Growth, sanctions and elections... Turkey’s troubling mix

After “solid” 6.7 percent real GDP growth in 2017, international credit rating agency Moody’s has revisited its projections for Turkey’s economy. In its updated Global Macro Outlook, alongside many other countries, the agency revised the real GDP growth rate forecast for Turkey to 4 percent from 3.2 percent for this year and to 3.5 percent from 3.3 percent for 2019. Moody’s bases its better expectations for the next two years’ economic activity in Turkey on further fiscal support from the government through further measures “to keep economic growth high in advance of the November 2019 presidential election”.

Moody’s also stresses that 2017 growth of 6.7 percent was “well above potential”, taking its toll on CPI inflation -- bringing it to 12 percent -- and on the current count deficit, now about 4.5 percent of GDP.

Perhaps it can be inferred by Moody’s predictions for growth in both 2018 and 2019, about half of the 2017 level, that economic activity is set to start normalizing soon. Yet, with incompatible monetary policy, cost and demand-push inflation is unlikely to ease from around 10 percent levels by the end of this year despite slowing growth rates. And there is no need to remind people that the current account deficit to GDP ratio is set to march towards 5 percent. 

Turkey current account
Turkey fiscal balance

Just earlier in February, Moody’s had warned Turkey about the widening of its current account deficit, the biggest in the emerging market universe. With continuing fiscal support for growth in 2018, Turkey’s budget deficit to GDP ratio is also expected to deteriorate to a critical 3 percent of GDP by the end of this year. Both combined, the risk premium for Turkey’s economy is set to edge higher because of the threat of the growing double-deficit, especially in an environment where risk aversion is to dominate the global backdrop as U.S. 10-year bond yields head toward 3.5-4 percent.

All combined, any upgraded growth forecasts for Turkey do not have the muscle to lift Turkey’s current credit rating from junk (Ba1 with a negative outlook) back to investment grade. Apart from the increasing imbalances of Turkey’s macro indicators, which also include a problematic external deficit, Moody’s had based the ratings downgrade back in September 2016 on Turkey’s rapid deterioration in the rule of law. With the state of emergency, implemented after the July 2016 coup attempt, extended almost into its second year, any macro improvement that appears on the horizon is hardly likely to lift Turkey’s rating from junk. 

The six-million-dollar question then is whether even much slower economic growth in Turkey can be sustained, given the brewing political and economic problems on the horizon. Or as Moody’s puts it, whether Turkey will be able to thrive once the “current ‘goldilocks’ period of synchronized upward growth momentum, low inflation, low interest rates, steadily rising asset prices and historically low volatility gradually wanes”, as major central banks reverse extreme monetary easing.

It’s still too early to judge, but the initial indicators are not promising. Sentiment indices for businesses and consumer confidence have weakened following a good start to the year. It seems that as long as the government exerts a push from the fiscal front, there will be temporary upticks in consumption, but the effects of those measures are set to fade as soon as they expire.

Most recently, we saw the economic confidence index drop in February from a five-month high, led by the construction sector and retail trade, with the former having led Turkey’s growth over the past decade. The deterioration in both of these sectors is of course not good news for the months ahead. As I mentioned above, through loan guarantees for manufacturers and exporters, further stimulus measures to boost house purchases and state banks gearing to cut loan rates, the AKP government will use all the means at its disposal to keep growth rates high. Though with the banking sector having a hard time in supplying fresh funds -- its lira loan to deposit ratio is already close to 150 percent -- and productivity declining in the real sector, the Turkish economy is more problematic than it looks, with inflation, external accounts and the fiscal balance at the forefront of these issues.

Turkey could have muddled through with its economic performance if there were no presidential elections down the road. Yet, with a heavy political agenda in 2019 it seems that, with the imbalances created through aggressive growth efforts, Turkey will remain in the fragile five of major emerging markets for some time to come.    

Turkish loans to deposits
Turkish industrial productivity

And, despite the recent visit by U.S. Secretary of State Rex Tillerson to Ankara, Turkey-U.S. ties remain strained and talk of sanctions is still on the agenda.

In a recent report for the Bipartisan Policy Center called “Things to Think about When Thinking about Sanctioning Turkey”, a senior policy analyst for the national security program concludes that putting an end to Turkey’s operations in Syria, where U.S. Special Forces are currently located, and securing the release of State Department employees and U.S. citizens jailed by the Turkish government remain the most critical issues. He refers to past Russia-Turkey tension, when Putin implemented economic sanctions on Turkey after Ankara shot down a Russian plane over Syria. Putin got what he wanted in return, he said. Also mentioning Germany’s suspension of military sales to secure the release of its imprisoned citizens, the advisor calls on the U.S. administration to take a similar stance on Turkey.

That brings us back to the economic sanctions talk. The question is whether sanctions would help Erdoğan get elected, with enhanced power, in 2019 at the cost of the further isolation of Turkey, a weaker economy and democracy, or whether they would help neutralise his powers and bolster Turkey’s ailing democracy.

Still, what is not ambiguous, according to the Bipartisan Police Center report, is that sanctions appear guaranteed should Erdoğan “continue to threaten U.S. soldiers, imprison U.S. citizens or attack protestors on U.S. soil”.

The analyst wraps up the report rather irritably urging U.S. policymakers to punish Erdoğan carefully with concrete, consistent and achievable goals in mind, rather than hurting the average Turkish citizen economically and hence deepening already negative public opinion about the United States.