Following a stormy 2016 blighted by a failed coup and a spate of terror attacks, Turkey's weakened economy has shown signs of recovery. But with a divisive referendum campaign dominating the first months of 2017, questions about the recovery's resilience remain. David O'Byrne reports.

Turkey turbulence

Few would disagree with the contention that Turkey endured a torrid 2016. A spate of major terror attacks hit both the tourism sector and consumer confidence, while a failed military coup in July rocked both the political establishment and the country's broader economic stability.

Yet while the early months of 2017 have passed under the shadow of a deeply divisive referendum campaign on whether to change the constitution to one granting president Recep Tayyip Erdogan executive power, there are signs that a recovery of sorts may be under way.

Ratings shock

If anything, the failed coup served to demonstrate just how vulnerable the Turkish economy is to "external shock" – even when the shock in question comes from inside the country.

This political instability, coupled with increasing concern over the country's rising external debt and deteriorating balance of payments, led to a spate of ratings blows, with first Moody's downgrading Turkey to Ba1 – junk bond status – followed by Fitch and Standard & Poor's. Although still rating Turkey as 'stable', those downgrades caused investment-grade bond holders to sell up, in turn causing a run on the Turkish lira, which saw it plummet to an all-time low of 3.88 against the US dollar.

And as the underlying economic problems remained, in March Moody's downgraded its 'stable' outlook to 'negative', citing a number of key issues. Blaming increasing authoritarianism in the wake of last year's coup attempt for eroding the independence of state institutions and hence weakening private sector confidence, the agency suggested this had impacted already slowing growth and was causing inflation to rise.

Lira worries

There was also widespread concern that government efforts to stimulate the economy by encouraging loan restructuring and growth, and introducing wage subsidies to boost employment levels, may backfire, increasing the risk of macro imbalances and increasing public spending.

Aggressive rate rises by the central bank helped the lira recover some of its lost value. However, weakened capital inflows and lowered foreign exchange reserves raised Turkey's external vulnerability factor to about 202%, well above the 50% recorded in other similar emerging markets, despite them too experiencing serious political instability.

"The lira is still down compared to the [South African] rand despite the severe political problems facing South Africa," says Inan Demir, chief eastern Europe, Middle East and Africa economist at Nomura, explaining that this reflects investor concerns over Turkey's continuing political instability.  

The lira's woes have also taken their toll on inflation with Consumer Price Index inflation for March hitting 11.29%, the highest since October 2008.

With Producer Price Index inflation having also hit a seven-year peak at 16.1%, suggesting more retail price increases to come, analysts are predicting that retail inflation could peak at more than 12% and remain in double digits for the rest of 2017.

GDP questions

The outlook for economic growth in Turkey is equally cloudy. The stellar gross domestic product (GDP) growth of 8% to 9% Turkey recorded in 2010-11 fell to between 3% to 4% in 2013-15, and thanks to a combination of regional and internal instabilities, as well as long-standing structural problems, it is expected that the data for 2016 will show an even sharper drop, even before July's failed coup.

The coup attempt heralded a 1.8% GDP drop in the third quarter, largely due to a 1.7% contraction in consumer spending as Turks opted to hold on to their cash until things had calmed down.

Subsequent data indicates a swift recovery in the fourth quarter, with GDP growth of 3.5%, on the back of a 5.7% rise in private consumption. This could be explained if, indeed, Turks had opted to make purchases that had been postponed after the coup attempt, but instead the picture is severely muddied by state statistics body Turkish Statistical Institute reconfiguring the way it calculates GDP. This retroactively raised 2015 growth from 4% to 6.1% and boosted growth for the first three quarters of 2016 to give a figure of 2.9% for GDP growth in 2016 - markedly higher than the 2.2% economists were predicting.

"It's difficult to see where the impetus for such growth is coming from, so we are watching for a future downward revision," says Mr Demir, suggesting that the new system is a work in progress, which has already been subject to "tweaking".

Either way the consensus is that, using the new system, GDP growth for 2017 will be in the region of 2.5%, still far lower than the official government target of 4.4% and, according to analysts, far lower than Turkey should be recording.

"Growth of [about] 3% for an emerging market is OK, and puts Turkey at the top end of Europe – but the question is why isn't Turkey top of the emerging market pile," says Tim Ash, emerging markets senior sovereign strategist at BlueBay Asset Management, pointing to Turkey's unique regional and internal political problems as continuing to hold the country back.

Mixed signals

Other indicators are no less confusing, suggesting on the one hand an economy in recovery and on the other one still suffering from systemic problems dampening potential growth. 

The Purchasing Managers Index, a useful barometer of how business views the coming months, has been rising steadily from 48.7 in January to 52.3 in March, the first time in 13 months it has indicated growth.

However, unemployment figures suggest the opposite, with the latest data for December 2016 showing official unemployment at 12.7%, up from 12.1% in November and 10.8% a year earlier. This represents the highest recorded since March 2010. 

Again, the exact source of the rise is difficult to make out, with slowing growth, increasing company bankruptcies, job losses due to post-coup attempt purges, and the increased unregulated use of Syrian refugees by employers all believed to have had an impact. 

Employment in agriculture, industry and construction have all declined, suggesting the effect both by the economic downturn and cheap unregulated labour.

Service sector boost

Only the service sector recorded a rise in employment, possibly indicating that government programmes aimed at creating 2 million new jobs in the country have begun to bear fruit. According to labour minister Mehmet Muezzinoglu, these programmes created 407,000 new jobs in the first three months of 2017, a figure he expects to reach 1 million by June.

While this is a step in the right direction, youth unemployment, which stands at 24%, clearly shows that there is still some way to go, especially as official policy has for some years stated that to create enough jobs for school leavers, Turkey needs to record steady GDP growth of above 5%.

While the funding of programmes to create new jobs brings its advantages, providing wage subsidies for new employees and postponing tax and social security payments is not without risks.

For some years, the key anchor of Turkey's credit rating has been the government's careful management of public finances and comparatively low government debt. In its last rating review, Moody's predicted increased government spending will continue through 2018, impacting the fiscal deficit, bond yields and Turkey's overall debt position. This is an increasingly important consideration given that Turkey's overall external debt stock ended 2016 at $404bn, up from $396bn at year-end 2015, despite having declined by $10bn in the fourth quarter of 2016, largely related to the private sector.

This puts the ratio of Turkey's external debt to GDP at 47.2%, up from 46% at the end of 2015, and to the highest level recorded since 2002 – despite the new method for calculating GDP. Interestingly, it was then, in 2002, when Turkey's Justice and Development Party (AKP) was first elected to power on the back of a wave of discontent following the collapse of the economy 18 months previously.

Referendum worries

It is also worth noting that Turkey has been going through a deeply divisive referendum campaign on whether to introduce an executive presidency – a vote Mr Erdogan and his supporters won. 

"The economy won't/collapse – there is durability, but Turkey should be doing better," says Mr Ash, pointing out that the reforms introduced by Mr Erdogan and the AKP over their first decade of government were the foundation of the country's economic success.

Three successive victories in transparent democratic elections allowed the AKP to maintain balanced public finances, stabilise the banking system and steer it through the 2008 global crisis, as well as to oversee a period of continued economic growth.

Since then though, says Mr Ash, the picture has become somewhat muddied. "For the past few years the focus has been on politics and not economics," says Mr Ash. "The AKP's success was in business and the economy and creating jobs; it needs to get back to that." 

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