The Turkish economy - handle with care

By bne IntelliNews February 17, 2014

David O'Byrne in Istanbul -

Only a few years ago Turkey was the rising star of emerging market economies, boasting political stability few others could match and registering growth rates that developed nations could only dream about. Now it looks increasingly likely a combination of external and internal factors will conspire to cause a "hard landing".

Most worrying perhaps is the opinion of the US Federal Reserve, which in its Monetary Policy Report to Congress on February 11 listed Turkey as the most vulnerable among 15 emerging markets - a conclusion also reached last year by the International Monetary Fund (IMF), which ranked Turkey as the most vulnerable of 17 such markets.

Accepting that its own signals last year about "tapering" its bond buying programme had prompted the selloff of emerging market assets, the Fed also cautioned that the extent of the effects in individual emerging markets were down to their own vulnerabilities, and warned that stopgap measures wouldn't be enough to protect from future shocks.

Internal vulnerabilities are certainly a problem Turkey is familiar with, two months on from the eruption of a major corruption scandal that has prompted unprecedented government intervention in the police, judiciary and the media.

Arguably, the full ramifications of the past two months have possibly yet to hit home, but they have already proved enough to send the local currency, the lira, tumbling and prompted a major policy volte face in the form of a sharp rise in interest rates, which for the time being at least seems to have introduced a measure of stability.

However, that stability was not enough to prevent rating agency Standard & Poor's from revising its outlook on Turkey's 'BB+' rating to negative in February, citing political uncertainty and predicting a "one-in-three likelihood for lower ratings within the next 12 months". "Turkey appears to have suffered an unanticipated erosion of institutional check and balances and governance standards," S&P noted, revising its projection for GDP growth down to 2.2% from 3.4%.

The media was full of talk about how a downgrade from another rating agency (Fitch Ratings and Moody's Investors Service have promoted Turkey out of junk status) could lose Turkey its investment grade status, which in turn could lead to an exodus of funds that track bond ratings. But Ozgur Altug, senior economist at the Istanbul office of BGS Partners, argues it is still too early for such predictions of doom. "Global developments and domestic politics will determine whether Turkey will face a hard landing or not," he writes in a briefing note, pointing out that of 22 of the most frequently updated indicators, only three signal that the Turkish economy is contracting. Of the remainder, 13 signal a slowdown, while five - including the number of newly established companies - actually signal growth. He predicts that Turkey's GDP growth will fall from around 4% in the last quarter of 2013 to 1-2% in in the first quarter.

Current problems

There was further bad economic news for Turkey on February 13 with the publication of the balance of payment figures for December. At $8.3bn, the current account deficit was considerably worse than market predictions of around $7.6bn and brought the deficit for the whole of 2013 to $65bn, a 34% increase on the $48.5bn reported in 2012.

The December figures, though, came before the sharp fall in the value of the lira in January and February and the central bank's sudden hike in its interest rate corridor, which raised effective rates from around 7% to around 10% - a move which seems so far to have helped the lira to stabilise at around TRY2.2 to the dollar.

Coupled with new restrictions on credit growth, the central bank appears to be gambling that the combination of higher interest rates and a weaker lira should reduce local demand for imported goods and hence help reduce the deficit. At the same time, reduced domestic demand is expected help to dampen inflation, which reached 7.5% in December.

However, lower demand could prove tricky for some of Turkey's corporations, whose net foreign-exchange debts stand at around $170bn - a figure which has almost doubled over the past two years. Part of this rapid increase can be explained by major infrastructure and energy projects, as well as privatization purchases funded by forex credits from local banks. Of the rest, some corporations with forex positions do generate forex income, but those whose income is in Turkish lira could face difficulties.

Even before the sudden fall in the lira, a fall in demand was expected as a result of the coming election cycle, which will see local elections in March followed by Presidential elections in August and general elections in 2015. The cycle has already caused considerable uncertainty and if, as expected, the March elections indicate a drop in support for the ruling AK Party, it could well further heighten tensions and reduce private sector appetite for investment.

The coming elections do pose a risk for economic activity, points out Inan Demir, chief economist at Turkey's Finansbank. "Arguably these are the first elections since 2002 where there is considerable uncertainty over the outcome," he says, explaining that this is likely to cause companies to postpone or cut back investment, which in turn will hurt domestic demand.

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