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Rating Action:

Moody's affirms Turkey's Baa3 government credit rating, maintains negative outlook

04 Dec 2015

London, 04 December 2015 -- Moody's Investors Service has today affirmed Turkey's Baa3 government debt and issuer ratings and maintained the negative outlook.

Moody's affirmation of Turkey's Baa3 government rating reflects the country's economic resilience and strong fiscal metrics, which have been maintained through the long electoral cycle. In particular, the government's low debt ratio is broadly stable after falling over the past decade, and the debt structure is favourable showing relative resilience to Turkish Lira weakness and forthcoming global interest rate increases.

The key drivers for maintaining the negative outlook are:

• The ongoing risks to the country's external financing capacity as a result of its large external funding needs, exacerbated by the fragility of global capital markets and the elevated geopolitical risks that Turkey is facing.

• The lack of visibility on whether the government will embark decisively on the economic reforms needed to support growth, promote institutional stability and reduce external vulnerability.

Concurrently, Moody's has affirmed the Baa3 bond rating of Hazine Mustesarligi Varlik Kiralama A.S., a special purpose vehicle wholly owned by the Republic of Turkey. The Baa3 rating carries a negative outlook.

Turkey's local-currency bond and deposit ceilings remain at A3, its long-term foreign-currency bond ceiling remains at Baa1, and its short-term foreign-currency debt ceiling is Prime-2. The long-term foreign-currency bank deposit ceiling remains Baa3, and the short-term foreign-currency bank deposit ceiling is Prime-3.

RATIONALE FOR AFFIRMING THE Baa3 RATING

Moody's decision to affirm the current Baa3 sovereign rating primarily reflects the continuing strength of Turkey's fiscal position and the government's balance sheet. Headline fiscal metrics are still favourable, notwithstanding the fact that the country has only just completed an almost two-year electoral cycle. Since the beginning of 2009, Turkey's debt burden has fallen by more than 10 percentage points to 33.5% of GDP in 2014 and Moody's expects the debt ratio to remain broadly stable at 34% of GDP in 2015.

Turkey's ability to finance its outstanding stock of debt is supported by the relatively low share of foreign-currency-denominated debt (35.3% in October 2015, from 46.3% in 2003) and the favourable maturity profile of the central government's debt stock: The average maturity of the debt stock is now 6.4 years (and the maturity of its foreign debt stock is now almost 10 years). This favourable structure shields the government's balance sheet from further depreciation of the Turkish lira against the US dollar, and from expected rises in global interest rates. In fact, the central government's foreign currency payments due next year are modest at only USD8.7 billion (1.2% of forecast 2016 GDP).

Turkey's fiscal metrics compare very strongly to its Baa3 peers, having benefitted over the past four years from high nominal GDP growth and revenue outperformance. Looking ahead, Turkey's policy direction and its ability to maintain fiscal stability in an environment of prolonged lower growth (than previously seen) will be an important driver of sovereign creditworthiness.

Real economic growth performance has also remained relatively resilient to shocks over the past two years, reflecting the strengths of Turkey's large, diversified economy. Although Moody's expects growth to slow to around 2.9% this year (and remain modest next year as well) it still remains higher than other large emerging market sovereigns facing credit challenges. Turkey's wealth, size, demographic dividend and diversification also support the Baa3 rating. Turkey's average income level on a PPP basis of USD19,698 is higher than the median for Baa-rated countries and nominal GDP has more than tripled over 2000-2014 to stand at USD798 billion in 2014, making it the 18th largest economy in the world.

RATIONALE FOR MAINTAINING THE NEGATIVE OUTLOOK

Notwithstanding those strengths, Turkey faces a challenging combination of slowing growth and diminishing external confidence that only more political stability and a broad economic reform programme could improve. The ongoing negative outlook reflects the risk associated with delays to the economic programme.

