten quickly. High external debt that jumped to 62% of GDP mid-2019 remains an important challenge and a serious source of an increasing risk premium for Turkey. Yet, this figure deserves a detailed breakdown. The challenging part of the external debt is the one maturing within a year (short-term external debt). Turkey’s short-term external debt was at 16% of its GDP as of Q2 2019, with non-financial private companies’ short-term external debt standing at 8% of GDP. Therefore, even though the factors mentioned above are expected to support growth performance in the near-term, in the middle to long-term, the credit-driven nature of growth, the high level of debt (especially for non-financial companies) and squeezed profit margins, as well as the absence of significant progress on labor and products markets, insolvency framework and R&D will restrain the pace of economic recovery and keep investments at low levels.
Despite wider budget deficit, public debt will remain low; external gap narrows
The government expenditure remained high in 2019 due to the elections and the government’s efforts to support the ailing economy, while revenues were impacted by stagnation. Economic recovery will support tax revenues. Yet, they are expected to remain weak due to slow growth performance. On the expenditure side, the high level of unemployment (nearly 14% compared with 11% on average in 2018) and costs related to public guaranteed credit schemes will weigh on expenditures. As a result, Turkey is expected to run budget deficits higher than in the previous decade. Nevertheless, public debt to GDP ratio will remain low compared to Turkey’s emerging peers, giving the government more room to contract more debt. The economic contraction dragged down import demand in 2019 and contributed to the improvement of the current account balance. Consequently, the latter is expected to produce again a slight deficit in 2020, on the back of recovering domestic demand, particularly from the production side. Turkey’s production tissue is dependent on imported inputs that dig the current account balance. Despite regional tensions, tourism revenues are expected to increase in 2020, as this industry remains immune to them, and an important positive contributor to the current account balance. The core current account (excluding gold and energy) recorded a record-high level surplus of USD 48 billion in September 2019, on a 12-month cumulative basis. The country continues to attract foreign direct investments for a total of around USD 8 billion annually (1% of GDP), while there is a very shy return of portfolio investments. Because the country recorded a current account surplus, the central bank’s reserves increased, covering nearly 4.5 months of imports. However, this trend may be reversed in 2020.
Domestic stability but external challenges
After several years of successive elections, Turkey is now supposed to have a period without elections until 2023. This is expected to be a positive contributor to the business environment. Any rise in tensions with the US, which led to a sharp currency devaluation in August 2018, will be on the radar of investors. Threats of US sanctions continue to be a drag on confidence and keep Turkey’s risk premium higher than its peers, as well as adding to the lira’s volatility.