July 8 Ratings agency Fitch has downgraded Turkey's debt rating to "B" from "B+" on Friday, citing increasing inflation and broad concerns about the economy, from a widening current account deficit to interventionist policies.

Inflation in Turkey shot to a 24-year high 78.62 per cent in June, mainly due to a currency crisis at the end of last year and the lira's continued decline. The economic fallout from Russia's invasion of Ukraine has also stoked prices in import-dependent Turkey, especially due to rising energy and commodity costs.

In a statement, the agency affirmed its ratings outlook at "negative", adding that it expects Turkey's consumption to slow given rising inflation, a weaker exchange rate and diminishing domestic confidence.

Fitch forecast annual inflation to average 71.4 per cent this year, the highest among sovereigns rated by the agency, adding that its trajectory remains highly uncertain. Average inflation is set to slow to 57 per cent in 2023, Fitch said, due to overly accommodative policies until parliamentary and presidential elections scheduled for no later than June 2023.

Lira’s great fall

The lira lost 44 per cent of its value against the dollar last year, mainly due to a series of rate cuts from the central bank, sought by President Tayyip Erdogan. The currency is down a further 23 per cent so far this year.

The government has taken steps to stem the lira's decline. A recent move by the BDDK banking watchdog to restrict lira lending to foreign currency-rich companies helped it rally briefly last week as corporates sold hard currencies.

Referring to the move, Fitch said "policies are becoming increasingly interventionist as well as unpredictable." Last year's rate cuts were part of Erdogan's new economic programme, which prioritises exports, production and investments, while keeping lending costs low.

The policy rate has stood at 14 per cent since December, leaving real yields in deeply negative territory.

One of the goals was to turn Turkey's chronic current account deficits into a surplus, but those plans were derailed as energy and commodity prices soared due to the Ukraine conflict, sharply widening Turkey's trade deficit.

"The government's focus on maintaining high growth feeds FX demand, depreciation pressures on the lira, the decline in international reserves and spiralling inflation, and discourages capital inflows to fund the higher current account deficit," Fitch said.

It forecast the current account deficit at 5.1 per cent of gross domestic product this year, due to the higher energy prices and weakened external demand, despite a recovery in tourism.

The agency also cited the continued pressure on the central bank's forex reserves despite measures introduced to replenish them. As of July 1, the central bank's net forex reserves remained near a 20-year low at $7.51 billion.

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