Turkish Referendum May Lead To Economic Reform

Turkey’s constitutional referendum is part of a political shift that has been negative for the country’s sovereign credit profile, but may facilitate a revival of credit-positive economic reforms, global ratings agency Fitch Ratings says.

The April 16th referendum approved, by a slim margin (51.4%), 18 constitutional amendments that will increase the executive powers of the presidency. The opposition CHP said it will demand a partial recount and has criticized alleged “unfair conditions” in which the vote was held under.

Earlier this year, Fitch downgraded Turkey’s sovereign rating to BB+/Stable. This reflected, among other things, the erosion of checks and balances and institutional independence in Turkey in recent years. At the time of the downgrade, the agency assumed that the constitutional amendments would be approved.

The Turkish referendum may complete an extended political cycle now that President Recep Tayyip Erdogan has accomplished what is a key long-standing political goal of increasing presidential powers. New presidential and parliamentary elections are not required until late 2019. This timeframe should allow the economy to move back up the ruling AKP’s policy agenda.

Politics, Security Impact Economic Performance

Turkey’s volatile political and security environment damaged economic performance in 2016. A better-than-expected 4Q16 and revisions to 9M16 outturns mean growth was stronger than Fitch’s forecast, but it was still halved to 2.9%. The AKP has a developed what they say is an economic reform program, however little has been implemented in recent years due to the “fluid political backdrop, and structural weaknesses (including high net external debt and external financing requirements and poor composition of growth) have become more pronounced,” says Paul Gamble, sovereign analyst with Fitch Ratings explains.

Deputy Prime Minister Mehmet Simsek said before the referendum that the removal of political uncertainty would enable the government to “accelerate reforms starting [in] May 2017” to improve Turkey’s investment environment and the tax system. Successful economic reform was a feature of the first half of Erdogan’s rule.

The government may also loosen fiscal policy to lift growth.

The political commitment to fiscal prudence has been strong (additional revenue raising measures were introduced last year to keep the deficit within its target, for example), and Turkey has some fiscal headroom. Its general government debt/revenue ratio is under half the ‘BB’ category median due to primary surpluses and a broader revenue base.

Nevertheless, use of off-balance-sheet stimulus picked up ahead of the referendum, most notably through credit guarantees that are increasing the sovereign’s contingent liabilities, albeit from a low base.

The relative weight given to different policy options and their success in promoting stable and sustainable growth will be an important part of our sovereign rating assessment. Implementation of reforms that address structural deficiencies and reduce external vulnerabilities is a positive rating sensitivity. A weakening of public and external finances reflected in a deterioration of the government debt/GDP ratio or heightened external financing vulnerabilities are negative rating sensitivities.