Last week was rich in economic events and information. First, the International Monetary Fund (IMF) published its routine economic assessment in which it expressed some caustic criticism of Turkey's economic policies and forecast rather low growth for the near future.
Then at the beginning of the week, the medium-term economic program (OVP) for the years 2014-2016 was announced by the government, which forecast rather optimistic growth rates and unemployment dropping slightly in the coming years. Finally, the Turkish Statistics Institute (TurkStat) on Friday published the monthly labor market figures for the period of June-August which showed a jump in unemployment, increasing from 9.7 percent in June to 10.1 percent in July. So when I consider all these, my answer to the question in the title is: The Turkish economy is not going very well. But there are also some reasons to be optimistic.
Let's start with the IMF's criticisms. The feared organization does not agree with the multidimensional monetary policy employed by the Central Bank of Turkey for almost two years. The IMF believes this new policy addressing inflation as well as a stable and competitive real exchange rate using unconventional instruments is inconsistent when the risks stemming from the tightening of the Fed's monetary policy in the future are considered. Concretely, the IMF thinks the large current account deficit (CAD) cannot be financed if the policy interest rate of 4.5, well below the current inflation rate of 7 percent, is not increased. Turkey's fiscal policy was also in a mire according to the IMF. It admitted that this year's fiscal policy targets will be reached but said there are reasons to be worried in the future because public spending is rapidly increasing while part of the public revenue increases originate from privatization and tax amnesties. The IMF suggested a further tightening of the fiscal policy in order to increase the primary surplus.
If these recommendations are followed, what will happen? The growth rate will be lower than the IMF's forecast of 3.5 percent for the next year. The logic behind this double tightening is that if the macroeconomic unbalances, like a large CAD or high inflation, are not fixed in time, the risk of severe adjustments that could provoke a recession will dramatically increase. Thus, it would be wiser to make the necessary adjustments now, even if growth slows further. This is the only way, according to the IMF, to put the Turkish economy back on its potential growth path of 4-5 percent.
The OVP disagrees with the IMF's criticisms regarding monetary policy; me too. The OVP backs the central bank's unconventional policies. The IMF disregards one critical consequence of high interest rates: the risk of the appreciation of the lira that would contradict the aim of narrowing the CAD and put economic growth on a balanced path. The question of inflation remains, of course. The central bank and the government intend to address this question using instruments other than the policy interest rate, such as controlling credit expansion by different measures or using the interest rate corridor to keep market interest rates relatively high. The OVP is confident of falling inflation that would come closer to the targeted 5 percent in the coming years. I hope they will succeed.
However, the government fully agrees with the IMF in terms of tightening its fiscal policy. This is rather a nice good surprise when one considers that the Justice and Development Party (AK Party) will be facing important electoral challenges in the coming months. Indeed, the OVP plans to reduce the general public deficit from 1 percent of gross domestic product (GDP) this year to 0.5 percent in the next year and to increase the primary surplus from 0.9 percent to 1.3 percent through a reduction of the share of public expenditure in GDP. Fiscal policy being a unique discretionary instrument at the government's disposal ensures that the political will is sufficient to achieve these fiscal targets.
In this context, the OVP forecasts 4 percent growth for 2014 and 5 percent for the next two years, while the unemployment rate will fall slightly from the unrealistically estimated 9.5 percent this year to 8.9 percent in 2016. The targeted growth rates as well as the unemployment rates are not exaggerated but quite challenging. There is broad consensus that 4-5 percent growth rates are achievable, and if they are attained, a fall in unemployment will follow. Nevertheless, achieving this growth performance requires the implementation of a comprehensive reform agenda. This will be the topic of this column next Tuesday.