The normalisation of economic policy (tightening of monetary policy and a dose of fiscal restraint) has restored confidence among investors and rating agencies. Official foreign exchange reserves consolidated over the summer, the lira is much more stable and risk premiums have eased. Economic growth remains resilient despite the slowdown in domestic credit, and the budget deficit is much lower than expected given pre-election promises. However, inflation has accelerated once again and the current account deficit has just about stabilised. The rebalancing of growth and de-dollarization have not yet been achieved, but it is more likely now that these will be seen in 2024.
Since the presidential and legislative elections in May, the Turkish lira has fallen sharply again and domestic interest rates have increased. Calm has returned in recent weeks with the monetary turnaround of the central bank (CBRT), now led by Hafize Gaye Erkan, and the return of Mehmet Simsek, who in the past has been the AKP government’s guarantor to foreign markets and investors, at the head of the Ministry of Treasury and Finance. But their task of rebalancing a real economy in a state of overheating and faced with stubbornly high inflation is a challenge. More than the recent slowdown in growth, the likely risk of worsening twin deficits must be closely monitored. However, the alarmist analyses that conclude that there is a risk of a balance-of-payments crisis are exaggerated.
Türkiye has enjoyed a period of financial calm since mid-2022 with exchange rate stability relative to the first half of the year, lower risk premiums and bond yields. Growth stagnated in Q3 2022, but monthly inflation slowed and the economic indicators available for Q4 2022 continued to be positive. For 2023, a slowdown is inevitable given the weaker levels of activity expected from the country’s main trading partners. But domestic demand could mitigate the external shock and the fall in oil prices should help to reduce the current account deficit. However, it is still too early to draw any conclusions about the success of economic policy combining fiscal support, monetary easing, and measures to channel the growth of credit and to encourage liraization.
In Turkey, growth has held up well (+4% year-on-year in Q3 2022) despite the rise in inflation. Consumer spending was the main supporting element, with an increase of 18%. However, the acceleration in inflation (from 19% year-on-year in Q3 2021 to 74% in Q2 2022) led to a contraction in the wage bill in real terms up to Q2 2022, despite a strong recovery in employment. Since mid-2022, inflation has continued to accelerate (+84.4% in November) but a wages catch-up has occurred following the revaluation of the minimum wage. However, this cannot explain the difference between consumption and the wage bill purchasing power.
Turkey's economic situation continues to offer a stark contrast, with resilient growth on one hand and soaring inflation, dwindling foreign exchange reserves and a depreciating lira on the other. In short, the reed bends but does not break. Some explanations in this new issue of Eco TV Week.
The economic situation in Turkey offers striking contrasts between (i) sustained growth until Q1 2022 and stubbornly huge inflation, (ii) much greater confidence among companies than among households, (iii) a primary budget surplus and a deteriorating current account deficit due to the surge in the price of energy, and (iv) domestic borrowing conditions for the State at an unprecedented negative real rate despite massive outflows from portfolio investments. Economic policy still combines a deliberately accommodative monetary policy and a competitive exchange rate to stimulate investment, exports and import substitution
The Turkish monetary & exchange rate policy in times of financial instability: economic rationale and consequences.
Over the past 15 days, the Turkish lira has depreciated 21% against the euro, including a single-day decline of more than 10% on 23 November. At the same time, 10-year government bond yields have risen above the 20% threshold. This bout of weakness was triggered by 1) another cut in the central bank’s key rate on 19 November, from 16% to 15%, despite surging inflation, which reached 19.9% year-on-year in October, and 2) President Erdogan’s statements justifying the easing of monetary policy as part of a new economic policy, after the President demanded that the National Security Council declare an “economic war of independence”. The President also lashed out at the opportunistic speculative behaviour that took advantage of the lira’s depreciation to raise prices
Turkey is enjoying strong economic growth in 2021, following the credit-driven stimulus implemented in 2020. The cumulative performance over 2020 and 2021 has allowed the country to close the growth gap that resulted from the series of shocks between 2018 and 2020. Investment and the industrial sector have thus regained their previous size. Foreign currency reserves have recovered from the low levels they reached in 2020. Nevertheless, this has come at a price: inflation is running well ahead of levels seen in other emerging economies. As well as common factors (rising prices for oil and other commodities), there are specific country drivers (depreciation of the lira, untimely monetary policy decisions)
The November 2020 announcement that monetary policy would move in a new direction had tamed financial tensions. However, as the Central Bank Governor was removed in March 2021, uncertainty came back. Exchange rate depreciation pressures have reappeared and interest rates and risk premiums have risen. Growth support will be the top policy priority, but at the price of maintaining significant macroeconomic imbalances. Credit risk is not reflected into the non-performing loan ratio but the forbearance period which is allowing the postponement of their reporting will end at mid-2021. The observed corporate investment recovery is welcomed, as a precondition to improve potential growth, but other conditions such as productivity growth are still missing.
