Turkey’s Domestic Sukuk Issuances Maintain Traction as Ankara Issues its Latest Offering of TL846.5m Sukuk Al Ijarah Despite Continuing Global Trade Tensions and Domestic Economic Woes

The Turkish Ministry of Treasury and Finance successfully issued its latest offering of domestic Sukuk – a TR846.5 million (US$148.12) issuance of Lease Certificates (Sukuk Al Ijarah) on 21 August 2019. The issuance was done through the Central Bank of Turkey Auction System under Central Bank Payment Systems). The certificates have a tenor of two years and a maturity date of 18 August 2021 (728 days).            

In a statement, the Turkish Ministry of Treasury and Finance confirmed that “in order to increase the domestic savings, broaden the investor base and diversify borrowing instruments, TR-denominated fixed rent rate lease certificates will be issued to the banks through direct sale method on 21 August 2019 (settlement date).” In this respect, participants submitted their bids on 20 August 2019 to the Treasury.

Demand for the certificates was good and the issuance was oversubscribed more than 1.5 times. The Treasury planned to raise TR500 million initially but because of the market response, the amount was upsized to TR846.5 million. The issuance is priced at a fixed period rent rate of 7.4% to be paid every six months.

Despite the fact that the Turkish economy, according to the International Monetary Fund (IMF), is projected to contract by 2.5% in real GDP growth and inflation (consumer prices) is projected to touch 17.5% in 2019, the Turkish Ministry of Treasury & Finance continues to tap the domestic and international markets with issuances of lease certificates (Sukuk Ijarah) to fund government budgetary requirements as part of its active but diversified public funding and debt strategy, assisting its aim to ease the liquidity squeeze in the economy and financial system.

“The subdued outlook for emerging and developing Europe in 2019 largely reflects prospects for Turkey, where—after a growth surprise in the first quarter from stronger-than-expected fiscal support—the contraction in activity associated with needed policy adjustments is projected to resume,” stressed the IMF in its World Economic Outlook in July 2019.

Similarly, Moody’s Investors Service in its latest rating outlook on Turkey, stressed that the country’s economy is faced with deep structural problems including intermittent currency crises, fall in FX reserves, further concerns about the transparency and independence of the central bank and, by extension, Turkey’s broader institutional framework. These are further exacerbated by the knock-on effect of the external pressures such as the continuing uncertainty of the US-China trade tensions, the Brexit impasse in the UK, and ongoing tension between Turkey and the United States, this time relating to Turkey’s purchase of the S-400 missile system from Russia.

Not surprisingly, Moody’s in June 2019 downgraded the Government of Turkey’s long-term issuer ratings to B1 from Ba3 and maintained its negative outlook, But the resilience of the underlying fundamentals of the Turkish economy should not be underestimated.

In its August 2019 periodic review of its Turkish government ratings, which does not amount to a credit rating action and is not an indication of whether or not a credit rating action is likely in the near future, Moody’s stresses that “the credit profile of Turkey (issuer rating B1) is supported by the country’s “High” economic strength, reflecting the Turkish economy’s large size, high diversification, relatively high per-capita income and young population.”

However, it also underpins the economy’s large albeit diminishing growth potential, whilst Turkey’s “Low” institutional strength reflects the erosion of the effectiveness of policymaking, which accelerated after last year’s constitutional changes that placed primary responsibility for policymaking in the president’s hands.

The review also reflects risks posed by the country’s external vulnerability stemming from an over-reliance on short-term external financing, exacerbated by elevated political and banking sector risks.

The Moody’s downgrade has direct consequences for Turkish sovereign bond/Sukuk issuances. “The senior unsecured bond ratings and senior unsecured shelf ratings have also been downgraded to B1 and (P)B1 respectively from Ba3/(P)Ba3. Concurrently, Moody’s has downgraded to B1 from Ba3 the backed senior unsecured bond ratings of Hazine Mustesarligi Varlik Kiralama A.S., a special purpose vehicle wholly owned by the Republic of Turkey from which the Turkish Treasury issues Sukuk lease certificates, and has maintained the negative outlook,” explained Moody’s in its downgrade rationale.

In contrast, Standard & Poor’s (S&P) rating agency kept Turkey’s long-term foreign currency credit rating unchanged at B+, while its long-term local currency credit rating was also preserved at BB-. S&P also affirmed the country’s short-term foreign and local currency sovereign credit ratings, which were both B.

“Despite the absence of a coordinated and proactive policy response, the Turkish economy and banking system will navigate existing challenges over the next year, helped by the U.S. Federal Reserve’s looser monetary policy,” said S&P. A rating upgrade is dependent on whether the Turkish government increased the economy’s credibility and transparency. S&P projects that Turkey’s GDP would shrink by 0.5% in 2019 before expanding by 3.2% during the following three years.

The implications for the Turkish Sukuk and participation banking market is present and clear. Ankara is a prolific issuer of domestic Sukuk, accompanied by the occasional foray into the international markets. For example, in June the Ministry of Finance issued TL1,60596 billion of 2-Year Fixed Rate Lease Certificates through Hazine Mustesarligi Varlik Kiralama, which mature on 16 June, 2021.

In May 2019, the Treasury issued an €622 million Euro-denominated Sukuk. In a further ‘innovative’ development to increase liquidity in the system, the Ministry of Treasury and Finance issued gold-backed lease certificates once again “to diversify borrowing instruments, broaden the investor base and bring the idle gold into the economy.”

As part of its 2019 external borrowing programme, Turkey will continue to access funding both through bond and Sukuk issuances.

Another rating agency, Fitch Ratings, in its report of the participation banking sector, stressed that the market share of Turkey’s participation (Islamic) banks has remained broadly stable and growth is set to remain subdued in the short term due to the weaker growth outlook, the high interest-rate environment, the end to foreign currency-indexed financing and asset-quality pressures.

However, the segment continues to offer reasonable medium-term growth prospects considering the strategic importance of participation banking to the Turkish authorities, its current low base, the recent establishment of two new state-owned banks and also the establishment of a Sharia’a advisory board to the Participation Banks Association (TKBB), to facilitate product growth.

“Credit risk remains high due to SME exposure, significant FC financing and exposure, to varying degrees, to risky sectors such as construction. Capitalisation is moderate but capital ratios are sensitive to Turkish lira depreciation and further NPF growth. Segment internal capital generation is set to weaken. The reliance of Islamic banks on wholesale funding is below that of conventional banks (9M18: 26% of total funding versus 40%) but refinancing risks are high due to high short-term maturing FC liabilities. FC liquidity at the foreign-owned, Fitch-rated banks is underpinned by shareholder support,” said Fitch.

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