Looking for the right policy mix

The “hot debate” about low economic growth that I was talking about in this column two weeks ago (“Second quarter confirmed worries about low growth”) is wide open.
From now on, all protagonists of the debate admit the unpleasant reality of low growth. Central Bank of Turkey Governor Erdem Başçı forecasts 3-4 percent growth for this year. I agree in broad terms, but I should note that the final result could be worse. So the critical question today is how to give a push to domestic demand, which is on a decreasing path, without jeopardizing the rebalancing process of the national economy. I must say that this is not an easy task and falls on the shoulders of, quite naturally, the central bank and the government. What can be done regarding monetary policy and fiscal policy? How could the policy mix, the combination of monetary and fiscal policies, be organized in order to push up growth without endangering the decreasing trend of the current account deficit (CAD) as well as that of inflation? The first responses from the central bank and the government to these questions came last week. In brief, monetary policy will be cautiously relaxed if necessary, while fiscal policy will continue to be kept tight. Is it the right policy mix? Let’s see. Two weeks ago I wrote that while I recognize the serious risk in abandoning the rebalancing process too early, I keep my optimism, given my hope to see the Turkish troika -- Deputy Prime Minister Ali Babacan, Minister of Finance Mehmet Şimşek and Governor Başçı -- prioritizing the rebalancing process, and that they will be able to convince Prime Minister Recep Tayyip Erdoğan of this stance. I have not been disappointed, at least for the moment. Indeed, important decisions that have been taken as well as stands made last week confirm my optimism. Regarding monetary policy, last week’s Monetary Policy Committee (PPK) of the central bank did not change its policy interest rate, keeping it at 5.75 percent, and contented itself with lowering the upper limit of its overnight interest rate corridor by only 1.5 percentage points. For the non-experts, let me explain that this move does not mean a loosening of monetary policy; it is just a signal of possible loosening in the future, if necessary. In fact, the daily interest rate (cost of liquidity for banks) asked by the central bank has for months been well below the upper limit of the corridor, which was set at 11.5 percent and is now lowered to 10 percent. The bank still has enough room to make the cost of money available in the market higher. Along with this decision, the statement of Governor Başçı in his conference with the business community of Kocaeli province must be considered in this context. Responding in a way to Economy Minister Zafer Çağlayan -- who previously said, following the disappointing growth rate of the second quarter, that “the brakes have started to burn” -- Mr. Başçı declared that “the brakes are being smoothly released. Otherwise the domestic demand could increase tremendously, causing in turn an increase of the CAD.” He also added that “domestic demand will be encouraged only within the limits of export increases.” Again, all this can seem quite complicated, but let me make it clear that Mr. Başçı is simply saying that monetary policy will be loosened cautiously as long as rebalancing process is not endangered. On the fiscal policy front, the same firm attitude is observed. This year’s budget deficit, counting on a growth rate of 4 percent, has been set at 1.5 percent of gross domestic product (GDP). But by the end of August it became obvious that the deficit would be larger, for two main reasons. First, growth is lower than what has been predicted, and this decreases planned tax revenue. Second, the expenditures are higher than planned because public employees’ salaries have been increased more than planned, as well as social transfers. During a conference in London last week, Mr. Babacan announced that the deficit would reach 2.5 percent of GDP instead of 1.5 percent. He has not specified if he includes in his forecast both of these two adverse effects, but I think that he took into account only the effect of low growth on tax revenue. Indeed, on Saturday, while the country was in its weekend torpor, the Ministry of Finance announced tax increases on fuel and alcoholic beverages. Anyway, this is only the first wave, and other tax increases will follow for sure. Otherwise the deficit would be higher than the fateful 3 percent threshold. To sum up, two points have to be noted: First, the central bank will not lower its policy rate, except in the case of huge hot money inflows capable of appreciating Turkish lira. Mr. Başçı remarked during the conference mentioned above that the value of the national currency is actually at the right level. So his bank will do nothing to discourage exports. Second, indirect tax increases are bad news for inflation, and once again Başçı noted that we are still far from the inflation target of 5 percent. This means that the bank is ready to compensate for inflation pressures originating from indirect tax increases if necessary; too bad for domestic demand. Given these dilemmas -- we economists call them “tradeoffs” -- and given the puzzling delay of low growth’s impact on unemployment, which is still stagnating, I think the decisive battle of low growth through economic policies has not yet started and that what we are witnessing at the moment are only skirmishes.

