Nesrin Nas
Nov 14 2017

Turkey's economic frailty becoming permanent

We have been living with psychosis for some time in Turkey.

While Turkey continues to be the only major economy remaining on S&P's dreaded list of "fragile five" states, mainly due to its unmanageable trade and budget deficit, the Turkish government keeps feeding the insanity.

Every day the Turkish public wakes up to a new story about a "Great and Strong Turkey". One day the 'national automobile' production is green-lighted, the next 'national tank' production. Another day the government announces that Turkey will start producing its own 'national aircraft'. Every day the government discloses another "major national project" big enough to intimidate European producers.

Meanwhile, the government is revamping the "national education system" to serve the "national cause".

It seems very likely that the government will keep manipulating the public with these surreal, hypnotic stories as long as interest rates, foreign exchange rates, inflation and unemployment continue to soar.

Deepening economic and financial problems will be portrayed as "temporary troubles" that the Turkish people should endure for a "Great and Strong Turkey".

Can the ruling party consolidate a majority around this virtual reality?

I have no doubt the ruling Justice and Development Party (AKP) will try everything in its power to bring round the public, but I do doubt that economic indicators will grant the government infinite flexibility because economic stagnation is now becoming an undeniable reality.

Despite some good news here and there, market expectations are mostly trending towards the negative. For example, industrial production figures for September 2017 were above expectations; with a monthly growth rate of 0.6 percent, and 10.4 percent for the year. But Turkish markets, which generally embrace good news, ignored this development as overall, the picture is deteriorating.

After an extended period of low inflation and favourable exchange rates, price increases are back to double digits - 11.9 percent annually – and pushing up medium and long-term interest rates.

Annual interest rates have moved up to 12.25 percent for 10-year bonds, almost the same as one-year bond rates. That means the markets do not expect interest rates or prices to fall in the short, medium, or long-term.

Financial circles know Turkey is returning to a period of high unemployment, high inflation and high interest rates. They also are aware that the Turkish Central Bank cannot intervene.

Figures for October show that core inflation rose by 2.37 percent, to 12.1 percent annually. Core inflation for the last quarter is 13.5 percent. Meanwhile, the manufacturing price index increase peaked at 17.3 percent. This inflation is partly due to the devaluation of the Turkish lira.

In October, the Turkish lira lost almost 12 percent of its value against major currencies. This increase is due to both more expensive imports and the Treasury's need to increase its borrowing requirement; it needs 80 billion liras every month due to the devaluation of the currency.

Yet the central bank had only recently updated its inflation forecast for the end of 2017 to a maximum 10.3 percent. The markets have not taken central bank forecasts seriously for some time now, but this was still considered a huge blunder.

It is doubtful that the Turkish Central Bank, which has not seemed troubled by missed inflation targets and forecasts until recently, can maintain the same lax attitude. Both price behaviour and interest "swap" rates have deteriorated. Consequently, it is gradually becoming harder to borrow money from international markets and expand credit in the local economy.

In other words, it is almost impossible for the central bank to keep interest rates at 12 percent.

All the while, the costs of Turkey’s foreign policy are growing day by day. The United States and European Union are increasingly becoming distant towards Turkey, and the Middle East keeps getting messier.

The increasing tension between Saudi Arabia and Iran has the potential to embroil Turkey in the sectarian stand-off and possible conflict. If this happens, it will also have economic consequences.

Oger, the co-owner of Türk Telekom, is also part of the investigation in Saudi Arabia. Saudi Arabia froze 1,700 accounts for about $850 billion including some Qatari accounts. It is hard to imagine that petrodollars will become a lifeline for Turkey any time soon.

It looks unlikely that this economic deterioration will stop. Relations with the West are on the brink. And political tension is rising inside the country.

If there is an active war in the region, I fear the Treasury will have to borrow more and more, and central bank gold reserves will not be enough to sustain us.

If that happens, we will be left with a "National Cause," and nothing else.

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