Exit from the middle-income trap may take years

Almost one year ago I wrote an article about the difficulties that were facing the Turkish economy with regard to increasing per capita income for two years.

In my article titled “Turkey on the brink of middle-income trap," I argued that the high per capita income growth that was led by robust labor productivity growth during the first years of Justice and Development Party (AKP) rule, slowed down first and then totally stopped in 2012, based on a research published by Bahçeşehir University's Center for Economic and Social Research (BETAM) in August 2013.

BETAM published an updated version of this research last Wednesday titled  "Turkey's exit from the middle-income trap may take years" aiming to scrutinize changes in the per capita growth, employment rate and labor productivity that has occurred over one year.

Indeed, from 2002 to 2011, per capita income rose roughly from $3,000 to 10,500. Since then, it has stagnated. This astonishing performance is due to two basic factors: the appreciation of the Turkish lira in real terms against the United States dollar and an average gross domestic product (GDP) growth rate close to 6 percent, which provided a per capita income increase over 4 percent per year, given the population growth rate. This means an overall per capita income increase of over 40 percent in real terms in nine years.

Furthermore, we know this improvement has profited all segments of society almost equally, with the low-income segments being slightly more favored. For more information, see my recent piece “The growth of the middle class." The strong per capita income increase has allowed a modest decrease in income inequality and a rather remarkable decrease in poverty, which, however, continues to be quite high. The BETAM research focuses on the evolution of the main factors that contributed to this striking per capita income increase at the beginning and its abrupt stop at the end of the research period.

As one of the authors of the report, let me briefly explain the methodology used. It is possible to break down the per capita income increase into three contributors: the ratio of the working age population to the total population; the employment ratio (employment by working-age population); and labor productivity, defined as GDP per employed individual.

The contribution of the working-age population ratio is marginal. Though the working-age population is still growing more rapidly than the total population, this factor shall be extending in the 2020s because of an aging population. As for the two other factors -- namely employment ratios and labor productivity -- three different sub periods have been observed. Until the second quarter of 2008, the entry date of the economy into recession, high per capita income growth was driven largely by increases in labor productivity. During this period, total employment almost stagnated; non-farming employment rose significantly, while agricultural employment declined.

In the aftermath of the global crisis, the nature of per capita income growth changed dramatically. From the last quarter of 2009 to the last quarter of 2011, the economy had very high per capita income growth rates -- over 7 percent. Both increases in the employment ratio and in labor productivity contributed more or less equally to this performance.

However, starting at the beginning of 2012, The increase of per capita income decelerated dramatically along with the slowing GDP growth. BETAM's analysis shows that until the second quarter of 2013, the per capita income increases declined under 1 percent; however, the most striking future of this decline was that the decrease in labor productivity turned out to be negative.
In other words, the weak growth -- GDP growth was limited to 2 percent in 2012 -- was supported only by the increase of employment ratio. During the following three quarters one observes slight improvement in the growth performance; labor productivity resumed to contribute to the per capita income increase that rose to some extent and reached 2 percent. Nevertheless, in the first quarter of this year, the contribution of labor productivity had become negative again.

At the end of the day, we can assert that more than two years of labor productivity has not contributed to the per capita income growth, which continues to be quite low. Strong employment increases certainly have prevented the increase of unemployment, but this low level of per capita income growth will not allow Turkey to escape from the middle-income trap quickly.  

  (this article is published in Todays' Zaman, July 26, 2014)

