Why Turkey?

2018 MACROECONOMIC OVERVIEW AND 2019 OUTLOOK 

A YEAR OF MARKEDLY INCREASED VOLATILITIES

Despite performing better than its trend in recent years, global economic activity lost pace as compared to 2017, and acquired an outlook of decreased synchronization among geographies in 2018. Increased protectionist measures in trade, coupled with the financial stress inflicting some developing economies already began affecting the world growth negatively. Increased volatility in commercial activity and deteriorated confidence indicators confirm that the global outlook is worsening. According to our projections, global growth can come to 3.7% in 2018, similar to its 2017 value, before slowing down to 3.5% in 2019. 

Although the anticipated direct impact (trade channel) of the recently introduced protectionist measures is relatively restricted, indirect impact can be higher through confidence and financial channel particularly for China and developing countries. While this situation that pervaded the whole 2018 gave the US a year of positive decoupling owing to her strong performance backed by fiscal policy incentives, the instability that began in the Eurozone, gradual slowdown of China, and the correction in some developing economies such as Brazil, Turkey and Argentina have been the key factors to give a push to the volatility in financial markets. 

While China’s strategies aimed at alleviating the effects of trade protectionism without further deepening the financial vulnerabilities (by way of successfully managing the level of Yuan and the debt-reduction process in the private sector) are expected to prop growth above 6% in 2019, overall concerns about global growth is likely to be the main agenda topic of 2019. In fact, the postponement of monetary tightening steps by global central banks could prove to be somewhat supportive for global financing conditions. This could result in relatively more positive portfolio inflows, primarily to developing economies. 

With respect to the monetary policy strategies in developed markets, we predict that the normalization process will continue with differentiated steps. We are anticipating the US Federal Reserve (the Fed) to continue rate hikes and to increase the benchmark interest rate to the 2.75-3% interval through two additional rate increases in June and December. We are forecasting that the European Central Bank (ECB) will shift the first repo rate hike timing previously anticipated as December 2019 to June 2020. 

As a result, while global outlook has some downside risks, we predict that it could adopt a momentum dominated by trade wars and the Fed’s exit strategy (the renewed sell-off pressures in developing economies can act as a potential leverage). The main risks, particularly in the US, could include a faster-than anticipated tightening by the Fed and a drastic economic slowdown (although low, the likelihood of an economic recession in 2020 is increasing). As the protectionist measures in China bear potential risks that will hinder the debt-reduction process of the private sector.In Europe, uncertainties increase in connection with Brexit, while deceleration in growth reached worrisome levels. 

REBALANCING IN THE TURKISH ECONOMY 

2018 was anticipated to be a year of rebalancing for the Turkish economy after its strong performance in 2017 that experienced a growth rate of higher than 7%. However, this impact has been somewhat faster and harder than expected. Lagging impact on inflation and current account balance put extra pressure on Turkey’s risk premium during the sell-off in developing countries’ assets that commenced in March. Moreover, the decision to move presidential and general elections forward to June 2018 from the scheduled November 2019, and the Constitutional change increased the negative impact on Turkish financial assets. Lastly, geopolitical developments and the conflict with the US led to a free fall in the Turkish currency (TL) on August 10th, resulting in a pronounced deterioration of Turkey’s risk premium. The new economy administration immediately responded to these developments with several steps in the right direction. The Central Bank of the Republic of Turkey (CBRT) surprised the market on the upside with 625 bps increase in its policy rate in September (cumulative increase in interest rates in 2018: 1125 bps) and the Government introduced the New Economic Program (NEP) including a strict financial consolidation plan. In the aftermath of these events, the atmosphere dominating the markets was reversed to a positive one upon renewal of syndicated loans by major banks with a rollover ratio of above 100% and the easing of the tension with the US. In addition, Turkey was temporarily exempted from the US sanctions against Iran in relation to importing Iranian oil, which relieved the markets greatly. 

As a result, although normalization began replacing the recent financial shocks since September, the lagging impact upon the real economy began to become evident as of the last quarter of 2018. Given these conditions, we are anticipating the Turkish economy to attain around 3.0% growth for the full year, after growing 6.2% in the first half of the year and registering a relatively very weak performance in the second half. This year, we are anticipating growth to slow down to 1%. On the inflation part, we have observed a rapid increase due to the sharp currency depreciation, and the significantly deteriorated pricing behavior. After making its peak of recent years at 25% in October, consumer inflation declined quickly thanks to lower oil prices, appreciation inthe currency , poor demand, discount campaigns and tax cuts, and closed 2018 at 20.3%. In 2019, we are expecting year-end inflation to go down to 16% with the support of base effects that will become evident in the second half of the year, in the absence of a further negative shock. In this respect, we foresee that the CBRT will maintain its current stance in the first half of the year, and might initiate limited rate reductions as of June. The developments on the part of fiscal policy will also take place among the key topics of 2019. Since realizations close to the targets set down in the New Economic Program (NEP) will satisfy anticipations, they will support the gains on the exchange rate. We think that 2019 will be a year of rebalancing for the Turkish economy and also a year of corrections in terms of financial variables. 

