Guldem Atabay
Sep 21 2018

Turkey’s New Economic Programme is no anchor

Treasury and Finance Minister Berat Albayrak has unveiled the details of Turkey’s new three-year economic programme under the title “New Economy Programme” (NEP). The initial market reaction was rather neutral, with the expected economic aggregates within the programme looking a few notches closer to what reality calls for with regards to the Turkish economy, which has been on a roller-coaster ride since the start of the year. 

Yet as usual, the devil is in the detail. There are serious inconsistencies and uncertainties within both the NEP’s macroeconomic forecasts and among its main pillars. These should not be overlooked. 

To begin with, the NEP’s growth estimates for the coming three years acknowledge a sharp economic slowdown - a reversal from President Recep Tayyip Erdogan’s rhetoric that Turkey would continue to grow strongly despite what he called attacks on its economy. From 3.8 percent year-on-year economic growth expected for 2018 (which translates into at least one quarter of economic contraction in 2H18), GDP growth will be slowing to 2.3 percent in 2019 and will slightly improve to 3.5 percent in 2020, reaching its assumed potential growth rate of 5 percent by 2021. 

Even such a slowdown could appear overly optimistic, especially in 2019, since it does not look possible for domestic demand to grow by 2 percent next year as assumed, taking into account a lasting currency shock that will keep consumer price inflation (CPI) elevated at 16-18 percent.  The government has also failed to label the troubles of the Turkish economy as a currency crisis. In fact, Albayrak, Erdogan’s son-in-law, announced on Wednesday, the day before he announced the plan, that the “currency problems were over for Turkey”. In not labelling Turkey’s dire situation as a crisis, the remedies he has set forth appear as treatment for a wider emerging market business cycle - the by-product of the U.S. Federal Reserve’s rate hikes. But Turkey stands out from almost every other emerging market due to five years of accumulated economic mismanagement. 

More troubling is the programme’s main assumption for the lira. From the GDP figures, dollar/lira parity is expected to average 5.59 for 2019, which seems rather out of reach given that the Fed will continue with its rate hikes and the ECB will join in tightening later next year. A permanent appreciation in the lira of 15 percent just because of the announcement of the NEP looks very unlikely. A similar argument is applicable for the government’s 2020-2021 dollar/lira assumptions of 6.00 and 6.28 respectively. 

 

 

GDP

Consumer Price Inflation

 

Current Account Balance

Budget Balance to GDP

Primary Balance to GDP

2018:

+3.8%

20.8%

-4.7%

-1.9%

0.1%

2019:

+ 2.3%

15.9%

-3.3%

-1.8%

0.8%

2020: 

+ 3.5%

9.8%

-2.7%

-1.9%

1.0%

2021:

+ 5.0%

6.0%

-2.6%

-1.7%

1.3%

 

As for the current account deficit, which is now narrowing from a peak of 6.5 percent of GDP, the government expects the gap to reduce to 4.7 percent by year-end amid a stagflationary environment that has long set in. Yet, the rest of its targets look tenuous - the NEP envisages the decline in GDP growth to continue to 2.6 percent by 2021. Yes, the government plans to shift growth from consumption to domestically produced goods and the shift is planned via incentives for local production. Yet, given Turkey’s import dependency ratio of as high as 70 percent for exported goods, aiming for such a profound change in the composition of exports, while commendable, is impossible to achieve in a three-year time period. For Turkey’s current account deficit to stay below 3 percent of GDP, as Albayrak says it will after the end of the NEP, Turkey would only be importing energy-related raw materials and producing the rest of its goods entirely from domestic materials. The target of 5 percent GDP growth for 2021 and a matching 2.6 percent current account deficit ratio looks inconsistent when taking into account the structure of the Turkish economy.     

On the inflation front, much needs to be said as well.

It is rather curious that the government is establishing a new committee for “financial stability and development” to monitor the financial markets, as outlined in the NEP, when there is a central bank that will be taking monetary policy decisions autonomously as promised.

As for the target figures for inflation, there is no doubt that CPI is set to accelerate further from August’s 18 percent in the months of September and October, as confirmed by Albayrak.  Thus, end-of-year CPI expectations of 20 to 25 percent render the NEP estimate of 21 percent credible. 

Yet, even with the doubtful lira estimate plugged into the programme, the lira is still set to devaluate further in the years ahead. Knowing that cost-side pressures on inflation accompanied by higher interest rates will be reflected gradually onto end prices over the next 12 months, along with how sticky inflation can be in Turkey once the anchors are broken, how end-2021 CPI can ease back to 6 percent begs a comprehensive explanation from the treasury and finance minister.   

Last, but of course not least, are the fiscal targets laid out in the NEP. Fiscal discipline to rebalance the Turkish economy is in fact the main pillar of the Justice and Development Party (AKP) government’s three-year scheme.

Budget savings of 1.7 percent of GDP in 2019, the worst year for projected economic growth in Turkey - whether the expansion is 2.3 percent, as targeted, or a more realistic 0.5 percent as predicted by the OECD - are of critical importance. The announced 75.9 billion-lira savings plan lacks details and is the main weakness of the NEP. Albayrak announced that out of this total, 16 billion lira would come from additional revenues. This looks unattainable as it means tax hikes in an economy that is almost shrinking. Savings on the spending side to the tune of 60 billion lira look similarly bewildering. Investments that have not started will be cancelled, raising some 31 billion liras due for 2019, according to the government. Revising existing support schemes for all sectors, according to the changing economic environment, is required, that is true. But saving some 14 billion lira from this step, as targeted, looks questionable again. Moreover, given the ever-widening deficit in the social security system, restructuring the system in 2019 and saving 10 billion liras constitutes another goal that is unlikely to be attained.        

Then we come to the heart of the problem: the heavily indebted private sector in Turkey and its increasing burden on banks that stand out as the main fragility of the Turkish economy. The government says in the NEP that it will begin inspections of banks’ fiscal positions and asset quality on Monday. If required, the capital structure of the banking sector will be improved so that financial institutions can make sure other firms are funded at much more attractive rates of interest.     

The resources for such a big plan are totally absent under the NEP. The government’s programme fails to unveil a detailed, credible scheme supported with available resources that will most certainly be needed in the coming months to resolve problems for non-financial companies and the banking industry. These problems are at the root of all the economic fragilities of Turkey.

Turkey does not have the kind of funds it would have at its disposal had it agreed an IMF bailout. In fact, it would not be incorrect to say that the AKP government is trying to implement a much softer version of what an IMF program would have looked like. But it lacks details, resources, credible macroeconomic forecasts and the credibility that an IMF deal itself would have brought to rapidly reverse market sentiment. Moreover, the NEP seems to be partly ignoring, if not shrugging off, the ongoing currency crisis and its full impact on industry and the banking sector. The latter could create even sharper economic contraction and higher inflation, never mind bigger fiscal deficits.

At this point, the rather limited positive market reaction to the NEP tells the story by itself.  The government of Turkey will be questioned at every step over the next three years and there is no room for mistakes.

The opinions expressed in this column are those of the author and do not necessarily reflect those of Ahval.