Poverty in Turkey

The state of poverty is one of the critical issues in all democratic societies. The social cohesion, electoral   outcomes and even the stability of democracy depend on the level of poverty and its evolution.
If it is decreasing, even from a high level, it can effectively contribute to the functioning of the democratic system, allowing the incumbent party (or parties) to solve political and economic problems that often requires difficult structural reforms. However, when poverty is increasing, all kinds of extremist movements can easily find large support, which can jeopardize the stability of the democratic regime. Everyone would easily agree on this assertion, but when it is questioned whether poverty is increasing or decreasing, a consensus is not so easily found. Indeed, the measure of poverty is not an easy task. I am not talking of course about personal observations expressed so frequently in my county in cheap talk, even sometimes in television debates during which we can hear serious opposition members and even academics express that “since it is obvious (sic) that poverty is increasing, one cannot understand how the Justice and Development Party [AK Party] could increase its voter support.” For readers who are not experts on the matter, I can briefly speak about the difficulties to measure poverty and say that the critical issue is the definition of poverty. Unfortunately or obviously, there is more than one, each with their own flaws. Since each definition contains partly subjective judgments, it is tricky to define the poverty line and for this reason they are all open to criticism from the people as well as from competing political movements and academics. Till now, Turkish Statistics Institute (TurkStat) essentially produced two poverty estimations -- the first being “Complete poverty [food+non food],” based on Households Budget Surveys (HBS), and the second called “Relative poverty,” based either on HBS and Income Distribution and Living Conditions Surveys (IDLCS). TurkStat recently decided to abandon the “Complete poverty” measure because of its flawed methodology producing paradoxical results originating from the definition of the poverty line expressed in terms of consumption expenditures; the line was increasing along with the diminution of the share of food expenditure, which is, in fact, a sign of increasing welfare. TurkStat is now in search of a new definition of the poverty line. The definition of the poverty line for “Relative poverty” is not so difficult because the individual income as a certain percentage of the median income defines the line. But the problem is that a relative poverty concept measures income inequality rather than poverty. According to IDLC figures, the poverty rate (the share of individuals having an income below 60 percent of the median income) has been estimated by TurkStat as 16.7 percent in 2010. When, say, in 10 years, per capita income reaches $15,000 ($8,000 actually), the share of “relatively poor” would not be far from 16.7 percent; this will depend on the impact of income growth on income distribution. OK, I agree that the introduction was too long, so I am coming to my point: The IDLC surveys produced in accordance with EU standards since 2006 are not only more reliable than HBS but also contain questions on living conditions, allowing us to produce straightforward measures of poverty. I suggest taking three of these questions and defining as poor whoever responds negatively to all of them. The three questions are: 1) Are you able to eat at least every two days either meat, chicken or fish? 2) Are you able to replace your used clothes? 3) Are you able to adequately heat your house? These three abilities are all about basic needs and we can define those who are not capable of meeting them as poor. Using the micro data of IDLC statistics and according to the definition above, we calculated in Bahçeşehir University's Center for Economic and Social Research (BETAM),  the poverty rate or the share of poor households from 2006 to 2010 as following: 2006 (25.7 percent), 2007 (25.2 percent), 2008 (24.1 percent), 2009 (21.2 percent), 2010 (19.1 percent). So, one can assert without hesitation that, considering the ability to access basic needs, poverty is still quite high in Turkey, but it has decreased remarkably in recent years. The factors behind this improvement have to be determined through more detailed analysis, but we can already assert that the increase of per capita income during this period (approximately 10 percent) should be the main driver. The distribution of poverty among the regions is also interesting, albeit without surprise. In 2010, the lowest poverty rate belongs to western Anatolia (10 percent), followed by Central Anatolia (12.7 percent) while Southeast Anatolia by far is the poorest with 35.3 percent, followed by the East Black Sea with 25.7 percent. I think that decreasing poverty in Turkey is very consistent with the increasing electoral support for the AK Party, and the opposition -- rather than speculating on the “obvious increase in poverty” -- should focus on the alternative policies able to produce better results. Or, to wait till the low growth, in which Turkish economy seems to be trapped nowadays, produces adverse effects on poverty.

