ANALYSIS: Overheating confirmed; now what’s next?
The economic reality on the other hand calls for a 5-6 percent contraction for 3Q18 and a near contraction performance due for the last quarter of the year, following the 500 basis points rate hike delivered over the course of last one month.
Today the first quarter GDP and the April balance of payments data were released in Turkey. Both point to how the Turkish economy went into the “overheating zone” during the first three months of the year that resulted in the lira’s catastrophic fall accompanied by CPI inflation becoming sticky in the double-digit levels at around 12 percent.
Beginning with GDP, first quarter y/y figure at 7.4 percent and q/q growth at 2 percent following 1.7 percent in 4Q17, just confirm how the strength of the economic growth was extended from 2017’s 7.4 percent into early 2018; on the back of both loose fiscal and monetary policies. In other words, the Turkish economy continued on growing above its potential growth having its negative toll on macroeconomic balances starting with inflation and the current account deficit.
The details of the GDP data reveal growth was mostly based on the manufacturing sector (+9.3 percent y/y), construction sector (+6.9 percent y/y), services sector (+10.0 percent y/Y); in other words an across the board boost was seen among almost all the sub-sectors. The laggards were the agriculture sector (+4.6 percent y/y) and real estate activities (+2.9 percent y/Y).
Thus, it was no surprise the growth in domestic demand was a hefty +11.0 percent y/y (+4.2 percent q/q) explaining how Turkey’s inflation went out of control to above 12.0 percent. Compensation of employees increased by 18.7 percent while net operating surplus/mixed income increased by 22.8 percent in 1Q18 y/y. Consumption was mostly based on imports yet again, with growth of net exports at 0.5 percent mitigated by the soaring 15.6 percent spike in the growth of net imports.
On note should be added and it’s the slowdown in machinery and equipment investments to +7.0 percent in 1Q18 compared to the +15.7 percent and +8.3 percent recorded in the previous two quarters. On the other hand growth in the construction sector was +12.0 percent in 1Q18 versus 4.8 percent in 4Q17.
Current account deficit now reaches to 6.4 percent of GDP
Having the 1Q18 GDP details at hand, it was no surprise seeing the April current account deficit at 5.4 billion dollar bringing the 12-month rolling deficit to 57.1 billion dollars; or to 6.4 percent of GDP. Current account deficit was 34.1 billion dollars a year ago. The role that the surge in price of oil has played a role that is below 1.5 percent of GDP while mostly it was the strong domestic demand that kept on elevating the current account deficit. The tourism sector revenues confirmed the recovery expectations in the sector and tourism revenues, rose by a net of 1.1 billion dollars in April bringing the first four months’ inflows to 3.8 billion dollars.
The financing details show the effects of Fed’s rate hikes that turn investors away from emerging markets and the turmoil in Turkey’s economic management. In figures, portfolio inflows, which are an important item in Turkey’s deficit financing were a negative 502 million dollars in April; adding up to a mere 1.8 billion dollars for the first four months of the year versus last year’s 5.7 billion dollars. Similarly, foreign direct investment equaled 1.8 billion dollars for the January to April period, down from 2.7 billion dollars a year ago. Not surprisingly, foreign exchange reserve assets fell 2.8 billion dollars in April and 2.1 billion dollars for the first four months of 2018. Net errors and omissions (the flows with undefined sources) were a mere 264 million dollars; though its cumulative at 3.8 billion dollars in the first four months corresponds to roughly 20 percent of the accrued deficit for the same term.
Can overheating ease in the second half of the year into 2019?
Turkey’s central bank has raised interest rates by 500 basis points to 17.75 percent since April which will soon turn growth picture to negative; expectedly in the third quarter of 2018. The central bank had been under fire from the markets for not acting on the evident overheating in the Turkish economy manifested as lira’s painful devaluation. Yet, the bank was stuck between and a rock and a hard place as the president himself harshly “directed” the bank to not the raise the interest rates in Turkey.
Following the release of the 1Q18 GDP details, it was curious enough to see the president promising further strong growth for the coming quarters as he added that Turkey had performed well even under “economic attack from foreign forces”. Furthermore, Economy Minister Zeybekci as a follow up to GDP release argued that 7.4 percent GDP growth was a very good reply to rating agencies that have downgraded Turkey’s growth expectations recently following the spike in the rate of interest.
These two high profile comments are detached from economic reality and perhaps are said for the sake of the critical June 24 elections with only days left. Nonetheless, for the investors it really is hard to get over President Erdogan’s shocking revelations when he was in London last month and he declared a promise to lower interest rates and take a more active role in monetary policy should he win a second term as president with enhanced executive powers.
GDP, inflation and current account for 2H18?
The economic reality on the other hand calls for a 5-6 percent contraction for 3Q18 and a near contraction performance due for the last quarter of the year, following the 500 basis points rate hike delivered over the course of last one month. Thus, a sharp slowdown from the 1Q18 growth rate of 7.4 percent is in the cards for the second half of the year. Turkey’s 2018 GDP growth is thus expected to be at around 3.5-4.0 percent.
The impact of economic overheating on inflation is harder to get under control as the reversal in lira was limited and the price of oil has potential to surge further in the months ahead. Thus, peaking to 15 percent by 3Q18, Turkey’s CPI inflation is set to end the year in double-digits at around 13 percent.
For the current account that has already reached 6.4 percent of GDP as of April, pulling it below 5.5 percent is hardly feasible for 2018.
The health of the economy, whether the incoming government would care for tuning the Turkish economy to a sustainable growth path which is in IMF’s calculations at around 4.0 percent, is to be seen. While Erdogan’s announcements following the release of the GDP figures are not really promising; as was the case with the rate hikes economic realities will dictate again for the post-election period.
Whether it would be a planned slowdown or hard landing will be at the hands of the incoming administration.