Guldem Atabay
Dec 13 2017

The dark side of Turkey’s strong GDP growth...

Turkey’s economy posted mouthwatering 11.1 percent year-on-year growth in the third quarter, compared to 5.4 percent in the previous three months, mostly due to a weak base effect and working day adjustments.  Household consumption, with a hefty contribution of 7 percentage points of total growth, outperformed, thanks to temporary tax cuts on various durable goods.

growth

However, sequential quarter-on-quarter growth, which is a more reliable indicator of trends in the economy, was not so impressive. The expansion decelerated to 1.2 percent from 2.2 percent in the second quarter, on an adjusted basis. That ranks Turkey fifth in the G20 group of industrialized nation after Indonesia (3.2 percent), China (1.7 percent), South Korea (1.5 percent) and India (1.4 percent). 

In fact, setting aside a contraction of 2.6 percent in the third quarter of last year, Turkey’s 1.2 percent quarter-on-quarter growth is the weakest since 2009. Another engine of third-quarter growth was investment, which posted a 4 percent increase after a 4.4 percent expansion in the previous three months. The manufacturing sector shrank by 1.3 percent in adjusted terms following a 3 percent expansion in the second quarter. 

gdp growth

There is no doubt that the government’s innovative use of its credit guarantee fund kept the ball rolling and helped the economy recover after the failed coup attempt of 2016. Rather than direct spending to boost economic activity, the government stimulated the economy to the tune of some $65 billion in loan guarantees to companies that faced rollover difficulties. A significant chunk of companies were able to restructure their debt obligations. On the other side of the coin, of course, these firms, operating across a variety of sectors, have merely postponed their rollover problems to further down the road.     

loans

On the darker side of Turkey’s staggering year-to-date 7.4 percent GDP growth rate lies its unbalanced nature. 

That is, the marginal cost of depending on so much credit to boost domestic consumption has increased the current account deficit, Turkey’s long-standing Achilles heel, to 5 percent of GDP.  Last year it was at 3.8 percent. Such a widening in the current account deficit comes despite higher exports, thanks to the recovery of the EU economy. 

Moreover, not only have Turkey’s external accounts weakened as a result of this unbalanced growth dynamic, but Turkey’s budget deficit also grew significantly on the back of tax cuts and a postponement of social security premium collections in the first half. Higher public spending, which had accelerated ahead of the presidential referendum, added to troubles for the budget. All combined, the deficit widened to 1.8 percent of GDP, almost double last year’s level. And domestic demand strength, shown in third-quarter growth numbers, explains why consumer price inflation accelerated in the final quarter to reach 13 percent in November. 

current account

Hatice Karahan, senior economic advisor to President Erdogan, notes that growth will inevitably slow in the coming quarters because the government had been employing one-off measures to boost economic confidence after last year’s failed coup attempt. Stimulating the economy heavily was also a useful tool as the government prepared for a referendum on a move to a presidential system in April. Now Karahan argues that no further stimulus is needed to keep the Turkish economy afloat, aside from some additional incentives for “selective and strategic” sectors to support growth and employment, slated for early next year. 

So, this week’s meeting of the central bank’s Monetary Policy Council (MPC) is being eagerly anticipated. A rate hike of some sort is on the cards.

core inflation

Following the double-digit GDP growth, and with consumer price inflation far exceeding the central bank’s 5 percent goal, policymakers have the opportunity to make this a milestone meeting. Common sense would require a sizeable, orthodox hike in the late liquidity rate (LLR) to at least 15-16 percent from the current upper limit of 12.25 percent and to fix average market funding costs at the maximum upper level for at least six months. Such a maneuver would rein in inflation expectations right away as it would tame lira weakness and also help guard the currency against a likely penalty for Turkish banks from the Iran sanctions-busting case in the United States.

A sizeable and long-lasting rate hike would slow GDP growth to about 3-3.5 percent next year, as economic stimulus ends and the strong base year effect kicks in. In fact, Turkey’s main economic maladies of high inflation and a wide current account deficit (along with a now-larger fiscal deficit) all call for slower GDP growth.   

But, given the level of political pressure on the central bank, which itself already claims to be conducting “tight monetary policy”, such a coherent move can hardly be expected.

Early presidential and parliamentary elections are already the subject of daily discussion in the media. With Erdogan desperate to win a majority to preserve his position, the government will probably seek and find new ways to stimulate the economy. Hence, normalization of any sort, even on an economic level, is barely foreseeable. The current situation even makes one hope for early elections in 2018, so that maybe the country will have a chance to calm down once the presidential race is over.