Turkish deficit forecast raised as monetary policy remains stuck

By bne IntelliNews October 17, 2012

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Continued slowing growth saw the Turkish government widen its budget deficit target for 2012 from 1.5% to 2.3% of GDP on October 16. However, analysts point out that potential stimulus via monetary policy remains limited by the current account deficit.

Finance Minister Mehmet Simsek announced on October 16 that the deficit is set to widen sharply to TYR33.5bn ($18.5bn) this year, exceeding the original official forecast by more than half, reports Reuters. The deficit is then expected to widen marginally to TRY33.893bn in 2013, Simsek told a news conference to detail budget forecasts outlined last week in the government's medium-term programme for 2012-2015.

In that programme, the government also cut its growth forecasts for this year and next, predicting growth of 3.2% in 2012 as the country heads for a soft landing after surging 8.5% last year. "The soft landing process is very important to us," Simsek said. "Measures we have taken have been largely successful in bringing growth and the current account deficit down to reasonable levels."

However, Turkey is now caught in a vicious circle stemming from that rapid growth's dependence on domestic demand. The current account deficit verged on 10% last year, and although the imbalance has narrowed to around 7.5%, it is still hitting Turkey hard.

The reliance on Europe's shaky banking sector to fund the gap is responsible for the fact that the ratings agencies refuse to upgrade the country's sovereign debt to investment grade. Yet most pertinently right now, despite expectation that the Central Bank of Turkey (CBT) will ease rates later this week, it restrains the hand of the banking authority to offer deeper and long-term monetary easing help boost growth, due to the country's consequent exposure to the lira's strength.

With less opportunity to grow the economy to raise revenue, Ankara is left needing to find other ways to shore up its budget. That has led to a series of tax hikes, which have raised levies on vehicles, alcohol, and fuel, as well as raising gas and electricity tariffs.

However, Neil Shearing at Capital Economics doubts it will be enough. "Despite the remedial action, we suspect that the government will still fall short of its budget deficit target for 2013. Whereas it expects the economy to grow by 4% next year, we think growth will be a more modest 2%. This will keep a lid on revenue growth and mean that non-discretionary government expenditure (for example on social security) is higher. We have pencilled in a budget deficit of 3% of GDP in 2013."

Due to similar hikes in 2011, the analyst doesn't expect to see this year's tax increases provoke the inflation that the CBT has been so worried about. "Instead, the tax changes mean that inflation will now fall at a slower rate than would otherwise have been the case. We had previously expected headline inflation to end the year at just under 6%, but we now think it will end the year at around 7.5% (compared to 9.2% in September)," Shearing writes. "What's more, assuming that there are no further tax measures, we think inflation is still on track to fall to the CBT's target of 5% by the end of next year."

The CBT's fretting over price rises should reduce throughout the rest of the year then, but the analyst insists that has never really been the major issue, despite ongoing fights between the government and CBT Governor Basci. "We doubt that any of this has major implications for monetary policy," Shearing adds. "The key point is that monetary policy decisions remain governed by concerns over the lira against a backdrop of a large current account deficit. The summer rally in global risk appetite has allowed the CBT to let market interest rates fall to the bottom end of its "corridor". This represents a significant monetary stimulus. But keeping rates at these lows will be difficult if global risk appetite starts to sour once again (as we expect) and the lira comes under renewed pressure. The big picture remains that even though inflation should fall over the next year, the scope for a monetary policy response to revive growth is limited."

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