The Road to November 2019
After a narrow and somewhat contentious YES victory at the April 16th constitutional referendum, Turkey has achieved political stability of sorts, but as it is unlikely to translate to more democracy or better relations with the key Western allies, it is a tenuous one at best. Our base-case scenario continues to be one of “muddle-through”, with main policy settings remaining broadly unchanged until the November 2019 presidential and general elections.
We continue to think that growth is in secular decline, but fiscal and quasi-fiscal measures as well as exports should give it a cyclical boost in the short-run. We think the economy should lose momentum visibly late in the year or early next however, with growth decelerating to around 2%-2.5% next year, from an (upwardly revised) 3%-3.5% this year.
Headline inflation has likely peaked in April at just under 12%, but inflation outlook has markedly worsened, with inflation expectations on a two-year horizon at their highest level in over a decade. The CBRT’s pro-growth stance and heightened tolerance toward lira weakness -- essentially hiking only when ‘financial stability’ is gravely threatened -- are largely to blame. The good news is that the recent tightening has stabilized the lira, relatively speaking, but we doubt monetary policy is tight and/or credible enough to drive inflation toward the 5% target. Moreover, credit growth is surging despite higher rates, thanks to the credit guarantee scheme, fending off political pressures on the Bank -- for now. But this “sweet spot” is unlikely to last for too long, with pressures likely escalating with a vengeance, in just a few months’ time.
The central government primary surplus is rapidly vanishing – and is in deeply negative territory after adjusting for one-off revenues, the worst such performance since the global crisis. The deterioration appears in good part structural, too, suggesting that it might be hard to reverse it this time, without a substantive fiscal adjustment down the road. But this is unlikely, given the political backdrop; if anything, the government is likely to keep spending and continue with its highly distortionary interventions, given that Turkey’s private sector–led growth model appears badly stalled.
As for the external accounts, the current account deficit should end the year at $34-$35 billion (or 4.3% of GDP), and ease slightly next year, the financing of which will have to rely mainly on short-term flows and resident reflows. It is hard to imagine lira having a lasting respite in such a scenario.
The sustainability of this muddle-through trajectory until late 2019 is admittedly debatable, but “tail” scenarios are not so likely either.We do not expect a full-blown crisis, barring a perfect storm – comprising a political crisis, grave policy mistakes and a less supportive global backdrop striking at once. Envisaging a much more constructive scenario with a pragmatic leadership changing course and placing Turkey on the right trajectory is looking rather unlikely as well.
Please note that there will be no Weekly Update today.
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