Research Update:

Outlook On Republic of Turkey Revised To Negative On Risks Of A Hard Economic Landing; Ratings Affirmed
Primary Credit Analyst: Frank Gill, London (44) 20-7176-7129; frank.gill@standardandpoors.com Secondary Contact: Elliot Hentov, PhD, London (44) 207-176-7071; elliot.hentov@standardandpoors.com

Table Of Contents
Overview Rating Action Rationale Outlook Key Statistics Related Criteria And Research Ratings List

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Research Update:

Outlook On Republic of Turkey Revised To Negative On Risks Of A Hard Economic Landing; Ratings Affirmed
Overview
We see rising risks of a hard economic landing in Turkey, although our baseline projection still assumes positive GDP growth in 2014 and 2015, with average per capita GDP growth at 1%. The country's declining reserve coverage of net external financing needs is a credit weakness, in our view. We also believe Turkey's policy environment is becoming less predictable, and that this could weigh on the economy's resilience and long-term growth potential. We are therefore revising the outlook on the unsolicited 'BB+' long-term foreign currency and 'BBB' long-term local currency ratings on Turkey to negative from stable. Nevertheless, we note that low and largely local currency-denominated general government debt provides significant buffers. As a "sovereign rating" (as defined in EU CRA Regulation 1060/2009 ("EU CRA Regulation"), the ratings on Turkey are subject to certain publication restrictions set out in Art 8a of the EU CRA Regulation, including publication in accordance with a pre-established calendar (see "Calendar of 2014 Publication Dates for EMEA Sovereign, Regional, And Local Government Ratings," Dec. 30, 2013). Under the EU CRA Regulation, deviations from the announced calendar are allowed only in limited circumstances and must be accompanied by a detailed explanation of the reasons for the deviation. In this case, the reason for the deviation is described below.

Rating Action
On Feb. 7, 2014, Standard & Poor's Ratings Services revised its outlook on the long-term ratings on the Republic of Turkey to negative from stable. At the same time, we affirmed the unsolicited 'BB+/B' long- and short-term foreign currency sovereign credit ratings, 'BBB/A-2' long- and short-term local currency sovereign credit ratings, and 'trAAA/trA-1' long- and short-term Turkey national scale ratings.

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Research Update: Outlook On Republic of Turkey Revised To Negative On Risks Of A Hard Economic Landing; Ratings Affirmed

Rationale
The outlook revision reflects two emerging risks to our ratings on Turkey. First, we believe that Turkey's fiscal and monetary policies have exposed the country to a potential hard landing as external conditions tighten. In particular, Turkey's external and fiscal positions could suffer beyond our base-line forecasts published on Nov. 22, 2013, should GDP performance worsen beyond our current expectations. Versus November, we have revised downward our projections for Turkey's GDP, foreign exchange reserves, exchange rate stability, and domestic interest rates and credit conditions. We have lowered our projection of average GDP in 2014-2015 to 2.2% from 3.4%, and consider that unfavorable exchange and interest rate dynamics would pose further downside risks to these forecasts. Weaker growth would almost certainly lead to poorer fiscal performance (as it did in 2009), and could also put pressure on asset quality in Turkey's financial sector. In light of our criteria, the effect of these revisions has prompted us to reevaluate risks to Turkey's sovereign creditworthiness. Second, Turkey appears to have suffered an unanticipated erosion of institutional checks and balances and governance standards. For example, we believe that any constraints on the independence and transparency of the Central Bank of the Republic of Turkey (CBRT) pose a risk to an economy that has traditionally relied on significant external financing needs. At the same time, we recognize that the Central Bank has recently normalized its interest rate policy by reactivating the one-week repo rate at a level above expected inflation. During most of 2013, as private investment stagnated, GDP growth relied on credit-driven private consumption (additionally stimulated by an early 2013 rate cut) and an accommodative fiscal stance to expand at an estimated pace of 3.6% (or 2.4% per capita). Prospects for a tightening of global and domestic monetary policy in 2014 and 2015 suggest that external funding will become more expensive amid declining net foreign exchange reserves. This would force Turkish aggregate demand to converge toward aggregate production, lowering the current account deficit (CAD) to a projected 2.9% of GDP versus 7.6% of GDP last year. In our assessment, much of the foreign-financed lending since 2007 has flowed into the domestic services sector, property development and construction, and an untested small and midsize enterprises (SME) loan book. Lower GDP growth is likely to stress the creditworthiness of these recent borrowers. If the Turkish banking system's asset quality declines, foreign lenders could potentially make it more expensive for Turkish financial institutions to rollover their short-term external debt. This has increased fivefold since 2007--including nonresident local- and foreign-currency deposits--to an estimated $91 billion (11.5% of GDP) as of fourth-quarter 2013. Complicating our assessment of Turkish financial sector asset quality is the relatively high percentage of loans denominated in foreign currencies that

