Turkey’s economy is suffering for many reasons and the situation is being exacerbated, say the government’s critics, because of official policy. Michael Imeson reports.
International news headlines sum up the parlous state of Turkey’s economy. “Turkish inflation hits 20-year high of 54%” and “Discontent grows about state of economy as lira tumbles” was how the Financial Times reported on it a few months ago.
“Fallout of Ukraine war exposes Turkey’s vulnerable economy” was Reuters’ take on the situation, while Bloomberg’s view was that “Turkish inflation’s rush towards a new 20-year high leaves lira vulnerable”.
The facts are that Turkey’s president Recep Tayyip Erdoğan’s policy of using low interest rates and a cheaper lira to boost manufacturing exports and economic growth is having harmful side effects. The country’s real interest rates, when adjusted for prices, are the world’s lowest and causing a rapid decline in the currency. The lira, which has lost more than half of its value in the past 12 months, is making imports pricier and stoking inflation, which climbed to an annual 61.5% in March, according to figures from Bloomberg.
Russia’s invasion of Ukraine is making matters worse for Turkey, which relies heavily on gas, oil and wheat imports, further driving up prices.
GDP growth rate stalls
According to the World Bank, Turkey’s economy is likely to expand at a much slower pace this year amid rising domestic, macroeconomic and financial challenges. The World Bank expects gross domestic product (GDP) growth of just 2% this year, rising slightly to 3% next year. This is well down on the 11% of GDP growth that was achieved last year as the economy bounced back from the Covid-19 pandemic, driven by good progress in vaccination rollouts, a quick economic rebound from the pandemic and robust growth in exports to the EU.
“Frequent changes in the monetary policy setting, epitomised by a series of interest rate cuts since last September, sent the lira dropping to historic lows and inflation soaring to record highs,” said the World Bank, in its latest Turkey Economic Monitor report, published in February before the Russian invasion of Ukraine. “The Covid-19 pandemic added to the problem and negatively impacted poverty reduction.”
Economic activity was already decelerating before the war in Ukraine, after the currency shock experienced in December 2021
High and persistent inflation will be the main macroeconomic challenge in the medium term, says the report. Other problems include continued pandemic risks at home and abroad; climate change-related disasters; supply chain disruptions; declining foreign direct investment; the impact of the EU’s carbon border adjustment mechanism, which will affect Turkey’s exports to the bloc; and pressure on bank balance sheets, which is reducing the availability of long-term finance.
The report stresses the need for a “normalisation of monetary policy”, “fiscal sustainability”, meeting “pandemic-related health system and social protection needs” and “efforts to broaden the tax base to generate revenues”. Auguste Kouame, the World Bank’s country director for Turkey, says that “these are challenging times for the Turkish economy”.
Inflation risks
Gaurav Ganguly, senior director, economic research at Moody's Analytics, is growing increasingly negative about Turkey’s economic outlook this year. “Turkey has faced strong headwinds from high inflation and the domestic monetary policy stance,” he says. “The Russian invasion of Ukraine has compounded its woes, given its reliance on energy imports from Russia and wheat imports from both Russia and Ukraine. Turkey’s lack of national savings, a deteriorating outlook for the banking sector, and increasing private sector indebtedness pose real threats to growth and financial stability.”
Accelerating inflation is also a significant concern. “We expect 2022 to be a record year for consumer prices ... In monthly data, inflation increased to 61.14% year-on-year in April, the highest since March 2002. There are question marks around official statistics that suggest that the actual inflation rate is much higher.”
The war in Ukraine presents further inflation risks as Turkey imports nearly all its energy and Turkey’s central bank remains unresponsive. Even if energy prices stabilise, inflation will continue to be a problem as fundamental inflation factors such as price stickiness, backward indexation and the credibility gap will remain.
“Even though the minimum wage was raised by 50% this year, high inflation has washed away the increase in real terms and purchasing power has declined,” says Mr Ganguly. “Widespread strikes with demands for wage increases reflect growing dissatisfaction in the workforce. The government’s economic policies were expected to weigh on the current account deficit in 2022, and high energy and food prices will only make matters worse. An expected decline in Russian visitors will also affect tourism receipts. Official reserves have declined as capital flows out of the country.”
Recent monthly figures show a government budget surplus, but this can be mainly explained by a large central bank transfer to offset high energy costs, according to Moody’s analysis. High tax receipts currently help support the increased expenditure on state-run services. However, the monthly figures do not change the overall negative outlook as Turkey recorded a fiscal deficit in 2021 and this is expected to increase in 2022.
“As for monetary policy, the central bank has kept its main interest rate at 14% which is clearly insufficient to combat current inflation,” says Mr Ganguly. “Political pressure to maintain this stance is strong, but it is clearly bad not just for inflation and the currency, but also for the credibility of the central bank and other government institutions. Banks' profits have risen supported by the surge in credit and gains from inflation linked income. Looking ahead, however, the sector faces significant challenges.”
Government stimulus could help
Seda Guler Mert, BBVA Research’s chief economist in Istanbul, takes a similarly downbeat view. “The Turkish economy will face a slow-down this year following the spill-over the world is dealing with because of the conflict in Ukraine and the negative base effects from last year,” she says, adding that she expects the economy to grow by 2.5% in 2022.
“Current high volatility and uncertainty in financial markets and their potential impact on global demand are clear downside risks on the near-term growth outlook for Turkey,” says Ms Mert. “Economic activity was already decelerating before the war in Ukraine, after the currency shock experienced in December 2021. Nonetheless, the expansionary bias of the government, recent stimulus in credits and post-pandemic positive effects might absorb some of the pressures, so we expect GDP growth not to be severely affected, led by the help of countercyclical domestic policies.”
Turkey’s import bill will increase enormously, driving its external financing needs in kind. “We expect a net energy bill of $75bn (10% of GDP) in 2022, compared with $42bn at the end of last year,” says Ms Mert. “This time, it is not only an oil shock, but commodities in general. Turkey imports 66% of its wheat from Russia and 18% from Ukraine.” Restricted supplies of wheat will increase its price and force Turkish inflation even higher, which she expects to hover near 70% in the second and third quarters before levelling off at 50% at the end of the year.
Ukraine war will damage trade
Hakan Ates, founder and CEO of DenizBank, Turkey’s ninth-biggest according to The Banker’s latest Top 1000 World Banks ranking, says that the war in Ukraine will damage trade between Turkey and its long-standing Black Sea neighbours.
“Turkish companies operating in the fields of finance, telecommunications, manufacturing and construction in Russia will surely be affected,” says Mr Ates. “What we observe is that up to now, for our customers doing business in Russia, the effects are at manageable levels. Also, as Russia is an important tourism partner of Turkey, it is likely that there may be a decrease in the number of tourists visiting Turkey. We are saying ‘may’ because in the case of Russian tourists, Turkey is currently one of few destinations available, hence the issue here is related to transportation of tourists and solving the payment issue.”
Mr Ates accepts that running a bank in a high inflation environment is difficult. DenizBank is experiencing demand for short-term loans as working capital needs accelerate, but he says that is “hard to estimate loan-to-deposit spreads, and we need to be careful on liquidity and capital buffers, as always”.
However, the government’s scheme to encourage the switching of foreign exchange (FX) deposits into exchange-rate-protected Turkish lira deposits currently paying 17% interest is having some success and creating lower-cost funding options for banks.
“So far, FX-rate-protected deposits have reached more than 10% of the whole deposit base and extended the duration of time deposits from around one month to more than three months,” says Mr Ates.