On the external balance front, shrinking domestic demand caused a rapid reduction of current account deficit in 2018. After producing a monthly surplus for the fourth month in November, the 12-month deficit went down to USD 27.6 billion (3.5% of GDP) by year end (year-end 2017: 5.6% of GDP with USD 47.3 billion). The slowing economy, still ongoing supportive tourism revenues, and the recently low oil prices have been the key drivers behind the decline in the current account deficit. On the financing side, while CBRT reserves and net errors and omissions made up the main items, there were outflows from the portfolio and net other investments. We estimate the 12-month current account deficit to be around USD 16 billion (2.2% of GDP) at year-end 2019. 

Budget realizations proved to be in line with the Government’s targets by end 2018. While budget expenditures remained strong due to high personnel expenses and goods & services purchases, budget revenues continued to be supportive thanks to one-off revenues such as zoning reform, tax amnesty and military service by payment. Hence, the central government budget produced a deficit of TL 72.6 billion (1.9% of GDP) in 2018, while primary balance generated a surplus of TL 1.3 billion (0% of GDP). In the period ahead, the extension of tax incentives, the weak performance expected in tax revenues as a result of the slowdown in economy and previously unbudgeted employer subsidies may affect the budget performance negatively. On the other hand, the zoning reform extended until July 2019 and a higher-than-expected profit transfer from the CBRT could act as a buffer against the deterioration in the budget. At the bottom line, we are projecting a budget deficit to GDP ratio of 2.2% in 2018, somewhat above the New Economic Program (NEP) forecast of 1.8%. 

OPPORTUNITIES AND CHALLENGES OF THE TURKISH ECONOMY 

Serving as a bridge between Asia and Europe, Turkey’s economy had a year of rebalancing in 2018. With a GDP of USD 713 billion, Turkey is the 17th largest economy in the world1. After the global financial crisis in 2008-2009, the Turkish economy managed to grow by more than 6%, a rate that is well above the rates of EU and other developing countries excluding China and proves the dynamic nature of the Turkish economy. In this respect, although we forecast 2018 and 2019 as a period of rebalancing , we are still projecting our potential growth rate close to 5%. Fiscal discipline, sound monetary policy, a strong and well supervised financial system and a reform agenda continue to be the main pillars of Turkey’s economic program. Turkey’s central government is expected to produce a budget deficit to GDP ratio of 1.9% in 2018. The general government debt stock ratio has been meeting the EU Maastricht Criteria of 60% since 2004. 

Another important factor that supports the growth profile is the demographics of Turkey. Turkey has a sizable, young and growing population. With around 80 million people, Turkey has one of the highest populations in Europe and the CEEMEA countries. 55% of the Turkish population is under 35 years old and the labor force is constantly evolving towards a more qualified level with increasing participation of women. In 2030, the population is expected to reach 88 million, compared to a negative growth in Europe and the CEEMEA region. 

One of the main challenges Turkey faces is the high dependence of the production on intermediate goods imports, which, being in the lower part of the global supply chain, results in both higher trade and current account deficit as the Turkish economy grows. Hence, it is vital for Turkey to attract capital inflows in order to finance the deficit. This fact has been recently posing challenges as central banks of the advanced economies, especially the Fed, continue to withdraw from the accommodative monetary policies. The likelihood that the monetary policy normalization could be gradual in advanced economies may alleviate the pressure on emerging markets by giving more room to implement necessary reforms as capital inflows would remain moderate despite the likely increase in the cost of financing. To this aim, the economy management in Turkey has already begun implementing some structural reforms such as increasing savings tendencies and lowering intermediate goods imports by replacing them with domestic production. 

Another main challenge could be the real sector’s open FX position of around 25% of GDP. It exacerbates vulnerabilities of the economy to external shocks as exchange rate volatility could get higher during a turbulence in global financial markets. Meanwhile, to tackle the problem, the economy management has initiated certain measures such as non-deliverable TL forward contracts and some limitations of foreign currency loans under a risk exposure of 15 million dollars. All in all, together with the program initiated to increase savings, both external financing needs and vulnerabilities in the economy could be diminished as the Government continues to pursue indispensable structural reforms.