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ANALYSIS: Heads-up for Turkey’s alarmingly dismal fiscal performance

16 July 2019

Turkey’s first half 2019 central government budget details were released to show the level of deterioration in the fiscal performance.

As per the announcement from the Treasury and Finance Ministry,  central government budget balance posted a deficit of TL 78.6 billion (USD 14 billion) in the first half of the current year compared very unfavorably with the 2019 fiscal deficit target of TL 80.6 billion.  Reaching the end of year fiscal deficit estimation which was set last autumn as per the budget law in the first six month of 2019 is a bad omen for Turkey’s economic risk profile.

Going over the details briefly, the highlights are as follows:

  • January-June 2019 budget revenues totaled TL 403 billion (USD 71.7 billion) up 14% year-on-year in nominal terms; and down by 1.5% in real terms given Turkey’s consumer price inflation is 15.7% as of June 2019. Such a sour performance comes despite the hefty TL 33.8 billion (USD 5.9 billion) profit transfers from the central bank of Turkey which was completed back in January and was reflected fiscally amidst some 40.0% yoy real spike in non-tax revenues.
  • The economic contraction which has lasted throughout 1H19 is pressuring both tax revenue generation and tax collection of the Finance Ministry.
  • Such is evident from the 9.8% real yoy drop in tax income; which jumps to 17.0% yoy real contraction in taxes generated from consumption. Specifically, the VAT contraction of 26.3% yoy real terms and the 9.5% yoy drop in the foreign trade taxes is eye-catching; latter as the reflection of sky-diving imports amidst Turkey’s halted domestic demand.
  • Budget expenditures on the contrary posted 4.1% real yoy increase to TL 481.6 billion (US$86 billion) marking the massive TL 78.6 billion (US$14 billion) fiscal deficit in the first half of the year and scarily corresponding to the end of year estimation of TL 80.6 billion.
  • Amidst heavy recruiting, the state’s personnel spending with 10.9% yoy real spike stands out as the personnel expenditures account to 31% of Turkey’s total budget expenditures.
  • Transfers from the state to fill the huge gap in the social security system also have escalated by a sizable 12.8% yoy real terms; accounting to 21% of the total expenditures.
  • On the contrary, public investments and goods and services procurement are down by 24.8% and 10.2%, yoy real terms, respectively. Nonetheless, both combined amount to 13% of the total expenditures.
  • Not surprisingly, the interest bill is up by 30% yoy real terms, following the creeping rise in risk premium over the past years added the last year’s currency crisis.

All combined, Turkey posted a primary deficit (budget balance minus interest payments) of TL 27.8 billion (US$5 billion) from January to June 2019 which is double that of last year’s same period. Recalling that the government’s estimation was TL 36.7 billion (US$ 6.4 billion) primary surplus for the end of 2019, the first half’s primary deficit level is astonishingly off from what was envisaged as the fiscal layout; the last standing castle to anchor positive expectations about the Turkish economy.

Solely the June budget performance is also worth looking closely.  In June alone the overall fiscal deficit is again sizable at TL 12.1 billion (US$2 billion) almost half of last year’s. The primary deficit also shrank to TL 7.7 billion (US$1.3 billion) last month from last June’s TL 23.2 billion (US$ 4.6 billion).

Barring the 58% yy real spike in the June interest bill, it seems the completion of the local elections have urged the government to slowdown the heavy spending spree.  Or from the counter perspective it could be that the economic contraction taking its toll through very weak revenue performance have left no room for the AKP government to spend when considering the whole year fiscal deficit target is fulfilled as of the first half of the year.

The outlook for such a poor 1H19 fiscal performance

Well the numbers speak for themselves.  The good mighty years of posting primary surpluses to GDP at 4.5-5.3% were the 2004-2008 period; the IMF standby program years that had a focus of disinflation and public sector transparency/accountability. When the IMF program expired back at 2008, the AKP government felt free to reduce the primary surplus/GDP to around 1% given the easy money years on a global scale. The negative primary surplus/GDP set foot starting from 2017 which was -0.9% and soon rose to -1.5% by the end of 2018. No need to say, as fiscal policy eased Turkey’s inflation rose steadily to skyrocket to 25% last September amidst a huge currency meltdown.

Now the central bank of Turkey under the new appointed governor who seems to be under the strict supervision from President Erdogan is about to launch an aggressive rate cut scheme.  A loose monetary policy will be combined with an ultra-loose fiscal policy in the second half of 2019.  The government has little room to beat inflation in revenue growth in the coming six months while Erdogan seems determined to jump start Turkey’s once eye-catching economic growth that was torn to pieces along with a burning overheated economy last year.

Thus, it should be no surprise that the AKP passed a bill to transfer fresh resources from the central bank to Treasury in the coming months just to get “enabled” so that it can keep on with its spending frenzy.

The result will be a 2019 fiscal deficit to a tune of 4% of GDP; double of last year’s, a weaker lira and a sticky inflation plateau of around 15%. Added the expected economic sanctions from the US government which is forced to plug in CAATSA as a reaction to Turkey’s S-400 purchase, Turkey’s risk premium is set to rise in the coming terms.

Any Fed rate cut in July and perhaps another one in 2020 will be of no help this time around, while Turkey’s crashing current account deficit along with its domestic demand can only help in preventing a repeat of August 2018-like lira devaluation.

The combination of a monetary policy that is now positioned for growth, while the financial performance is waning, heralds a difficult winter for Turkey.

 

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