Moody's downgraded Turkey's issuer and senior unsecured debt ratings to B2 from B1 and maintained a negative outlook, citing the country's external vulnerabilities that could eventually take shape as a balance of payments crisis.

The rating agency said Turkey's external vulnerability indicator, which measures the adequacy of foreign currency reserves to cover external debt repayments and nonresident deposits, is expected to climb to 409% in 2021 from 263% in 2019. The country's foreign currency reserves as a percentage of GDP have fallen to a multi-decade low due to the central bank's unsuccessful attempts to defend the weakening lira since the start of 2020, according to Moody's.

"The lower gross and net reserves go, the more likely it is that Turkey experiences a severe [balance of payments] crisis, causing acute disruptions to economic activity and further deterioration in the government's balance sheet," Moody's said, adding that the country's dollarization also raises the risk of a balance of payments crisis.

Moody's also cited Turkey's weak monetary policy credibility and effectiveness as a trigger for the ratings downgrade, pointing out that the central bank is grappling with political pressures and limited independence.

"[T]he central bank has taken only modest action to tighten monetary policy," the rating agency said. "The longer this goes on, the more likely it is that there will be continued downward pressure on the currency."

Turkey's fiscal strength has likewise declined as rising government debt levels and poor debt structure weakened the country's debt affordability, Moody's added.

The rating agency projects the government debt burden to increase to 42.9% of GDP in 2020 and above 46% in the coming years, from 32.5% in 2019. It expects the fiscal deficit to widen to 7.5% of GDP in 2020 due to the impact of weak economic growth and fiscal measures deployed by the government to mitigate the fallout from the coronavirus pandemic.