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Research Update: Outlook On Republic of Turkey Revised To Negative On Risks Of A Hard Economic Landing; Ratings Affirmed

banks have extended to the partially unhedged corporate sector. Moreover, the recent depreciation of the Turkish lira by 14% on a trade weighted basis since end-2012 in nominal terms will likely strain the capacity of some Turkish nonfinancial companies to service their loans in a rising interest rate environment. Added to this, we expect that net general government debt to GDP will peak at just under 34% next year. Even under alternative scenarios, we do not believe Turkey's general government debt-to-GDP ratio will be pushed substantially higher by rising real interest rates or further sustained real exchange rate depreciation. In our view, a larger shock to general government debt to GDP would only come either from an unexpected decline in nominal GDP or the need for the government to recapitalize weaker components of the banking system. We see the former as low probability, while the latter would depend upon the level of economic stress and extent of lira depreciation. In our view, Turkey's recent primary budgetary surpluses reflect a fiscal windfall from rapid demand growth rather than a particularly tight fiscal policy. Weaker anticipated domestic demand for 2014 is therefore likely to weigh on government revenues, even as public spending expands further given the busy electoral calendar. For this reason, we anticipate that the 2014 general government deficit could widen to 3% of GDP. We project that export volume growth (excluding non-monetary gold) will average 5% over the next four years. The floating exchange rate should, in our view, ultimately facilitate an even stronger recovery of exports over the medium term. Nevertheless, we still see considerable external vulnerabilities over and above the large current account deficit. Standard & Poor's estimates Turkish narrow net external debt (gross debt minus liquid financial sector and general government assets) was 135% of current account receipts (CAR) as of end-2013. The low coverage of net debt by CAR suggests Turkey's private sector is vulnerable to rollover risk for its external debt in the event of a sudden stop of nonresident lending inflows. During 2014, we estimate that Turkey's current account deficit plus external debt redemptions (including short-term debt) will total an estimated 100% of CAR, equivalent to one-quarter of GDP, or an estimated 1.6x Turkish estimated net international reserves (based on the projection that the CAD will decline by half in 2014). Excluding trade financing from this figure, net external financing requirements for 2014 still total 85% of CAR, which is equivalent to 23% of GDP. Turkey's moderate and mostly local currency-denominated general government debt burden support the ratings, as does our estimation of the country's still resilient long-term growth potential. The CBRT has increased its reported gross foreign exchange reserves by encouraging banks to meet local currency reserve requirements with foreign exchange deposits. Although these operations put more gross resources at the CBRT's disposal, we view only net reserves as available to meet net financing

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Research Update: Outlook On Republic of Turkey Revised To Negative On Risks Of A Hard Economic Landing; Ratings Affirmed

needs or to finance exchange rate intervention. The CBRT has also responded to continued pressure on capital outflows by increasing interest rates, most recently at its Jan. 28 Monetary Policy Committee, both raising and reactivating the one-week repo rate to 10%. The weakened lira contributes to our expectations that the central bank is likely to miss its 5% inflation target in 2014 for the fourth year running.

Outlook
The negative outlook reflects our view that there is at least a one-in-three likelihood that we will lower our ratings on Turkey within the next 12 months. The triggers could be a weakening of the country's external profile, our view that institutional and governance standards have weakened further, or a larger balance of payments and growth shock. If such a shock were severe, it could affect financial sector stability through exchange rate volatility and weaker growth, potentially leading to contingent liabilities crystallizing on the sovereign balance sheet. We believe downward pressure on the ratings on Turkey could recede if fiscal and monetary policies supported more balanced economic growth that depended less heavily on external borrowing.

Key Statistics
Table 1

Republic of Turkey - Selected Indicators

2007 Nominal GDP (US$ bil) GDP per capita (US$) Real GDP growth (%) Real GDP per capita growth (%) Change in general government debt/GDP (%) General government balance/GDP (%) General government debt/GDP (%) Net general government debt/GDP (%) General government interest expenditure/revenues (%) Oth dc claims on resident non-govt. sector/GDP (%) CPI growth (%) Gross external financing needs/CARs +use. res (%) 647 9,312 4.7 3.4 (1.9) (1.9) 39.9 35.8 15.3 30.7 8.8 129.1 2008 730 10,379 0.7 (0.6) 4.6 (2.7) 40.0 36.2 13.7 33.8 10.4 124.5 2009 615 8,627 (4.8) (6.0) 6.2 (6.0) 46.1 41.4 13.8 38.2 6.3 122.7 2010 731 10,135 9.2 7.8 2.4 (3.0) 42.3 38.5 11.1 46.2 8.6 131.3 2011 775 10,605 8.8 7.4 3.3 (0.7) 39.1 35.2 7.7 51.6 6.5 145.6 2012 788 10,653 2.2 0.9 0.3 (1.6) 36.2 32.2 8.1 56.2 8.9 136.1 2013e 794 10,605 3.6 2.4 2.8 (1.8) 35.6 31.9 6.4 62.2 7.5 133.4 2014f 749 9,890 2.4 1.2 4.1 (3.0) 36.0 32.8 6.6 58.0 9.8 124.2 2015f 749 9,771 2.0 0.8 3.3 (3.4) 36.8 33.8 6.7 56.1 7.0 128.0 2016f 817 10,520 3.4 2.1 2.7 (2.7) 36.5 33.7 6.8 54.0 6.5 123.7 2017f 890 11,327 3.4 2.1 2.7 (2.7) 36.1 33.6 6.8 52.1 6.5 121.2

