Guldem Atabay
Mar 22 2018

Turkey desperately needs “New Deal” for economy

Turkey has announced yet more macro-economic data that reflects uneasiness piling up across the country. Consumer confidence slid to 71.3 in February following December’s sharp rise to 72.3.

Deteriorating expectations are reflected in souring expectations for unemployment over the next 12 months, hence the wage outlook. While the Bloomberg Consumer confidence index signalled a brighter outlook for March, hitting 88.8 from the previous month’s 87.0, the details reveal weakening appetite for consumer durables.

The government, of course, is aware of the situation and is gearing up to announce another budget-burdening incentives’ scheme to support investment and consumption. But still, the lira’s 7 percent depreciation against the dollar-euro basket over the past two months, coupled with two-year benchmark bond yields of almost 14 percent, constitute significant barriers to keeping sprits among consumers and businesses high.

With consumer price inflation in the 10-11 percent range and core inflation at similarly high levels, inflation inertia is creeping into the economy. Combined with the continuing slide in the lira, the deteriorating current account deficit to gross domestic product (GDP) ratio - set to reach 5.5 percent of GDP by the year end - and the budget deficit, rising towards 3 percent of GDP, are the main indicators that lay the foundations for the deteriorating expectations. 

Turkish consumer confidence
Turkish consumption and investment

Turkey is demonstrating the perfect textbook definition of economic overheating, delivered by none other than the government itself.

Turning a blind eye to economic facts and apparently locked in a self-created fiction, top advisers to President Recep Tayyip Erdoğan are almost scary in the way they interpret so-called realities. The president’s highly vocal senior adviser Cemil Ertem argues that the “powers that be” are trying to stop the rising “new Turkey”. Thus, he says, the ruling Justice and Development Party (AKP) will keep on doing the exact opposite of what international institutions such as the International Monetary Fund and Moody’s have been recommending Turkey do – tackle inflation and the current account gap.

Therefore, the chances of a rational response to the fire burning in Turkey’s economy are zero. The main problem, of course, is now government inaction in addressing economic imbalances. Economic growth is taking precedent over all other factors for the sake of winning elections due in 2019.

Turkish core inflation and investment
Turkish budget

In this respect, it is worth taking a look at the flow of foreign funds to Turkey. As per central bank data, in the first two weeks of March, foreign investors were net sellers of $223 million dollars in the equity market and $477 million in the bond market. In terms of 52-week rolling figures, inflows into the stock market declined to $1.8 billion from $2 billion dollars, while bond market inflows slid to $7.8 billion from $8.6 billion.   

The facts are not that hard to grasp as gross imbalances in Turkey’s economy come at a time when the global backdrop is rapidly changing, spurred by expectations for rate hikes by the U.S. Federal Reserve. With a possible fourth rate hike due in 2018, as opposed to the three originally envisaged, volatility in the currency and bond markets is set to continue because of the anticipated flow of funds to the U.S. bond market, where yields are rising. 

Even more important is President Donald Trump’s openly declared trade war against China and many other industrial economies via tariffs, which could render sentiment towards emerging markets bearish for an extended period. While ample global liquidity will perhaps make the task of emerging market governments easier, Turkey, with its exceptionally irrational approach to macroeconomic management, is set to bear an increasing burden as the global landscape changes.        

Turkish bond holdings
Turkish exchange rates and interest rates

There is, of course, a way out of this spiral of negative events.

The government should start by finding a credible anchor for the economy. What Turkey needs is normalisation at home at every level, rather than political rhetoric that fuels division and economic policy that stimulates growth while deepening frailties.

The reality check should begin with accepting two basic facts. At the current pace of economic growth, Turkey is expected to post a large current account deficit while its fiscal deficit – which is increasingly becoming the main source of growth - is set to widen further over the next two to three years. The situation translates into having “twin deficits”, meaning Turkey has a savings shortage at all levels, with the deficit funded by foreign savings.

This dangerous combination could persist for some time given persistent liquidity in global financial markets. Yet at some point, sooner rather than later, either Turkey’s savings rate needs to increase, or lira depreciation will gain fresh momentum.

The required rise in the savings rate should come from both sides - the private sector and the public sector. When one looks at the global level, such a change in direction can only come when interest rates are higher.

Turkish financial account
Turkish financial account: corporate borrowing and FDI

Yet this new anchor must constitute more than a few notches of hikes to the central bank’s main interest rate. Turkey, dependent on foreign inflows to keep its economy afloat, should start to re-engage in macroeconomic management realistically. Otherwise, a spiral of events beginning with faster lira depreciation will mean higher inflation and slower growth; though in a forced manner rather via market forces.

The starting point of re-anchoring Turkey’s economy should be targeting slower growth in the short to medium term in order to re-balance. On a grander scale, this “New Deal” for Turkey should crucially be based on grasping reality, across the board, both socially and economically. More than ever, re-introducing autonomy into the legal system, currently compromised by politicians, will be just as crucial.

Whether the government has the muscle to turn things around is yet to be seen. The same AKP administration, though far different from that of today, between 2002 and 2006 demonstrated the required ability and willingness to steer the economy in a relatively rational manner.

Similar rationality, however, cannot be expected prior to presidential and parliamentary elections due by November next year. In the meantime, it seems all we can do is to keep our fingers crossed and hope to weather the changing global tide with the least possible damage.