The current economic model accumulates imbalances and increases the cost of a disorderly adjustment


Scope Ratings has revised down the GDP growth forecast for Turkey (rated by Scope B-/Negative) to 5.3% from 5.8% in 2022 and to 3% from 3.5% in 2023 while economic imbalances accumulate. There is an even more pronounced downside risk unless the government reverts to more sustainable economic policies.

The next government after elections scheduled for 2023 will inherit an even more fragile set of economic fundamentals than those facing today’s policymakers, which will complicate any further efforts to stabilize Turkey’s economy.

Aggregate supply in Turkey has long failed to catch up with aggregate demand despite ultra-loose monetary policy in stark contrast to the tightening of other G20 central banks. Businesses have reduced their inventories since the fourth quarter of 2020 due to strong consumption and exports – two main drivers of economic growth in Turkey.

The negative contribution of inventories to growth reached around -10 pp in Q2 2022 (Figure 1). Industrial production rose just 0.9% in August from the same month a year ago, compared with 3.2% in July and 9.2% in the second quarter.

Figure 1. Stock market shock: Inventory depletion dampens the Turkish economy

Contributions to real GDP growth (percentage points, year-on-year)

Source: Turkstat, Scope Ratings

The data is further evidence that the country’s growth model is unsustainable with such high inflation and downward pressure on the exchange rate. Either the depreciation of the currency worsens to such an extent that the Turkish central bank is forced to raise interest rates to relieve pressure on the lira and contain inflation. Either the government starts again to restrict the economy’s access to foreign currencies while forcing the dedollarization of national deposits.

Monetary policy reset unlikely before election

The first option involves a monetary policy reset, which is highly unlikely, at least before the next elections scheduled for June 2023. President Erdoğan is behind potential presidential candidates from the main opposition Republican People’s Party , in opinion polls. This prompts Erdoğan to double down on current economic policy given the damage to his credibility a U-turn could inflict, even with annual inflation at 85.5% in October.

The government will continue to prioritize near-term growth with loose economic policies, including a likely pre-election spending spree, while securing hard currency from domestic banks, exporters as well as international allies. This includes the potential issuance of dollar-denominated Islamic bonds, currency swap agreements with allied central banks, and closer cooperation with Russia — all of which involve varying degrees of geopolitical, economic, and financial compromise.

The longer the current expansion continues, the higher the cost of the future correction in aggregate demand will be – through a substantial economic slowdown and a severe adjustment in the balance of payments.

The current account deficit widens sharply

Scope Ratings estimates that Turkey will run a current account deficit of around USD 40 billion, or 4.5% of GDP, over the next 12 months, compared to a deficit of USD 13.9 billion (1.7% of GDP) in 2021, due to an energy bill, continued credit stimulus and an expected decline in export earnings due to the economic slowdown in Europe.

This puts significant pressure on the lira and on the central bank’s already depleted reserves. Net central bank reserves, adjusted for short-term foreign exchange swap commitments with domestic banks, are near a record high of negative USD 59.7 billion in September 2022, from USD 18.5 billion. USD positive at the end of 2019.

Without a rate hike, the next government’s response could include additional capital controls to help finance these large external deficits.

Turkey raised $1.5 billion on an international dollar-denominated bond due 2028 on Tuesday, showing that investor sentiment towards emerging markets has improved slightly, although the 10% yield shows how difficult the outlook for Turkey remains.

Turkish banks were pressured by the central bank to buy more government debt to ease the costs of pre-election spending, so yields on 10-year lira bonds fell artificially to around 12.5% ​​in early November. , down from more than 25% in March – the lowest since January 2020.

Foreign investors have been leaving Turkey’s domestic markets for years amid concerns over unorthodox policies, with foreign holdings of national government debt falling to $1.5 billion in Q2 2022 from a peak of $64.9 billion USD in the first quarter of 2013. A rise in interest rates after the planned elections would therefore hurt the balance sheets of domestic banks.

For now, the current domestic policy decisions driving policymakers’ approaches to inflation continue to raise the risk of another monetary crisis and greater financial market instability, exacerbated by the uncertainty surrounding economic policy after the planned elections and its implications for capital flows.

For an overview of all of today’s economic events, check out our economic calendar.

Levon Kameryan is Associate Director of Sovereign and Public Sector Ratings at Scope Ratings GmbH.


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