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Research Update: Outlook On Republic of Turkey Revised To Negative On Risks Of A Hard Economic Landing; Ratings Affirmed

Table 1

Republic of Turkey - Selected Indicators (cont.)

Current account balance/GDP (%) Current account balance/CARs (%) Narrow net external debt/CARs (%) Net external liabilities/CARs (%) (5.8) (24.5) 97.8 204.0 (5.5) (21.6) 85.3 107.3 (2.0) (8.0) 96.6 180.6 (6.2) (27.9) 111.1 221.6 (9.7) (39.6) 105.8 166.1 (6.2) (22.8) 107.7 198.0 (7.6) (28.2) 134.8 223.3 (2.9) (10.5) 146.7 240.7 (2.7) (9.8) 149.8 250.1 (2.0) (7.2) 137.6 239.0 (1.3) (4.6) 124.0 226.0

Other depository corporations (dc) are financial corporations (other than the central bank) whose liabilities are included in the national definition of broad money. Gross external financing needs are defined as current account payments plus short-term external debt at the end of the prior year plus nonresident deposits at the end of the prior year plus long-term external debt maturing within the year. Narrow net external debt is defined as the stock of foreign and local currency public- and private- sector borrowings from nonresidents minus official reserves minus public-sector liquid assets held by nonresidents minus financial sector loans to, deposits with, or investments in nonresident entities. A negative number indicates net external lending. CARs--Current account receipts.

Related Criteria And Research

Related Criteria
Sovereign Government Rating Methodology And Assumptions, June 24, 2013. Methodology For Linking Short-Term And Long-Term Ratings For Corporate, Insurance, And Sovereign Issuers, May 7, 2013. Criteria For Determining Transfer And Convertibility Assessments, May 18, 2009

Related Research
Sovereign Defaults And Rating Transition Data, 2012 Update, March 29, 2013 Banking Industry Country Risk Assessment: Turkey, July 10, 2013 In accordance with our relevant policies and procedures, the Rating Committee was composed of analysts that are qualified to vote in the committee, with sufficient experience to convey the appropriate level of knowledge and understanding of the methodology applicable (see 'Related Criteria And Research'). At the onset of the committee, the chair confirmed that the information provided to the Rating Committee by the primary analyst had been distributed in a timely manner and was sufficient for Committee members to make an informed decision. After the primary analyst gave opening remarks and explained the recommendation, the Committee discussed key rating factors and critical issues in accordance with the relevant criteria. Qualitative and quantitative risk factors were considered and discussed, looking at track-record and forecasts. The chair ensured every voting member was given the opportunity to articulate his/her opinion. The chair or designee reviewed the draft report to ensure consistency with the Committee decision. The views and the decision of the rating committee are summarized in the above rationale and outlook.

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Research Update: Outlook On Republic of Turkey Revised To Negative On Risks Of A Hard Economic Landing; Ratings Affirmed

Ratings List
Ratings Affirmed; CreditWatch/Outlook Action To Turkey (Republic of) (Unsolicited Ratings) Sovereign Credit Rating Foreign Currency BB+/Negative/B Local Currency BBB/Negative/A-2 Turkey National Scale trAAA/--/trA-1 Transfer & Convertibility Assessment BBB From

BB+/Stable/B BBB/Stable/A-2

Additional Contact: SovereignEurope; SovereignEurope@standardandpoors.com

This unsolicited rating(s) was initiated by Standard & Poor's. It may be based solely on publicly available information and may or may not involve the participation of the issuer. Standard & Poor's has used information from sources believed to be reliable based on standards established in our Credit Ratings Information and Data Policy but does not guarantee the accuracy, adequacy, or completeness of any information used. Complete ratings information is available to subscribers of RatingsDirect at www.globalcreditportal.com and at spcapitaliq.com. All ratings affected by this rating action can be found on Standard & Poor's public Web site at www.standardandpoors.com. Use the Ratings search box located in the left column. Alternatively, call one of the following Standard & Poor's numbers: Client Support Europe (44) 20-7176-7176; London Press Office (44) 20-7176-3605; Paris (33) 1-4420-6708; Frankfurt (49) 69-33-999-225; Stockholm (46) 8-440-5914; or Moscow 7 (495) 783-4009.

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