The unpleasant low growth perspective

SEYFETTİN GÜRSEL s.gursel@todayszaman.com According to the Turkish Statistics Institute (TurkStat), the Turkish economy grew by 3.2 percent on a yearly basis in the first quarter. For the sake of comparison, let me highlight the fact that the yearly growth rate was above 11 percent in the first quarter of 2011 and above 5 percent in the last quarter.
Moreover, TurkStat estimated the quarter to quarter seasonally adjusted growth rate as minus 0.4 percent. Although current leading indicators predict a much better growth performance for the second quarter, the Turkish economy is obviously facing a deceleration of growth. Is it a transitory phenomenon? I do not think so, even if it is true that there is a base effect because of the significant growth in the first quarter of 2011. To understand if the low growth is transitory or not we should analyze the sources of growth. Private consumption, which constitutes the largest share of gross domestic product (GDP) with 70 percent, stagnated. Therefore, it did not contribute to growth at all. Private investment increased by a mere 1.6 percent, while the public sector grew by 5 percent. The contribution of domestic demand to growth remained less than 1 percentage point. Given this very weak domestic demand, firms reduced their stock, and this resulted in a contraction of 2.3 percentage points. So, the growth rate of 3.2 percent resulted mainly from net exports: Indeed, exports increased by 13 percent, while imports decreased by 5 percent. Therefore, the contribution of net exports to growth has been 4.5 percentage points. To know whether this relatively low growth -- around 3 percent -- will be there for a long time, we have to answer two questions: First, is there some room to increase domestic demand without jeopardizing the current account deficit (CAD) and inflation targets? Second, can net exports' contribution to growth be made permanent? My answer to the first question is “Yes, but not that much.” Regarding inflation we can say that Central Bank of Turkey stays in a relatively comfortable situation thanks to decreasing energy and food prices. Its forecast for the year end, set in the first quarter, is 6.5 percent but Governor Erdem Başçı announced recently that this figure could be lowered very soon. Moreover, last Friday we witnessed a decrease in interest rates by the Central European Bank as well by the Bank of England. So, the Turkish Central Bank has some room to relax its tight monetary policy to some extent, but there are limits to this: The inflation target is set at 5 percent, and there is still a long way to go to arrive at this rate. Too low interest rates can trigger capital outflows, causing exchange rate shocks; TL depreciation is not good news for inflation. Too low interest rates could also trigger a new consumption boom, pushing up prices. To sum up, I think the possibility of giving a push to the domestic demand via monetary policy is limited. Let me highlight that last Friday Governor Başçı pointed out that it is too early to consider changing their position and that they will wait to see the second quarter growth figures. The other possibility could be loosening fiscal policy. But we should note that a loosening is already on the way to some extent since tax revenue is decreasing along with decreasing growth, while public expenditure is continuing to increase. The budget deficit will probably be a little bit higher than last year, (my estimation is 2.5 percent instead of 1.5 percent), but this is the limit which must be respected. If not, as Deputy Prime Minister Ali Babacan likes to say, expectations could worsen, causing adverse effects on investments and market interest rates. If there is only limited room to increase domestic demand, what about exports? Two points have to be underlined: Global demand conditions, particularly in Europe, are not good, and a deceleration in the increase of Turkish exports has been quite perceptible in the last few months. The leading indicators show that the increase of exports in the second quarter will be less enthusiastic. Even though positive contribution of net exports has to be expected during the next quarters, in the long run this depends on a radical improvement of competitiveness of Turkish industry through lower production costs and extensive innovations. Now, improvement depends on radical reforms in the labor market, in taxation, in education and in the R&D field. For the moment we have just a new incentive scheme and a new trade law. The first one aims to lower labor costs in the least-developed regions, but only for new investments, and also to encourage some import substitution. Let's note that has not yet been implemented. The new trade law aims to improve the functioning of the market economy, but let me note also that last-minute compromises have diminished the effectiveness of the new regulations. However, on the other hand, let me highlight that the regional minimum wage project has definitely been abandoned and the severance pay reform postponed as well as the tax system reform. I believe, as an economist tracking the Turkish economy for quite a long time, that it can grow hardly more than 4 percent in the long term as long as the high growth episodes depend on ephemeral domestic demand booms, which unavoidably hurt the wall of high inflation as well as the high CAD.