--- FIRST DRIVER: PERSISTENT DOWNSIDE RISKS TO THE COUNTRY'S EXTERNAL FINANCING POSITION AS A RESULT OF LOWER GLOBAL LIQUIDITY AND HEIGHTENED GEOPOLITICAL RISK --

In contrast to the Turkish government's strong balance sheet, the Turkish economy, as a whole, has significant external financing requirements estimated at over 27% of GDP, that continues to expose the country to sudden shifts in investor confidence. Investor confidence has already been weak over the course of 2015, as reflected in the significant depreciation of the Turkish Lira (vis-a-vis the US dollar) and substantial portfolio capital outflows. The balance of payments has been under pressure, with net portfolio outflows in the first nine months of the year amounting to USD11.6 billion (compared to an inflow of USD13.7 billion in the same time span last year). Moreover, gross foreign exchange reserves have experienced downward pressure, falling by around USD 9 billion in the first 10 months of the year.

Moody's believes that these pressures will likely persist given the combination of external risks facing the country, implying a still low but rising possibility of an escalation in capital outflows, a more rapid fall in reserves and, ultimately, the possibility of a balance of payments crisis.

In particular, the rating agency expects that the normalisation of US monetary policy will likely increase Turkey's external refinancing costs, particularly in the context of rising geopolitical risks. While domestic political uncertainty has reduced somewhat after the completion of the long electoral cycle, the complex conflict in Syria and Iraq and the reversal of the three-year ceasefire with the Kurdistan Workers Party (PKK) have the potential to undermine foreign investor confidence and exacerbate pressures on the balance of payments.

In that context, Moody's notes

(1) the need to finance a current account deficit which remains large relative to that of other emerging market sovereigns despite a recent improvement tied to low oil prices; and

(2) the approximately USD170 billion in external liabilities estimated to be repaid next year by the Turkish corporate, banking and government sectors.

Looking across the economy in aggregate, the coverage of maturing external financing (which includes non-resident deposits and short-term external liabilities) by foreign-exchange reserves positions Turkey unfavourably vis-a-vis the country's peers -- as reflected in the country's high External Vulnerability Indicator, which Moody's estimates at 178% in 2015 and which will remain elevated next year.

Mitigating those risks somewhat, Moody's notes that the capacity of Turkey's banks, corporates and public institutions to roll over maturing foreign-exchange debt has historically been high, even at times of elevated financial distress. Moreover, parts of the Turkish private sector have buffers which offset some of the current financing challenges: the banking sector has significant reserves at the central bank which it could use to meet its maturing external debt at a period of shock; and Moody's estimates that a third of the corporate sector's foreign-currency short-term debt is trade finance, which traditionally also benefits from a high roll-over rate.

Nevertheless, Turkey continues to operate in a fragile financial and geopolitical environment, and its high external financing needs expose it to the risk of a shock which could have a significant impact on the economy.

--SECOND DRIVER: LACK OF VISIBILITY ON ECONOMIC REFORMS THAT COULD PROMOTE INSTITUTIONAL STABILITY AND REDUCE EXTERNAL VULNERABILITY

The second driver of the continued negative outlook is Turkey's weakening medium-term growth outlook. Moody's now expects Turkey's real GDP to grow at an average of 3% over the next three years, which follows average growth of 5.4% over 2010-2014. In order to increase growth momentum in the coming years, substantial economic reforms such as an increase in the domestic savings rate, an improving business climate and increasing overall productivity would be needed. Recent qualitative surveys on competitiveness and institutions indicate a gradual erosion of institutional strength which could have an adverse impact on medium-term growth. Although the completion of the long electoral cycle has somewhat reduced domestic political uncertainty, and Moody's acknowledges the appointment of the new cabinet and the government's recent announcement of its program, it is still unclear if there remains any great momentum for implementing reforms.

As an example, uncertainty remains regarding the government's aim of changing the Constitution and whether that could further delay immediate economic policy imperatives. Consequently, there is still the risk that policy momentum could be slow, delaying the evolution of a growth model which can deliver higher, more stable, broad-based growth. A stable growth model will also be important to maintaining robust fiscal policy, as high nominal growth has contributed quite strongly to the government's past strong fiscal performance.

The combination of challenges facing the country today -- heightened geopolitical risk, pressures on its external financing and the prospect of weaker growth in the medium term -- continue to keep the balance of credit risks to the downside and support the negative outlook on the rating.