Confessions from the finance minister

I am aware that readers of this column, which is mostly reserved for economic issues, may not have much interest in another article on economics because the local elections will be held this Sunday and extreme political tension is dominating the campaign.
Most readers would perhaps prefer I write again about the possible outcomes of March 30, but I already said what I think about them. I will just reiterate the main points of my personal thoughts on the electoral debate before discussing an assessment of the Turkish economy made last Saturday by Finance Minister Mehmet Şimşek. I think this assessment is worth being discussed, whatever the final result of March 30 may be. VPM Babacan & FM Şimşek, trying to be realistic  To be brief, I think that on March 30, for the future of our democracy as well as for economic stability, a sizable fall in the Justice and Development Party's (AKP) share of votes is crucial. I do not expect a clear defeat of the ruling party for many reasons. Nevertheless, a share of votes at around 40 percent nationally seems plausible to me, and this outcome would be sufficient to put in motion new political dynamics for getting the country out of the nightmare in which it is living nowadays. As for the finance minister, what he said last Saturday at the Uludağ Summit, a kind of local Davos Summit, goes beyond the impacts of the current political tension on the economy. Mr. Şimşek spoke on four points: current account deficit (CAD), budget performance, interest rates and economic growth. The key points of his speech were growth performance and, to some extent, the actual interest rate level. So, let's start with those. The finance minister claimed, "Maintaining [key] interest rates at just over 11 percent while the inflation rate is above 8 percent is a great success.” Alright! Due to the new monetary stance of the US Federal Reserve, expected real interest rates increased in developing countries, including Turkey. Given the slow but determined increase of the US Treasury Bond's interest rates and given the increased risk premiums for Turkey -- thanks to the authoritarian approach of Prime Minister Recep Tayyip Erdoğan regarding the biggest graft scandal of the republican era -- the actual interest rate level might be revealed as insufficient to stabilize the exchange rate and the inflation rate. What I understand when our finance minister says “great success” is that the central bank could be obliged to increase its policy rate in the near future. I'll let you guess what might be the reaction of our prime minister, the greatest enemy of high interest rates. The nominal and particularly the real interest rates are much higher nowadays than before, and this is, of course, not good for domestic demand. However, before the interest rate could increase, the AKP government took some restrictive measures on the use of consumer loans. It is aiming to discourage the import of consumption goods as well as take control of domestic demand. These measures started to have their effects felt in February. Şimşek said that businessmen are not happy with these measures, but the government had to take them because of the necessity to decrease the CAD. Finally, high interest rates coupled with restrictions on bank loans are expected to lower economic growth. Mr. Şimşek did not make any prediction about growth perspectives in Turkey, but he admitted that “developing countries have entered a period of low growth and the next decade will not be better than the last decade.” Nevertheless, Mr. Şimşek implicitly recognized that the growth rate will be lower than the planned 4 percent in the medium term, since he confessed that it would be very difficult to reach budget targets this year because of lower tax receipts due to weak domestic demand. The only good news he pointed out is the decreasing CAD, thanks to low domestic demand, low economic growth and decreasing imports; exports will receive an extra push due to a moderate revival in the European market. Well, given the finance minister's summary of the economy, what may be said regarding the AKP rule? At least two things: First, once low economic growth becomes apparent so close to the general elections, Erdoğan will strongly react to the tight monetary policy as well as to the loan restrictions, breaking the already fragile balance existing between him and those who govern the economy. Second, the low growth rate, around 3 percent, will start to show its adverse effects on the social conditions of the poor.