The unpleasant low growth perspective

SEYFETTİN GÜRSEL s.gursel@todayszaman.com

According to the Turkish Statistics Institute (TurkStat), the Turkish economy grew by 3.2 percent on a yearly basis in the first quarter. For the sake of comparison, let me highlight the fact that the yearly growth rate was above 11 percent in the first quarter of 2011 and above 5 percent in the last quarter.

Moreover, TurkStat estimated the quarter to quarter seasonally adjusted growth rate as minus 0.4 percent. Although current leading indicators predict a much better growth performance for the second quarter, the Turkish economy is obviously facing a deceleration of growth.

Is it a transitory phenomenon? I do not think so, even if it is true that there is a base effect because of the significant growth in the first quarter of 2011. To understand if the low growth is transitory or not we should analyze the sources of growth. Private consumption, which constitutes the largest share of gross domestic product (GDP) with 70 percent, stagnated. Therefore, it did not contribute to growth at all. Private investment increased by a mere 1.6 percent, while the public sector grew by 5 percent. The contribution of domestic demand to growth remained less than 1 percentage point.

Given this very weak domestic demand, firms reduced their stock, and this resulted in a contraction of 2.3 percentage points. So, the growth rate of 3.2 percent resulted mainly from net exports: Indeed, exports increased by 13 percent, while imports decreased by 5 percent. Therefore, the contribution of net exports to growth has been 4.5 percentage points. To know whether this relatively low growth -- around 3 percent -- will be there for a long time, we have to answer two questions: First, is there some room to increase domestic demand without jeopardizing the current account deficit (CAD) and inflation targets? Second, can net exports' contribution to growth be made permanent?

My answer to the first question is “Yes, but not that much.” Regarding inflation we can say that Central Bank of Turkey stays in a relatively comfortable situation thanks to decreasing energy and food prices. Its forecast for the year end, set in the first quarter, is 6.5 percent but Governor Erdem Başçı announced recently that this figure could be lowered very soon. Moreover, last Friday we witnessed a decrease in interest rates by the Central European Bank as well by the Bank of England. So, the Turkish Central Bank has some room to relax its tight monetary policy to some extent, but there are limits to this: The inflation target is set at 5 percent, and there is still a long way to go to arrive at this rate. Too low interest rates can trigger capital outflows, causing exchange rate shocks; TL depreciation is not good news for inflation. Too low interest rates could also trigger a new consumption boom, pushing up prices. To sum up, I think the possibility of giving a push to the domestic demand via monetary policy is limited. Let me highlight that last Friday Governor Başçı pointed out that it is too early to consider changing their position and that they will wait to see the second quarter growth figures.

The other possibility could be loosening fiscal policy. But we should note that a loosening is already on the way to some extent since tax revenue is decreasing along with decreasing growth, while public expenditure is continuing to increase. The budget deficit will probably be a little bit higher than last year, (my estimation is 2.5 percent instead of 1.5 percent), but this is the limit which must be respected. If not, as Deputy Prime Minister Ali Babacan likes to say, expectations could worsen, causing adverse effects on investments and market interest rates.

If there is only limited room to increase domestic demand, what about exports? Two points have to be underlined: Global demand conditions, particularly in Europe, are not good, and a deceleration in the increase of Turkish exports has been quite perceptible in the last few months. The leading indicators show that the increase of exports in the second quarter will be less enthusiastic. Even though positive contribution of net exports has to be expected during the next quarters, in the long run this depends on a radical improvement of competitiveness of Turkish industry through lower production costs and extensive innovations. Now, improvement depends on radical reforms in the labor market, in taxation, in education and in the R&D field.

For the moment we have just a new incentive scheme and a new trade law. The first one aims to lower labor costs in the least-developed regions, but only for new investments, and also to encourage some import substitution. Let's note that has not yet been implemented. The new trade law aims to improve the functioning of the market economy, but let me note also that last-minute compromises have diminished the effectiveness of the new regulations. However, on the other hand, let me highlight that the regional minimum wage project has definitely been abandoned and the severance pay reform postponed as well as the tax system reform.

I believe, as an economist tracking the Turkish economy for quite a long time, that it can grow hardly more than 4 percent in the long term as long as the high growth episodes depend on ephemeral domestic demand booms, which unavoidably hurt the wall of high inflation as well as the high CAD.

