Peace process going well but not the economy

The “peace process” aiming to put an end to the bloody and wearing “low intensity war” between the Turkish Armed Forces (TSK) and Kurdistan Workers' Party (PKK) militants is under way. The day before, the PKK officially announced the withdrawal of its armed teams from Turkey to northern Iraq. If this retrieval is hopefully terminated without any provocation, the first stage of the peace process will be completed and we will finally have a peaceful environment in eastern Turkey. Admittedly, this does not signify a definite solution of the “Kurdish problem.” Other steps, like a new constitution securing democracy and human rights for all citizens -- but particularly for Kurds, are a must. This is, for sure, not an easy task, but both sides estimate that the point of no return has already been passed.
Government postponed structural reforms The end of armed clashes along with the democratization of the Kurdish problem will certainly bring beneficial economic results, but the so-called “peace dividends” would not be, unfortunately, as high as expected. (See my March 18 column, “Peace dividends”) All of the energy and attention of the government -- particularly that of Prime Minister Recep Tayyip Erdoğan, whose energy and attention matter more than those of others -- are focused on the peace process. This is quite understandable, but this cannot be a pretext to neglect the economy, all the more since the economy is not doing well. Readers of this column are familiar with my worries, which are shared by most of the economists who are watching Turkey closely. A robust revival of domestic demand that would boost the sluggish growth is still not in sight. The leading indicators of the first two months were not very encouraging. The estimation of Bahçeşehir University's Center for Economic and Social Research (BETAM) for the yearly growth rate of the first quarter was 2.4 percent. (See my April 8 column, “A modest revival in sight”) Since then, the capacity use and real sector confidence index for March have been published. They are not encouraging, either. Another bit of bad news is in regards to the evolution of the real exchange rate. It had already entered the red zone, as defined by the Central Bank of Turkey, before the last interest rate loosening by the Monetary Policy Committee (PPK) a week ago. It had been expected that this strong loosening would prevent the Turkish lira from continuing to appreciate through a smooth nominal exchange rate adjustment. Nevertheless, the expected effect has not seemed to be produced, since the exchange rate of the currency basket, half of which is formed by the US dollar and the other half by the euro, continues to be under TL 2.10. International liquidity is still abundant, and the interest rates of Turkish Treasury Bonds, despite their historically low levels (around 5.5 percent), are still attractive for hot money. Yesterday, the most popular economic title in the press was: “5.6 billion USD capital inflows within a month.” Now, Turkish exporters desperately look after restoring competitiveness through a real exchange rate adjustment. Is further loosening of monetary policy needed? And if yes, is it possible? Let me first remark that the expected real interest rate is already in the negative zone, as inflation expectations are still well over 6 percent. I do not think that there remains too much room for the monetary policy cabale to contribute further to the domestic demand revival. More loosening could conflict with the fight against inflation. Under these circumstances, a balanced growth based on domestic and, at the same time, external demand seems pretty much impossible. There is still some hope to have a growth rate, say something between 3 and 4 percent, but it will be only an emanation of the domestic demand. So, we will be back again at the start -- an increasing current account deficit with, as a bonus, indomitable inflation. How to get out from these dilemmas? The only way, I believe, is a shock of reforms. All reform projects, such as severance pay reform, tax reform, etc., which are already finalized but postponed for political reasons, should be implemented as soon as possible. Other reforms aiming for things like more flexibility in the labor market and more fiscal autonomy for the universities must be designed and implemented. The only good news on the reforms' front is the recent admission by Parliament of a new electricity law which is able to make electricity production and distribution more competitive and more efficient. However, the Turkish economy, admittedly, needs more reforms as soon as possible.