Turkey in deadlock

In the last two years I wrote two academic papers published in Germany and the US on the economics of the 2002-2011 decade. In these papers I discussed the factors behind the success of the Justice and Development Party (AKP) rule, which can be summarized in two points: good economic governance and democratic reforms.
Good economic governance can be explained by a fiscal discipline that was not seen in decades, respecting the independence of the central bank, which was an unexpected gift given the historic command economy tradition in Turkey, and sound supervision of the banking system in the aftermath of the meltdown which occurred with the 2001 disaster. These factors allowed for a dramatic decrease in the two-digit inflation rate raging for more than 30 years as well as in real interest rates and they pushed growth rates up. The high economic growth based on booming private consumption and investment fueled by an abundance of international liquidity filled the state's coffers, enabling the AKP government to conduct vast social programs without jeopardizing the public sector balance. At the same time we witnessed important democratic reforms, the two main achievements being the start of membership negotiations with the European Union and ending the statuary interference of the army in politics. The start of membership negotiations in 2005 immediately had an effect on foreign direct investments (FDI), which made an impressive jump from $3 billion to $15 billion within a year. Moreover, EU membership negotiations became an important source of confidence with investors regarding the future of Turkey's democratic and economic stability. Solutions to historic problems like the Kurdish issue appeared to be within Turkey's reach. However, in concluding my papers, I argued that the next decade would not be as easy as the previous decade for the AKP because of three events: Real interest rates having reached their limits of around 1 percent are likely to only increase from now on; economic growth based exclusively on domestic demand as well as on an appreciation of the lira caused a huge and unsustainable current account deficit (CAD); and the international liquidity glut is ending. Thus, I wrote that the AKP faces harsh challenges. Pursuing economic growth, at least at a respectable level, and improving the social conditions of the poor will depend on the implementation of politically difficult reforms in the labor market, the fiscal system, etc. The electoral success of June 2011 -- receiving almost 50 percent of the vote -- originating from the achievements cited above pushed Prime Minister Recep Tayyip Erdoğan and his friends to claim more and exclusive power. Unaware of the challenges, they focused all their energies on a presidential system that would make Mr. Erdoğan the uncontested ruler of Turkey. Economic reforms were postponed, a new constitution process was blocked and the solution to the Kurdish problem reached a deadlock. The changes in AKP policies as well as in the global economic environment did not delay having adverse effects on the Turkish economy: Real interest rates increased, the lira depreciated and economic growth decelerated -- the average growth rate in the last two years has been limited to 3 percent -- while the CAD is still unsustainable despite its decline to some extent. As though these existing problems were not enough, the AKP added on to them. The so-called “interest rate lobby” discourse and political pressure on the central bank have undermined the bank's independence. Now we are witnessing an open authoritarian shift by the AKP. I don't want to detail the contents of this shift since readers of Today's Zaman should be well informed of the different anti-democratic laws voted in urgency by the AKP majority in the last few weeks as well the threats against freedom of the press. Furthermore, an alleged corruption scandal has definitely made the legitimacy of AKP rule questionable. The EU anchor is no longer guaranteed. Last but not least, the future of democracy has become uncertain. In this context the economic situation will further worsen. Admittedly, Turkey is in a deadlock. How is it possible to get out of this deadlock? I don't believe there is an easy answer. We have to wait for the results of the ballot boxes on March 30 to be able to see clearer.

Assessing the state of the Turkish economy

Last week Bahçeşehir University's Center for Economic and Social Research (Betam) published its latest “Economic Outlook and Forecasts” report, and yesterday, the Turkish Statistics Institute (TurkStat) released its 2013 labor market figures.
We are now in a position to make an accurate assessment of last year's employment figures and make the first comments for this year based on the recently published indicators by Betam. Overall, 2013 was a fairly good year, both in terms of economic growth and the continued decline of the current account deficit. However, unemployment increased – albeit only to a limited extent -- while some difficulties can be seen on the horizon for 2014. Betam did not change its 2013 prediction of economic growth, maintaining it at 4.2 percent. TurkStat will publish gross domestic product (GDP) statistics in March, but it is almost certain that the growth rate will be very close to 4 percent. This is rather a good achievement, all the more so because the economic growth will have been achieved without jeopardizing the current account deficit. The last point may seem controversial, since the current account deficit was expected to increase from just over 6 percent at the end of 2012 to 7.9 percent by the end of 2013, according to Betam's forecast. However, when one excludes imports of gold and exports from foreign trade accounts, the picture becomes very different. The fact that this decrease would be obtained while there is an increase in economic growth, from 2.2 percent in 2012 to around 4 percent, should be emphasized. This is proof that the increasing growth has been fairly balanced since the gold trade is not related to the contributors of economic growth like domestic demand and net exports. If the achievement is repeated this year, one can conclude that the Turkish economy is still capable of growing, but moderately; meanwhile, the current account deficit will steadily diminish. Developments in the labor market are not as positive as economic growth figures. According to November figures, the nonfarm labor force increased approximately by 600,000 and nonfarm employment by 450,000 from the previous year. As result, the nonfarm unemployment rate increased slightly from 11.7 percent to 12 percent. As for the seasonally adjusted figures, they show a stagnating rate at 12.1 percent. Those figures suggest that the Turkish labor market is on the way to normalization -- meaning, the period of strong increases of over 1 million per year for both labor force and employment has finished. Economic growth still continues creating a lot of jobs, but labor productivity has finally started going up. In 2012 employment increased by 3 percent while GDP grew only by 2.2 percent. When the final figures for 2013 are released, employment is expected to have risen by around 2.5 percent with GDP growth will be around 4 percent. I would like to add to this picture that the labor force participation rate (labor force by working age population) decreased from a high of 51.2 percent in April 2013 down to 50.7 percent in November of the same year. The growth performance as well as the decline in unemployment this year will be dependent on three major factors: the value of the Turkish lira, the changes to monetary policy and the future direction of the current political uncertainties. The high depreciation the Turkish lira suffered in recent months due to the US Federal Reserve's monetary policy and the adverse effects of the Dec.17 corruption scandal on the economy will probably cause negative growth from quarter to quarter. The first leading indicators seem to confirm this prediction: Capacity use in manufacturing as well as consumer confidence dropped in January. Loan interest rates continued to rise given interest increases decided by the Central Bank of Turkey. At the moment they stand at 12-14 percent, while inflation expectations are around 8 percent. One can easily predict that tight monetary policy will be maintained throughout 2014 because inflation is well over the target of 5 percent. As for the political uncertainties, they are not going away any time soon. Given this outlook, I expect economic growth to be well below 3 percent this year. Even though economic development will be balanced -- the current account deficit will still be narrowing -- unemployment will go up. I do not think that this mediocre economic outcome will satisfy the rulers of the Justice and Development Party (AK Party).