In third-quarter 2020, Turkish GDP had already returned to pre-Covid levels. Turkey’s economic recovery can be attributed to massive policy support – both fiscal and monetary –, which also involves risks. Inflation is significantly above 10%, and unlike many other emerging countries, the current account swung into a deficit again, which triggered a sharp depreciation in the Turkish lira. Faced with rising tensions, President Erdogan voiced to change the direction of economic policy. It should now have two pillars: a more rigorous policy mix, with a monetary policy that targets a lower inflation rate and greater attractiveness for non-resident investors
Since late spring, Turkey has enjoyed a rapid, buoyant recovery. This is rather typical for an economy regularly hit by external shocks that are magnified by capital outflows. Turkey has managed to bounce back yet again thanks to strong economic policy support. The bad news is that it is accumulating several imbalances, including another significant current account deficit and a sharp increase in credit growth, which is accelerating faster than during previous recovery phases. These two factors, which put downside pressure on the lira while driving up inflation, signal a deterioration in the quality of growth and imply higher debt ratios.
Our Pulse for Turkey shows good resilience of the economy until February/March. So far, the government has not imposed a generalized lockdown therefore the supply shock is less severe than for other European economies. Besides, the Central Bank has lowered its policy rate by 200 basis points since mid-March and one third of the support program announced by the government (2.3% of GDP) has been already spent at mid-March. We expect recession to be limited to -2% for 2020 as a whole.
The Turkish economy is facing problems of a sort it has dealt with in the past: a global crisis, that will trigger a sharp fall in exports, coupled with a contraction of external financing. Unlike in 2018, Turkey’s economy does not appear to be overheating, whilst the fall in oil prices and the emergence of a current account surplus are two factors that will reduce the risk. That said, the relatively weak levels of currency reserves, the high level of external debt and the recent rise in non-performing loans are all significant risk factors. In front of the current shock, the economic policy response will have to address foreign currency liquidity needs properly in a context of dwindling capital flows.
Our indicators show a rather resilient Turkish economy given the global slowdown and uncertainties linked to the military operation in Syria. Indeed, real GDP rebounded markedly in Q42019 (+5.9% yoy compared with 1% in Q3) thanks to a sustained private consumption. Moreover, business confidence has recovered. Household confidence has deteriorated with the rise in unemployment but consumer credit has skyrocketed as a result of very attractive borrowing conditions offered by public banks in the wake of monetary easing (the policy rate has been lowered to 10.75% from still 24% at end-July)
Mired in stagflation, the Turkish economy might have to forego its “stop and go” tradition given the need for deleveraging in the private sector and a less favourable international environment. Disinflation continues but remains vulnerable to bouts of forex volatility. (Geo)political risks and the dollarization of the economy make monetary policy management more complex. A swelling public deficit and uncertainty about the direction of fiscal policy are sources of concern. Reducing the current account deficit will not suffice to reassure investors since capital inflows and foreign exchange reserves are both diminishing faced with the country’s substantial external refinancing needs.
After a precipitous 42% decline against a euro-dollar average between January and August 2018, half of which occurred in the month of August alone, the Turkish lira (TRY) rebounded by 15% in September-December, following a massive interest rate hike by the Turkish central bank (CBRT). Nonetheless, the TRY has depreciated again by 10% over the past two months amid stagflation. FX volatility has spiked owing to uncertainty about the true level of “free” FX reserves. Net outflows of non-resident portfolio investment in local currency amounted to USD 1.4 bn in March-April as non-resident investors pulled out of the local equity market and, above all, the local bond market. They now hold only 12% of domestic public debt (vs. more than 20% through 2014).
With the approach of municipal elections on 31 March, which will be another key test for the government, major manoeuvres have been launched on both the macroeconomic and geopolitical fronts to stimulate activity and advance a foreign policy agenda (notably in Syria) at the expense of diplomatic tensions with the US. The financial strain has soothed since the currency crisis in August 2018, but cyclical conditions have deteriorated. We seem to be heading for a recession scenario lasting several quarters, with the financial weakness of many non-financial corporates being a main concern. The rapid narrowing in the current account deficit and the disinflationary process initiated in recent months attest to the scope of the macroeconomic currently underway.
Turkey is among the 20 world largest economies (and countries (84 million inhabitants). The country has diversified trade relationships with Europe, the Middle East and Asia.
Real GDP growth averaged 5.7% from 2002-2018, the result of deep structural reforms in the aftermath of the 2000-01 crisis. However, this performance was increasingly achieved through growing policy support and related macroeconomic imbalances. The country has experienced several boom-bust cycles during the last years, with two severe economic shocks: a currency crisis followed by a recession period in 2018, and the Covid outbreak in 2020 Q2. The country has coped with the COVID-19 outbreak through strong policy support (large public debt and domestic credit increases). Significant inflation (above 10% during the past 4 years, with no sign of disinflation) and the low level of foreign reserves put significant pressure on the exchange rate. Moreover, structural current account deficits are increasing its vulnerability to debt refinancing and exchange rate pressure.
