Betting on a "V", with no Plan B
“Prediction is difficult especially about the future”, thus the saying goes, which couldn’t be more accurate in these times of “radical uncertainty”. The COVID-19 epidemic has been ravaging the economies the world over, and Turkey is no exception. Where we go from here is difficult to fathom, for at least two reasons: we don’t know how the epidemic will play out, and for how long Ankara can cope with the damage wrought by it, without another major currency event.
Thanks to favorable demographics, partial lockdowns and solid health infrastructure, Turkey has weathered the COVID-19 storm reasonably well so far, but we fear, just as elsewhere, a second wave is likely, because of a premature easing of restrictions. Meanwhile, Ankara’s policy response to the shock has been relatively haphazard, comprising tax deferrals, opening of credit taps through state banks, driving real policy rates into negative territory and last but certainly not least, de facto monetary-financing of fiscal deficits.
It is hard to figure Ankara’s endgame, but it seems to be counting on a quick recovery: a near-complete “normalization” of the economy from June onwards, with growth ending the year in positive territory. In order to make the “Monetary Trilemma” stick in the interim, given the very low rates and an elevated country risk premium, the CBRT, in effect, has been financing the BOP outflows from reserves, the drain on which might have already amounted to around $35 billion (net) in the year through mid-May. Likewise, the budget deficit has been widening sharply on the back of tax deferrals, weak economic activity and stepped-up transfers, the financing of which has been rendered possible, partly owing to stepped up government debt purchases by the CBRT.
This is a highly fragile dynamic. Turkey might be able to muddle through a few months longer, but collapsing tourism revenue in the summer months, another COVID-19 wave in the fall and rising political risks, with the popularity of AKP/MHP alliance likely sliding in the polls, could expose the unsustainability of this policy mix, leading to another market backlash or currency turmoil.
Offering yearend forecasts against this sort of a backdrop is a fool’s errand, more so than usual, but we try anyway. Assuming that a full-blown financial crisis will be avoided, but a more or less complete normalization along the lines Ankara is hoping will be delayed to late this year or early next, we see the economy contracting by around 4%-5% this year. The outlook for inflation and current account is even more blurry, but we work with inflation ending the year in low double digits, and the current account in broad balance. We see the central government budget deficit heading toward 7% of GDP, financing of which would be very challenging, to say the least.
Given the unsustainability of the current policy mix and the strong possibility of the COVID-19 shock proving more protracted than hoped for, we continue to see Turkey ultimately heading to the IMF, which, in fact, looks even more inevitable now than before. Anticipating how and when we get there --and at what cost— remains more elusive than ever, however.
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