From rabbits, back to elephants
The year will close with a stellar growth rate, at around 6.5% we now estimate, thanks to massive stimulus measures and to a lesser extent growth in net exports. But macro imbalances have worsened as well, with inflation likely to end the year at around 11.5%, up from 8.5% at end-2016, and the current account deficit, at some 5% of GDP, above last year’s sub-4%.
In the Medium-Term Program, the government targets a similarly strong growth performance for next year, at 5.5%, but this is highly unlikely to be achieved as rising political risks (with early elections as our baseline), a high external financing requirement and ongoing monetary normalization in advanced economies should keep policy uncertainty as well as interest rates elevated, weighing down on the economy. Growth could thus slow to around 3%-3.5%, accompanied by modest reductions in Turkey’s chronic imbalances of a double-digit inflation rate and “above-norm” current account deficit.
New “rabbits”, i.e. more stimulus of sorts could, in principle, boost growth again, but we think there is not much room available because weaker inflows and deposit dollarization should limit expansion in financial sector’s funding base and hence, its ability to finance additional stimulus without pushing interest rates higher. In fact, combined with a worsening inflation outlook, this appears to have contributed to the rise in the benchmark interest rates by some 250 bps since the summer months.
Most probably, monetary policy tightening is not yet over, either. The CBRT’s recent move, which lifted the Late Liquidity Window rate and hence, the money market rates another 50 bps higher, may not be the last, because pressures on the lira are likely to continue throughout 2018. With monetary policy forced to tighten, the government’s deficit target of 1.9% of GDP for next year is likely to come under pressure.
Admittedly, this “muddle-through” scenario of sorts is not entirely “internally consistent” because growth deceleration, should it materialize, is unlikely to be politically acceptable on the way to 2019 elections, triggering risky policy interventions of all kinds. In fact, how this tension between slower growth prospects on the one hand, and the overarching objective of rapid growth would play out is arguably the biggest macro puzzle that lies ahead of us.
With few quick fixes (or “rabbits”) left available on the econ front, the answer, we surmise, must lie with politics (or “the elephant in the room” that we can no longer ignore), with either the early elections or AKP/Erdogan pragmatism coming to the “rescue”. The latter could take various forms such as the lifting of the State of Emergency, improved relations with the West, giving a much-needed boost to confidence, and encourage stronger inflows.
Unfortunately, we don’t think this scenario is too likely, which makes early elections a strong possibility, and the road ahead highly bumpy and accident-prone.
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