Awaiting the central bank's reaction

Taxi drivers are known as people with a good flair for economic speculation. We, the economists, make predictions based on reflections that combine economic theory and intuition, but we prefer to wait for the largest volume of statistics possible before risking a forecast. When the speed of economic events is rapid, waiting for the statistics becomes very painful, since, as an economist, you have to answer the standard, nasty question: How is the economy going? At those times, the flair of taxi drivers might be a great help.
On Thursday, when I hailed a taxi in front of my university, my driver recognized me thanks to my appearances on TV, and without losing a minute, he asked the famous nasty question. I answered “Not very well,” preferring to remain elusive. My driver reacted immediately, announcing vehemently, “The economy is going very badly.” “Why do you think so?” I asked. Because, he said, “My turnover has diminished by 40 percent since the new year,” adding that the current political crisis is so dangerous that it might lead to a civil war. “God forbid!” I said instinctively. “God forbids this in intelligent societies, not idiotic ones,” he responded. In fact, my taxi driver revealed not only an ambitious flair but also that he is a philosopher.   One hour later, when I was coming back to my office, I compared the flair of my first taxi driver with the new one. He confirmed to me that his taxi's turnover has effectively gone down. To be frank, I had been not thinking that the Turkish economy could be in such bad shape! In my last piece (“Exchange rate debate”) I argued that the duration of the Turkish lira's depreciation would be the determinant of economic growth. In other words, whether Turkey faces a recession or just slow growth will depend on the effects of the evolution of the exchange rate. Now, I think, thanks to the taxi drivers' flair as well as the evolution of the exchange rate since Monday, the risk of recession must be seriously considered. As of Friday, the dollar-Turkish lira parity exceeded 2.20, while it was around 2.17 a few days earlier. What happened in the meantime? Well, the crisis regarding the restructuring of the Supreme Board of Judges and Prosecutors (HSYK) through a new election system has deepened since the main opposition party, the Republican People's Party (CHP), refused the Justice and Development Party's (AK Party) proposal. Then the warnings coming from Europe about judicial independence became more vehement. European warnings must be considered seriously by the government, because they may result in a suspension of membership negotiations with the European Union if the incumbent party insists on its draft law to reorganize the HSYK.   Under these circumstances, the Turkish lira may continue to depreciate further. Even if it keeps its current value in the coming months, I am almost certain that a recession in the first quarter will be unavoidable, and if the political uncertainty is not dissipated, the slow growth that I predicted may become a recession for the whole year. Economic circles are now focused on the Monetary Policy Committee meeting to be held next Tuesday. As I already pointed out, the central bank cannot avoid reacting to this increase, i.e., by further tightening its monetary policy, since its credibility is already being questioned. I believe an interest rate increase has become unavoidable. Some commentators claim that an interest rate increase risks making the recession more probable. I do not agree. If the central bank's reaction is able to reverse the exchange rate and stabilize the USD-TL parity at around 2.10 at least, the damage caused to economic growth by higher interest rates will be less effective than the damage caused by an excessively depreciated Turkish lira. Indeed, in the worst-case scenario, investments and even private consumption risks being seriously affected. What might happen if an interest rate increase remains insufficient to reverse the pessimistic expectations and thus the exchange rate? This is a legitimate question, since the origin of the actual turmoil must be attributed mostly to the political crisis rather than economic factors. Probably an interest rate increase will not be a sufficient remedy, but it will announce, at least, that the central bank is not disoriented by the “interest rate lobby” discourse, and its independence is not in question. The best solution to the current threat is, of course, a compromise on the HSYK dispute between the incumbent party and the main opposition party, as President Abdullah Gül suggests. Nevertheless, if this compromise proves impossible, the central bank must move.

