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OPINION: Turkish economy: something’s gotta give…

With a clear cut victory in both presidential and parliamentary elections hardly guaranteed, it seems something has got to give in the Turkish economy during the upcoming election period and beyond.

OPINION: Turkish economy: something’s gotta give…

Our columnist Güldem Atabay Şanlı wrote on the recent unfortunate developments in the Turkish economy at Ahval News.  Below, we share her comments.

Even if one knows nothing about the dynamics of the Turkish economy, it’s easy to tell something is amiss just by looking at this chart of the lira and interests rate below.

Just earlier this week, Standard & Poor’s (S&P) downgraded Turkey further into junk territory amid concern about high inflation, the lira and the widening debt-financed current account deficit. The ratings agency warned about the hard landing risk for Turkey’s economy, following last year’s economic overheating fueled by extra loose fiscal, monetary and financial policies of credit expansion.  Speaking frankly, the agency added that the ever-extended state of emergency following the July 2016 coup that de facto allows the Turkish president to rule Turkey by decree escalated concern over centralized decision-making processes and an erosion of checks and balances. Thus, Turkey sank deeper into junk with its foreign currency sovereign credit rating now down at BB- from BB.

Turkey, once the darling of investors which had managed to earn investment grade the hard way after a self-made economic meltdown in 2001, is now two steps below investment grade, though with a stable outlook.

This was not the sole bad news for the economy over the past few days. The International Monetary Fund (IMF) issued its review of the Turkish economy just a day earlier, based on its Article IV consultations. With similar concerns to S&P, the fund urged the Justice and Development Party (AKP) government to take measures on the fiscal and monetary fronts urgently.  The aim is of course to stop the bleeding in the lira through a large rate hike that would serve both to rein in the double-digit inflation and ease the burden on Turkey’s private sector, which is pressured between its high external debt obligations and an ever sliding lira.  The IMF also urged the AKP to reverse the deteriorating picture on the fiscal front because the primary budget surplus has now turned into a primary deficit, eliminating an important potential buffer for harder times.

Turkey has early elections on June 24 for both parliament and the office of president.  The main reason for President Recep Tayyip Erdogan calling such early elections more than a year before the scheduled time is no secret: the rapid deterioration in the Turkish economy that would directly hurt the AKP’s voter base.

However, as the AKP government called early elections, it was interesting to hear from Deputy Prime Minister Mehmet Simsek- a former economist and finance minister- that the S&P downgrade was suspect in timing; meaning it aimed to weaken the AKP government prior to the early elections.  Simsek pointed out that the current account deficit was stabilizing and the recent 75 basis points central bank rate hike served to control inflation.

Further details should be added to his comments though. Turkey’s current account deficit is stabilizing at around 7 percent of GDP when the tide is turning for developing nations such as Turkey, which is listed in the top “fragile five” emerging markets globally.  Plus, the continuing weakening in the lira and the serious deterioration in inflation expectations that elevates pass through effects has already added roughly 100-150 basis points to end-year consumer price inflation that is set to creep up towards 11-12 percent. The central bank rate hikes, which total about 500 basis points since 2016, came too late and too gradually to have an effect on deteriorating inflation dynamics.

While sound and loud criticism about Turkey’s economy management is espoused by both the S&P and the IMF, the government has been busy announcing a new and a dangerously populist “economic package” to win votes at the upcoming election.  Turning a blind eye to Turkey’s swirling economic problems, the government announced measures that would cost the government an extra 24-30 billion liras, carrying the 2018 budget deficit to close to 3 percent of GDP, up from last year’s 1.5 percent. The package not only includes hikes to pension payments, but on a more disturbing level a new round of tax and building zone amnesties.

Such a fiscal boost that lacks a grounded economic target will no doubt add further pressure onto inflation, the lira, fiscal accounts and thus on interest rates and eventually on Turkey’s ratings outlook.

When the government had announced early elections past month, initial market reaction was positive based on expectation that it would eliminate uncertainty and stress on the economy. Initially, it was assumed that the AKP would win the polls and then bring much delayed economic reforms back to the table. But such optimism soon vanished, as reflected by the lira’s performance.  As Turkey also has local elections set for the spring of 2019, populism is likely to continue though on a lower scale for another 10 months after the June election.

Furthermore, the AKP government, which is expected to continue in power, would have to face tough choices right after the election, such as adjusting its fiscal and monetary policies in accordance with economic realities.  Now that the recent populist measures are further deteriorating macro-economic balances, the next government faces an even tougher task bringing the Turkish economy back on track through even harsher measures.  However, recent populist measures — lookalikes of the 1990’s that led up to the 2001 meltdown — add further imbalances to Turkey’s macro story. Averting a possible hard landing for the economy in 2019 and 2020 will require serious reversal from today’s mismanagement.

Turkey’s economy is set to cool down from last year’s overheating as its macro indicators have deteriorated significantly.  However, it is hard to give the government the benefit of the doubt for the period after the elections in taking the necessary measures to wrest back control, just by looking at the measures taken right before the elections.  With a clear cut victory in both presidential and parliamentary elections hardly guaranteed, it seems something has got to give in the Turkish economy during the upcoming election period and beyond.





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