Fed lowers interest rates, but Turkey’s economic growth is stagnating
Turkey just went through a difficult week. With war and death all around, it is not easy to write about the economy and pure data. However, the poor trajectory of the economy has such an important impact on Turkey’s political leadership that in order to make sense of daily political developments we need to look at the economy.
The figures show that the Turkish economy has entered 2020 with a higher rate of growth than expected. Economic output rose by 1.9 percent quarter-on-quarter in the final three months of last year and by 6 percent annually. The 0.9 percent rate of growth for 2019 as a whole surpassed the government’s 0.5 percent goal.
The effects of the 2018 currency crisis have receded in part and Turkey’s economy has emerged from a recession. However, the return to high rates of economic growth in the country did not bolster the popularity of the governing Justice and Development Party (AKP). Therefore, it is worth examining more closely the dynamics and sustainability of this expansion.
The causes behind economic crises reflect risks and entail costs, but so do the solutions employed to emerge from them.
In Turkey’s 2001 financial crisis, an International Monetary Fund loan programme helped the government enact structural reforms and brought discipline to public expenditure. A sharp economic downturn was followed by a long period of high growth rates. This period continued until the end of 2008. The gains made allowed Turkey to weather turbulence in the global economy from 2009 to 2013 relatively unscathed. But the complacency of the government towards the end of this period meant it continuously overlooked opportunities for reform. Consequently, a period of economic turbulence in Turkey began upon the Fed’s first interest rate hike in 2013.
Following the 2018 currency crisis - the product of cumulative mistakes made in the 2013-2018 period - the policies followed by the political leadership have put Turkey back on the path to economic growth. However, since it made no structural reforms to the economy during this period, economic growth rates achieved in the final quarter of 2019 have not reduced unemployment, the budget deficit has doubled in GDP terms and inflation is back in double digits.
Similarly, at the core of the economic expansion, attained through aggressive cuts to interest rates and public spending increases, is a 3.8 percent increase in private consumption. The main reason for the increase in private consumption is growth in borrowing that accompanied falling interest rates.
Economic growth has been prioritised and other economic targets have fallen by the wayside. In a pervading environment of insecurity, there has been little investment in the country, which is the key to sustainable growth. A succession of monthly trade deficits has similarly inhibited growth.
Economic growth in 2019 has not been healthy. And investments and net trade are among the factors dampening the expansion. As a result, for the AKP government, which has decided to rely on quantitative easing by the Federal Reserve and responded with excessive interest rate cuts, the political dangers continue. The expansion in the economy, created by excessive interest rate cuts seen last year, is not sustainable, even though it has continued into 2020.
Turkey’s economy also faces very real risks, including the coronavirus, policies toward the embattled Syrian enclave of Idlib and the government’s resultant stance on refugees.
When inflation in the country returned to double digits late last year, the central bank kept cutting interest rates under government pressure, leaving Turkey with negative real interest rates, increasing economic and financial risk. This is precisely why Turkey’s arguably unsustainable, fragile economic growth is once more under threat.
Although it does seem that the expansion may continue for the first half of 2020, what will follow is unknown. It seems difficult for the government to meet its 2020 target of growing the economy by more than 5 percent.
While the coronavirus further inhibits global output, the Fed’s interest rate cuts will have more effect on asset prices than on growth itself. Because Turkey’s central bank has reduced real interest rates to negative, the country will get a smaller slice of capital flows. Despite the Fed rate cuts, recent losses for the Turkish lira will become permanent, and the war in Syria will have a negative effect on consumption.
Therefore, while growth in Turkey may continue at around 6 percent annually in the first quarter, it will run out of steam in the periods that follow. Public spending will enter a decline due to the widening budget deficit, and the support that the economy had in 2019 will not be repeated this year. Depending on the war in Syria, there may even be negative economic growth in the final quarter of the year.
If policymakers in Turkey want growth to continue, they will have to find more sustainable solutions that take into account the growing economic risks now facing the country.