Winter of economic uncertainty

Long one of the most dynamic economies in Europe, Turkey appears to be losing its way, with growth forecasts being revised downward as trade gaps widen.

Questions are being asked as to whether Ankara can stem recent retreats and regain lost momentum. One of the most immediate causes of concern for the Turkish economy, one shared by many developing markets, is the expectation that the Federal Reserve is about to curtail its bond buying activities, a key plank in the US’s program to stimulate domestic growth.

By ending its bond buying, yields on Treasury papers are forecast to rise, making that market more attractive to investors, who have already started moving out of developing economies such as Turkey in search of the expected higher returns in the US.

Turkey is seen as particularly at risk should there be a general foreign capital exodus, being dependent on inflows from overseas to help bridge the gap in its current account deficit, at present running at 7.1% of gross domestic product (GDP). According to Erdem Basci, the Governor of the Central Bank, capital outflows from the Turkish market have amounted to around $8 billion since the end of May, a figure seen by many analysts to be on the conservative side.

Comments by US Federal Reserve head Ben Bernake in late August that the bank would look to taper its stimulus measures had an immediate impact on the Turkish economy, with the lira beginning a sharp decline against most foreign currencies, with the falls only bottoming out well into the next month.

By September 5 the Turkish currency had lost 17% since the beginning of the year, and though it clawed back some of its losses – in part due more to a softening of the US dollar rather than positive market forces – it still remains close to all time lows, despite the Turkish Central Bank pouring $6 billion into the market to prop up the lira.

As the lira fell, the Turkish state statistics agency released figures showing inflation was remaining well above both the central bank’s and the government’s year end target of 6.2%, with the consumer price index in August flat at 8.2%. Given that August is traditionally a month in which inflation falls in Turkey, with food at its cheapest at the end of the harvest season, the index could edge up further later in the year.

The bank has already pushed up its key lending rates twice since the beginning of July, with its overnight lending rate lifted to 7.75% from its previous record low of 6.25%, moves aimed at cooling domestic demand and also making Turkish debt more appealing to foreign investors.

Though broadly welcomed by the markets, applause for the central bank’s rates move was not universal. On September 5, the day the lira hit an all time low of 2.08 against the US dollar, Economy Minister Zafer Caglayan made it clear one weapon in the fight against inflation the government preferred the central bank keep sheathed was further interest rates.

Though acknowledging that earlier growth predictions of 4% or more were likely to be wide of the mark, with the economy in line to expand by a more modest 3% or there abouts, Caglayan said he did not see that the reserve bank would need to raise rates again to try and cool the outflow of hot money or curb inflation.

“I am allergic to interest rates,” he said during a television interview. “I should express my view that I don’t think the policy rate needs to change.”

One of the main causes of that allergy, though not one publicly acknowledged by Prime Minister Recep Tayyip Erdogan and his ministers, is that the government is gearing up to go to the ballot box no less than three times over the next 18 to two years.

While the AKP has a strong base among the religiously conservative element of the Turkish electorate, it as also gained widespread support from voters in other segments of society and the business community for its sound stewardship of the economy during its near 11 years in office. In the ten years since coming to power at the end of 2002, real GDP has expanded by more than 6% year on year, even taking into account a sharp 4.8% reversal of fortunes in 2009 as the country’s export trade froze during the global economic crisis, a performance that has won grudging praise from many of the AKP’s harshest critics.

Turkish Lire

However, the decade’s forward momentum faltered in 2012, with GDP expanding by a muted 2.2% and while both the government and the International Monetary Fund are predicting better results for this year, those results will still be well below recent performances and the latest revisions suggest growth will be closer to that of 2012 rather than those during the boom years. At least some of the reason behind the government’s allergy to further interest rate rises can be tied to its desire to take the country to the polls next year and in 2015 on the back of continued strong economic growth, growth that has in the past compensated for the at times slower than promised pace of progress in other areas, such as social reform.

The government has tried to allay fears that the economy is stalling. Soon after the lira began its slide towards it record low in early September, Finance Minister Mehmet Simsek said such activity was common among emerging economies took to the local media to try and reassure the public, and the business community, of the underlying strength of the currency and the economy as a whole.

“Turkey is not an island, it’s an economy integrated to the world economy,” he said in late August. “Therefore Turkey can be affected positively or negatively by the developments in the world. This is more the consequence of the effect of a re-pricing of assets than a structural crisis.”

Though there may not be a crisis in the economy’s structure, there are a few cracks widening, with some of these fissures having been present for a long time. One that threatens to develop into a chasm, especially if the lira falls further, it Turkey’s trade deficit, which blew out to more than $60 billion in the first half of the year, a jump of almost 20% on the opening six months of 2012. With the Turkish currency sliding, the country’s hunger for imports could cost it more in the future, especially if energy prices remain high or rise still further.

Though Turkey’s exports are continuing to expand, despite recession hovering over many of its key markets in Europe, and should actually increase thanks to the weaker lira making Turkish goods more affordable to overseas buyers, any increase is not likely to bridge the import-export coverage gap, currently at more than 57%.

An area where the government has struggled to have a real impact is in draining Turkey’s pool of jobless. Though posting growth for all but one of the past 12 years, the Turkish economy has still been unable to roll out sufficient positions to both soak up the flow of young school leavers and university graduates entering the market and lower long term unemployment rates. Currently, those on the jobless queues represent 9.6% of the national workforce, a level fairly constant for most of the AKP years. Turkey’s youth unemployment rate is almost double this, at 18.3%, comparable to many of the recession hit economies in Europe. Should Turkey’s economy again shift towards negative territory, as it did in 2009, the employment tidal pool could start to rise again, as could electoral discontent.

The drop in the lira and the increasing outward flow of foreign capital was, in part at least, prompted by the suggestion by the US Fed that it would scale back its pump priming. Though some degree of stability has returned to Turkish money markets in the weeks after the announcement the reserve would in time halt its bond buying programme, what will happen when suggestion becomes reality could be more dramatic, possibly forcing the government to take a bitter pill or two to counter a greater illness than its allergy to rate rises.