Uncertainty ahead as Turkey delays fiscal rule

By bne IntelliNews August 13, 2010

Justin Vela in Istanbul -

The Turkish stock market has experienced a rollercoaster few weeks as it hit a series of record highs only to retreat when the government appeared to have shot itself in the foot by delaying a market-friendly fiscal rule ahead of parliamentary elections next year. How much of an effect this delay will have on investors over the longer term is still unclear.

"The budgetary practice of 2011 will not be constituted on the fiscal rule, but it will be effective by 2012," Turkish Industry and Trade Minister Nihat Ergun told reporters at a press conference on August 10. "Fiscal rule legislation was postponed upon the objection of investor ministries."

Though the final word still rests with Prime Minister Recep Tayyip Erdogan of the ruling Justice and Development Party (AKP), investor concern is playing out barely two weeks after the Turkish stock market hit a series of historic highs, with the ISE-100 reaching 60,737 on July 29. The day after the announcement, the Turkish stock market fell to 58,691, its lowest level since July 21, the lira declined and bond yields rose. However, Fortis analyst Haluk Burumcekci points out that there is currently a global fall in risk appetite and a concurrent fall in the US stock market, which has resonated in Turkey. "The effect [of the delayed fiscal rule] is limited for me," says Burumcekci on August 12. "If you look at bond yields, they increased 15-20 basis points yesterday, but today there was a 10-basis-point decrease."

Confidence measures

Initially aimed at the 2011 budget, the fiscal rule will commit Turkey to an annual growth target of 5% and a budget deficit of 1% or less of GDP. Analysts both in Turkey and abroad told bne earlier this month that the implementation of the fiscal rule was crucial for investor confidence and increasing the country's investment rating. "Our concern over the delay of implementing the fiscal rule is that it could signify an underlying reluctance or preference to not operate a tight fiscal stance," says Frank Gill, Standard and Poor's director of European sovereign ratings, which ranks Turkey two notches below investment grade.

A postponement of the fiscal rule raises concerns that it may be revised altogether, leaving government spending unbound for the election year ahead. Having been applauded for its recent gains, the country is now quickly swinging into election mode, with a referendum in September on AKP's controversial constitutional amendments being seen as a litmus test for how the government will perform in next year's all-important parliamentary elections.

Economic growth, which surged 11.7% in the first quarter from the year before as the country recovered from the economic crisis and experienced strong capital inflows, is expected to moderate. Confirming a prediction of 7% GDP growth for 2010, Burumcekci says he doen't expect any new records from the Turkish stock market this year and less growth in 2011. "4% in 2011," he reckons.

But while it is an immediate concern to investors, the lack of a fiscal rule may not be Turkey's chief obstacle for the longer term. "It is not really about the fiscal rule," Gill says. "Investors are not likely to be responding to the dilution of the fiscal rule per se, but rather about what its possible delay signifies about this government's commitment to broader macro policies."

While the economy is expected to grow between 5-7% in 2010, those figures come in a year characterized by highly flattering base effects and robust foreign investor enthusiasm, prompting Gill to describe Turkey's growth prospects over the next 10 years as "good, but not Chinese."

This, along with uncertainty surrounding government policies, makes S&P cautious about the sustainability of Turkey's high external financing needs. "As soon as capital inflows weaken, growth will come under pressure," he says.

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