WHAT COULD MOVE THE RATING UP/DOWN

Moody's would consider moving the rating outlook back to stable if some of the following factors materialise: A more stable policy environment, characterised by solid progress in implementing the economic and institutional reforms needed to weaken the ties between economic growth and external finances and improve Turkey's institutional environment; and/or improved investor confidence in the economy supporting an easing of external financing pressures.

Conversely, downward pressure on the rating would arise from sustained further delays in implementing the structural reforms needed to reduce external imbalances and sustain economic, fiscal and institutional strength; and/or an increase in investor risk aversion which intensifies pressures on the country's external finances, thereby heightening the risk of a sudden and sustained halt in foreign capital flows.

GDP per capita (PPP basis, US$): 19,698 (2014 Actual) (also known as Per Capita Income)

Real GDP growth (% change): 2.9% (2014 Actual) (also known as GDP Growth)

Inflation Rate (CPI, % change Dec/Dec): 8.2% (2014 Actual)

Gen. Gov. Financial Balance/GDP: -1.4% (2014 Actual) (also known as Fiscal Balance)

Current Account Balance/GDP: -5.8% (2014 Actual) (also known as External Balance)

External debt/GDP: [not available]

Level of economic development: High level of economic resilience

Default history: At least one default event (on bonds and/or loans) has been recorded since 1983.

On 02 December 2015, a rating committee was called to discuss the rating of the Turkey, Government of. The main points raised during the discussion were: The issuer's economic fundamentals, including its economic strength, have remained resilient. The issuer's institutional strength/framework, reflects gradual erosion. The issuer's fiscal or financial strength, including its debt profile, have remained stable. The issuer has become increasingly susceptible to event risks.

The principal methodology used in these ratings was Sovereign Bond Ratings published in September 2013. Please see the Credit Policy page on www.moodys.com for a copy of this methodology.

The weighting of all rating factors is described in the methodology used in this rating action, if applicable.

REGULATORY DISCLOSURES

For ratings issued on a program, series or category/class of debt, this announcement provides certain regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series or category/class of debt or pursuant to a program for which the ratings are derived exclusively from existing ratings in accordance with Moody's rating practices. For ratings issued on a support provider, this announcement provides certain regulatory disclosures in relation to the rating action on the support provider and in relation to each particular rating action for securities that derive their credit ratings from the support provider's credit rating. For provisional ratings, this announcement provides certain regulatory disclosures in relation to the provisional rating assigned, and in relation to a definitive rating that may be assigned subsequent to the final issuance of the debt, in each case where the transaction structure and terms have not changed prior to the assignment of the definitive rating in a manner that would have affected the rating. For further information please see the ratings tab on the issuer/entity page for the respective issuer on www.moodys.com.

For any affected securities or rated entities receiving direct credit support from the primary entity(ies) of this rating action, and whose ratings may change as a result of this rating action, the associated regulatory disclosures will be those of the guarantor entity. Exceptions to this approach exist for the following disclosures, if applicable to jurisdiction: Ancillary Services, Disclosure to rated entity, Disclosure from rated entity.

Regulatory disclosures contained in this press release apply to the credit rating and, if applicable, the related rating outlook or rating review.

Please see www.moodys.com for any updates on changes to the lead rating analyst and to the Moody's legal entity that has issued the rating.

Please see the ratings tab on the issuer/entity page on www.moodys.com for additional regulatory disclosures for each credit rating.

Alpona Banerji
VP - Senior Credit Officer
Sovereign Risk Group
Moody's Investors Service Ltd.
One Canada Square
Canary Wharf
London E14 5FA
United Kingdom
JOURNALISTS: 44 20 7772 5456
SUBSCRIBERS: 44 20 7772 5454

Yves Lemay
MD-Banking & Sovereign
Sovereign Risk Group
JOURNALISTS: 44 20 7772 5456
SUBSCRIBERS: 44 20 7772 5454

Releasing Office:
Moody's Investors Service Ltd.
One Canada Square
Canary Wharf
London E14 5FA
United Kingdom
JOURNALISTS: 44 20 7772 5456
SUBSCRIBERS: 44 20 7772 5454

Moody's affirms Turkey's Baa3 government credit rating, maintains negative outlook
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