The Silver Linings Playbook
Turkey has marched to the end of a cul-de-sac, faced with a ‘no-choice’ between a painful belt-tightening program and restoration of relations with the West, or risking further economic deterioration and political instability. With global economy growing at a relatively healthy pace, monetary normalization, particularly in the US on track, and investor sentiment toward Turkey at all-time lows, avoiding a “hard-landing” heavily depends on whether Ankara can deliver in economic and foreign policy arenas, in our view.
Notwithstanding the very strong first-half headlines, economy is finally slowing, and growth should turn sequentially negative in H2. Fiscal policy remains expansionary, with the central government deficit likely to finish the year at around 3% of GDP, but its boost to growth should be limited because of the tight financial conditions. We forecast growth to finish this year at around 4%, down from 7.4% last year, before slowing further to some 3% next year.
Imbalances remain large and chronic, which will take a while to moderate. Inflation should edge up further in the next month or two, before ending the year at around 16%, up from 11.9% at end-2017, with risks firmly on the upside. The CBRT believes and claims that monetary policy is tight -- and has disappointed by leaving rates unchanged at its last meeting -- but simple Taylor Rule-type reckonings suggest that policy rates should be markedly higher.
The current account deficit (CAD) should start narrowing from June/July onward, but the year should finish with a CAD of around 6% of GDP, up from 5.6% last year and markedly higher than what is considered to be Turkey’s “norm”. Capital inflows remain erratic, with CAD financing often having to count on CBRT reserves and/or unidentified inflows, while external debt sustainability is starting to become a concern. Lira is fairly valued, the IMF says, which is important, but that doesn’t mean that it’s out of the woods.
The new economy czar Mr. Berat Albayrak’s initial comments and actions have been encouraging, but we have yet to see tangible action. The upcoming Medium-Term Economic Program will be closely monitored in this regard, but unless it includes a credible fiscal adjustment plan and accepts marked slowdown in growth, markets are likely to be disappointed. On the foreign policy front, the next few months will be extremely testing as well, with several highly consequential developments in store, particularly as regards the future of Turco-American relations.
Where, then, do we go from here? Call us the relentless optimists if you so wish, but this is where our “Silver Linings Hypothesis” steps in. We bet, with 65% odds, that Ankara will act responsibly to change tack and deliver Turkey to salvation after enough trial-and-error, errors being accompanied with punishments. There is, of course, an alternative to this reasonably constructive baseline, in which Ankara insists on its quest for alternate models and liaisons, taking us on a darker and more chaotic journey.
Now read on...
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