A modest revival in sight

Recent Industrial Production Index (IPI) publications, as well as the February current account balance allow us to see a bit more clearly now in the debate about an economic revival.  The growth in the Turkish economy has greatly decelerated in the last quarter of 2012 due to weak internal demand and sluggish exports. The monetary loosening introduced by the Central Bank (CBRT) in the autumn did not produce the expected signs of revival until February. However, these signs became more apparent with the February figures, keeping the 4 percent growth forecast in the medium-term economic program (OVP) still in range.
Central Bank Governor Başçı and Ministers Babacan and Şimşek  The seasonally adjusted IPI increased by 1.5 percent compared to January. This is rather a robust increase, signaling that the long-awaited revival is underway. Nevertheless, we should note that demand for consumer durables is still weak. The increase is due to a stronger demand for non-consumer durables and investment goods. But this modest revival had its expected impact on the current account balance without delay. The foreign trade deficit rose by $1 billion, reaching $6.9 billion and the current account deficit increased, for the first time since October, to $48.4 billion in February. Given these developments, Bahçeşehir University Center for Economic and Social Research (BETAM) revised its quarter to quarter gross domestic product (GDP) forecast for the first three months from 0.5 percent to 0.7 percent, computing the yearly growth at 2.4 percent. The İstanbul Stock Exchange (İMKB) leapt by an astonishing 2 percent within a day on the heels of the recent positive approach of Moody's to Turkey's grading based on advances in the so-called “peace process” and following the upgrade of Standard & Poor's two weeks ago. I expect a better growth performance in March compared to February. So, the yearly growth rate could approach 3 percent if this expectation is realized. However, I would like to underline that even in that case, we will be still far from the 4 percent growth rate that is admittedly the minimal level acceptable to the Justice and Development Party (AK Party) government, for obvious political reasons. The first electoral challenge is approaching, since the local elections will be held in March 2014. Moreover, as noted above, a revival only based on domestic demand will automatically raise the current account deficit. BETAM forecasts a ratio of 6 percent deficit to GDP for the first quarter, but this ratio would certainly increase with domestic-led growth. In the absence of radical structural reforms, the only remaining way to have more balanced growth would be the depreciation of the Turkish lira. Let me recall that the real exchange rate has already entered the danger zone as defined by the Central Bank (CBRT). The Bank will certainly try to prevent further appreciation of Turkish lira in the near future by lowering its interest corridor and even its policy rate, but at the same time it has to curb the credit expansion which has also entered the danger zone, according to the CBRT's criteria. As I mentioned in my article last Saturday, the CBRT is facing unpleasant trade offs. A further loosening of the monetary policy aiming to smoothly depreciate the real exchange rate could put the inflation target in difficulty and then the credibility of the CBRT would be at risk. Otherwise, a relatively high and at the same time balanced growth would be difficult to achieve, if not impossible. So, the Turkish economy seems to be squeezed between a low but safe growth and a decent growth, socially and politically acceptable, but threatening macroeconomic stability. This dilemma shows once again the limits of monetary policy to try to achieve multiple goals. I supported the new policies of the CBRT from the beginning and I believe that they have done a good job thus far in the implementation of the so-called “rebalancing process.” The current account deficit has been reduced to a controllable level, however economic growth could have been higher last year. But now the CBRT has difficulty launching policies on its own. The danger is that the AK Party government may make the wrong choice trying to help CBRT. It could be more inclined to loosen fiscal policy instead of pushing the structural reforms that have been put on hold for a while.