Turkey once again heading for a period of economic instability
It was only natural to expect Turkey’s central bank to announce another interest rate cut this week, after watching it slash its benchmark rate by 1,275 basis points since July, when Turkish President Recep Tayyip Erdoğan sacked and replaced its governor for resisting monetary easing.
As predicted in economic surveys, the central bank’s Monetary Policy Committee lowered its one-week lending rate by 50 basis points to 10.75 percent.
Ahead of the decision, Erdoğan announced that the benchmark rate should fall to single digits in the second half of the year, adding that it was time for investments in Turkey to ramp up following a slowdown in inflation. He called on businesses to shoulder the responsibility for economic recovery, saying the government had already done its best by pushing state bank lending rates down into single digits.
Of course, with the unemployment rate as high as 15 percent, it is crucial that Turkey returns to a positive growth path. But the sustainability of that expansion should also be a priority.
As the central bank continues pushing interest rates lower, the signs of an economic recovery in Turkey are visible from most key economic indicators.
Industrial output surged by an annual 8.6 percent in December, mainly boosted by a jump in the production of capital goods. The current account saw a deficit of $2.8 billion the same month, meaning the surplus for the year fell to $1.67 billion. While an economic contraction during most of 2019 led to a current account surplus, even small signs of life in the economy have sparked a swing back into a deficit, led by a jump in imports.
Turkey's Purchasing Managers Index (PMI), which measures manufacturing business conditions, passed the 50-point threshold for the first time in 22 months, reaching 51.3 points in January. Any figure above 50 indicates manufacturing expansion. Data for inflation is also interesting. Annual inflation accelerated to 12.2 percent, reflecting an increase in prices in almost all consumption categories. Moreover, there was a parallel acceleration in core inflation, which signals that inflationary pressures will prove a challenge going forward.
Budget data for January also reveals the real costs of Turkey’s economic expansion. Details of the budget figures show that the economic recovery is a result of a boost in public spending, rather than an increase in productivity, a shift to industrial production and services from the construction sector, or a jump in exports.
The monthly budget surplus for January and the accompanying surplus, excluding interest payments on debt, are the products of cosmetic intervention - the budget is in deficit when data is calculated using IMF methods. The budget deficit, which reached 3.2 percent of gross domestic product (GDP) last year - a level twice the average of the last five years – has accelerated to 4 percent of GDP in the first month of 2020, according to the IMF measure.
Acting on government orders, Turkey’s central bank transferred its precautionary reserves to the budget in January. When subtracting that one-off revenue, the 21 billion-lira ($3.4 billion) budget surplus becomes a 15 billion lira deficit. The accumulated primary deficit calculated according to IMF definitions, which has grown steadily since 2015, has reached a frightening 128 billion liras.
Though the market expects economic growth of 3.5 percent in 2020, Treasury and Finance Minister Berat Albayrak is reiterating on a daily basis that the government’s 5 percent growth target will be achieved. That means the authorities will need to use expansionary public spending and cheap credits offered by state-run banks to meet their goal. Assuming that the government keeps economic confidence intact, it will then pray for an increase in investments to see a decline in unemployment.
In the meantime, foreign investors will keep on leaving the Turkish market in droves. As a result, the current account deficit will continue to widen due to Turkey’s scarce domestic resources. The deficit will probably reach 2.5 percent of GDP by the end of the year. It will then become clear that the government’s plans to achieve its economic growth goals without an expanding current account deficit are nothing but a pipe dream.
While foreign investors stay away from the Turkish market and inflation remains in double digits at around 12 to 13 percent, the central bank will keep on pushing the benchmark rate down into single digits, in line with Erdoğan’s requirements. Negative real interest rates in Turkey will dry up currency resources.
Of course, it will take some time for the economic management to understand why negative real interest rates do not lead to a boost in investments. The policy of transferring central bank resources to the Treasury will also intensify. The central bank will attempt to suppress interest rates by buying government bonds at increasing rates, while state-run banks will seek to bolster the lira by increasing their sales of foreign currency beyond the current level of $17 billion.
The government’s experimental policies rely on the assumption that central banks should pursue expansionary policies given expectations of slowing growth in the global economy - China has lowered its growth expectations to 4 percent from 6 percent. But what policymakers do not realise is that foreign capital has been fleeing Turkey while other emerging markets enjoy a surge in liquidity.
The currency crisis Turkey faced in 2018 was the result of an accumulated overheating in the economy, in other words it was the product of policies that risked a deterioration in crucial indicators for the sake of higher growth.
Today, Turkey’s economy is even more vulnerable to a minor increase in economic growth, let alone overheating. Economic risks are again piling up.
The 2018 crisis was triggered by a similar indifference on the part of the Turkish authorities, the Fed’s monetary tightening and political stubbornness. It is impossible to predict what will trigger the release of the current build-up in Turkey’s economic stress, but you do not need to be an oracle to see that difficult days lie ahead.