Recent developments in Turkish economy

In my Oct. 11 column “How is the Turkish economy going?” I claimed: “The Turkish economy is not going very well. But there are also some reasons to be optimistic.”
My concerns were focused on two points: first, the ongoing unbalanced growth that is increasing the current account deficit, and second, the lack of political will or ability for structural reforms. As for my optimism, it was based on the decisiveness of the Justice and Development Party (AK Party) government on fiscal discipline before elections. The latest economic indicators for the third quarter allow us to renew our assessments on the state of the Turkish economy. In October, the International Monetary Fund (IMF) particularly criticized Turkey's monetary policy, claiming that it was not tight enough to confront the risk of capital outflows. The IMF also suggested that fiscal policy should be tightened further, particularly through better control of public expenditure. I wrote that I agree, as does the government, on the control of public expenditure, but disagree with further tightening of the monetary policy. The logic behind this double tightening defended by the IMF is that if macroeconomic imbalances such as a large current account deficit are not fixed in time, the risk of severe changes in the exchange rate, which could provoke a recession, will dramatically increase. The Turkish Central Bank did not follow the IMF's advice and maintained its policy rate at 4.25 percent while it continued to use so-called unconventional tools such as day-to-day management of interest rates, reserve option mechanisms and credit controls to fight inflation and at the same time achieve balanced growth. One month later, ongoing developments in the Turkish economy seem to prove the Turkish Central Bank correct. Let's start with the growth rate. Industrial production increased by 1 percent from the second quarter to the third. Although the increase from the first quarter to the second has been higher, at 1.4 percent, one should underline the continued growth. Bahçeşehir University Center for Economic and Social Research (Betam) estimated, in its recent Economic Outlook, the growth rate of gross domestic product (GDP) from the second quarter to the third at 1.3 percent and the yearly growth rate at 5.1 percent. Actually, growth over 4 percent for the whole year would not be surprising. Let me recall that the Medium-term Economic Program (OVP) forecast GDP growth at 3.6 percent. The critical aspect of this good growth performance lies, of course, in its character. I have reported the debate about “balanced growth” many times, but let me briefly reiterate. Last year, 2012, was the year of “rebalancing” -- i.e., turning the net exports contribution (exports growth minus import growth) to growth from negative to positive. The rebalancing succeeded, since the net exports contribution became positive, but nonetheless domestic demand stagnated, bringing the growth rate down to as low as 2.2 percent. In the first half of this year the growth rate increased to 3.7 percent thanks to a resurgence of private consumption, but at the same time, the net exports contribution became negative while the current account deficit started to rise again. Betam's last forecasts regarding the third quarter show a possible comeback for balanced growth. Indeed, according to Betam, the increase in exports of goods and services may have reached 2.9 percent in the third quarter, while imports might have decreased by 4.2 percent. This would mean a clear positive contribution from net exports to growth. Now, exports of goods and services had decreased by 1.7 percent from the first quarter to the second while imports had increased by 6.3 percent. It is true that the current account deficit is increasing, and the deficit over the GDP would have reached 7.2 percent in the third quarter from its level of 6.7 percent in the second quarter. However, one must note that this increase is almost wholly caused by gold imports. The gold inflows will probably become outflows in the future, as was the case in the past. We do not know yet if this rebalancing will persist in the future. This will depend, essentially, on two things: the value of the Turkish lira and the development of domestic savings. Do not forget that a tighter monetary policy risks the lira's appreciation, which might in turn jeopardize balanced growth.