The European deadlock

SEYFETTİN GÜRSEL s.gursel@todayszaman.com

This week will probably be one of the most critical in Europe's history. On Thursday a European summit will decide how to handle sovereign debt, as well as the banking crisis and also the Greek economic crisis. We are used to seeing European summits ending in compromise. This time it could be different.
The positions of the protagonists on fundamental issues such as common debt, direct aid to shaky banks and the Greek crisis are so opposed, and the ground for compromise so narrow, that rather than compromise the summit may simply result in a deadlock. Let's start with the most urgent issue, the Greek crisis. Early elections on June 17 finally produced a government, but quite a strange one. The winner of the elections, Antonis Samaras, leader of the New Democracy party, succeeded in forming a coalition government with the support of two leftist parties, the Panhellenic Socialist Movement (PASOK) and the Democratic Left (DIMAR), but these parties have declined to contribute ministers to the government, content to support them with a vote of confidence. Obviously the moderate left, facing aggressive opposition from the Coalition of the Radical Left (SYRIZA), does not want to take the full weight of government on its shoulders in case the attempt to renegotiate the current belt-tightening measures, which constitutes the backbone of the new government's policies, fails. This failure is more than probable. Samaras has made it clear that the stabilization program of the troika -- the European Commission, the European Central Bank (ECB) and the International Monetary Fund (IMF) -- is not working, and that its results are so painful (you can have a quick look at my previous article, “Sisyphus and the Danaids”) that it should be renegotiated. Samaras has asked to postpone austerity measures, worth 12 billion euros for the period 2014 to 2016, and prolong unemployment indemnities for up to two years, further extending them to the self-employed. Furthermore, he intends to implement a series of tax breaks, such as decreasing VAT in restaurants from 23 to 9 percent to give a push to the tourism industry and lowering the tax on profits to 15 percent, aiming to encourage investment. To balance this, he says that he is ready to accelerate privatizations. To put it simply, Samaras wants to increase public expenditure and decrease tax revenue, hoping that these measures will produce some growth. Indeed, a 4.7 percent contraction had been forecast for this year, but now experts are talking about a contraction of more than 6 percent, given the ongoing crisis. Even if the measures proposed by Samaras work, it is obvious that this will take time, and meanwhile Greece will have a much higher budget deficit than the 7.3 percent predicted for this year. I do not think that the promise to accelerate privatizations can convince even the supporters of renegotiation in Europe, given the fact that privatizations have yielded only 1 billion euros until now. One can be sure that even a minimal compromise on renegotiation will require billions of euros in fresh European money. According to an expert from Brussels (published in Le Monde, June 21), each year of delay in the program will cost between 20 and 25 billion euros. But the problem is, whatever the amount, the extra funds risk falling into the leaky barrel of the danaids. Furthermore, Greece risks becoming a “bad example” for other countries suffering under the same kind of austerity measures. During the last week many German figures have said “Nein” to the renegotiation, and it is noticeable that they have been strongly supported by the president of the Eurogroup, Jean-Claude Juncker, who has declared that “substantial modifications in the program are not possible.” The Greek crisis is not uniquely the headache of Europe. Spain has a government very committed to applying its own belt-tightening measures. The problem is that its banking system is on the brink of failure. The estimated cost of a bailout hovers around a minimum figure of 60 billion euros. As for Italy, its technocrat government does not seem strong enough to implement structural reforms and austerity measures. Remember that the sovereign debt of Spain and Italy together is 10 times greater than Greece's. If nothing is done, Spain and Italy will soon be unable to roll on their debt in the financial market. In past months Southern Europe, plus France, has asked for the issuing of bonds backed by EU members, and for the direct injection of capital into banks from European funds. Last Thursday this concept had a new supporter in the person of Christine Lagarde, IMF director, who called for an urgent decision on both issues as time is running out. She also urged the ECB to adopt a more relaxed monetary policy. German Chancellor Angela Merkel does not want to hear anything about this “irresponsible thinking.” A meeting held last Friday in Rome between the leaders of Germany, France, Italy and Spain failed to produce any compromise on the debated issues. Merkel said the direct bailout of banks “violates treaties” and reiterated her opposition to Eurobonds, as well as to the purchase of bonds by the ECB. Germany is afraid of an uncontrolled drift that may result in a situation in which it is finally forced to endorse a big part of the southern debt. But on the other hand, it does not know the possible cost of a European meltdown for Germany. This uncertainty frightens it as well.