Fitch rates Turkey’s new eurobond at B

Fitch believes that 2004 will be less impressive for Turkey than last year, but the government should experience no major problems meeting its financing requirements. Multilateral support is strong and it would take a policy deviation of some magnitude to raise concerns over a breakdown in relations with the International Monetary Fund (IMF).

Meanwhile, bilateral relations are improving and Turkey should be able to access up to $8.5 billion in US loans should they be needed. Further adjustment will probably be needed to achieve the 6.5 percent gross national product (GNP) primary fiscal surplus set out in the 2004 budget, but the primary surplus will still represent an important part of public financing this year. Fitch expects some progress on privatization, while the government could also borrow up to $5.5 billion in the international bond markets.

Local market sentiment remains solid, with nominal yields now in a range of 20-25 percent and good demand for government paper. The capacity of the financial system to absorb sizeable government issuance this year remains strong, with good demand from the banking and retail sectors.

Fitch believes that it would take a significant shock to reverse this virtuous cycle. However, it should be noted that the strong real appreciation of the lira had a major influence in reducing the government debt and financing burden in 2003. A repeat of this currency strength is improbable in 2004, and Fitch expects a flat real exchange rate this year. This means that a further large reduction in the government debt burden is unlikely.

Assuming further compression of interest rates, real GDP growth of around five percent and continued fiscal consolidation, the general government debt burden would fall by no more than 2-3 three percent of gross domestic product (GDP) this year, compared with roughly 10 percent in 2003.

While there are limited concerns over public sector financing in 2004, there is little room for complacency. Already there have been some signs of fiscal populism, while further structural fiscal adjustment is needed to ensure public finance sustainability. The vulnerability of the government debt stock to shocks will remain for the foreseeable future. Meanwhile, a new IMF program will probably be needed to cover 2004 and beyond, not least given a sharp rise in Fund repayments during these years. Consequently, serious deviations from program conditionality would be viewed in a negative light.

Fitch will monitor closely any progress towards EU accession. The complexities of Cyprus seem unlikely to be resolved by May, which could undermine the chances of receiving a negotiation date in December. While Fitch is moderately hopeful that Turkey will receive positive news on this front by the end of the year, currently this is not its base-case outlook. Of course, a green light from the EU would be strongly positive for the sovereign ratings as it would bolster market sentiment, help compress debt yields and, most importantly, provide an anchor for further and sustained economic and political reform.

Disappointment on the EU bid would be unlikely to prompt a public financing crisis in 2005, and would carry limited rating implications at this level, but it would make things more difficult next year. It might remove much of the current incentive for reform and prevent the country from putting its public debt and financial problems behind it, and could also prompt fresh political instability.