How is the Turkish economy going?

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.

Hard landing is confirmed

The Turkish Statistics Institute (TurkStat) published 2012 fourth quarter and annual growth statistics yesterday. There is a surprise here. TurkStat estimated a yearly growth rate at 2.2 percent. This is lower than the earlier forecasts that varied around 2.5 percent. One year ago, economists were intensely discussing whether the Turkish economy would experience a soft or hard landing. Everybody agreed that a landing of some kind was imminent since the domestic demand-led growth had reached its limit along with a very high current account deficit (CAD)-to-gross domestic product (GDP) ratio at 10 percent. To avoid the risk of a sudden cessation of capital inflows and a strict exchange rate adjustment -- which necessarily would have followed the sudden stop -- the government and central bank had decided to cool domestic demand and push the exports in order to have a relatively lower but balanced economic growth. This new approach represented the soft landing scenario. A Medium-term Economic Program (OVP) for 2012 was projecting a 4 percent growth rate, into which net exports as well as a modest domestic demand would contribute more or less equally. During the first month of 2012, I thought like most of my colleagues, that a soft landing was possible. But when spring came, I had already joined the pessimistic camp, asserting that the growth would be lower than planned. In the summer, I wrote many times in this column that I expected a growth rate of lower than 3 percent. We now have a much lower one. We must admit that the landing has been hard rather than soft. What happened? Simply, domestic demand has declined more than planned. Indeed, private consumption decreased by 0.7 percent and investments by 4.5 percent. Despite the positive contribution of public expenditures, the domestic demand over all contribution stayed negative. The bad performance of the fourth quarter has to be particularly noted. TurkStat estimates the quarter-to-quarter growth rate at 0 percent. Consumption and investments pursued their decreasing path during the fourth quarter. This means that the loosening of monetary policy did not produce the expected impact on the revival of domestic demand. The hopes are now postponed to the first quarter of this year. The OVP still forecasts a balanced growth rate of 4 percent this year. The government and Central Bank expect the continuation of the positive contribution of net exports but also, contrary to last year's disappointment, a positive domestic demand contribution as well. Will it be possible? I am afraid that this time we risk coming back to our standard growth regime; that is, a domestic-led growth instead of a balanced one. Advanced indicators of the first three months point out a timid revival in domestic demand. Given the delayed impact of the easing of the monetary policy and the expected positive impact of the new investment incentives implemented in June 2012, I am rather optimistic about domestic demand revival, but not about the positive contribution of net exports. During the first two months of this year, when foreign trade figures are seasonally adjusted, the cumulative increase of exports of goods during January and February shows a limited increase at 2.7 percent compared with the last two months of 2012, while imports show a high increase of 10.5 percent. These figures are not a good omen for the contribution of net exports to the GDP this year; if the gap between export and import increases persists, the contribution of net exports will be negative, for sure. The fact that the European market, still being the principal destination for Turkish exports, has stayed in a recession, does not give us too much hope for exports. They can continue growing in other markets, as they did last year, but it is not guaranteed that the total increase in exports can still surpass the increase of imports, as was the case in 2012. I think the targeted 4 percent growth is still attainable, but it will not be a balanced one, for sure. Reaching 4 percent growth will depend on the intensity of the revival in domestic demand. The main handicap would be the possible ineffectiveness of the monetary policy. Monetary policy seems to be reaching its limit and I do not believe that further easing is possible. Thus, only fiscal policy remains. Nevertheless, fiscal discipline continues to be the red line for the government, given the persistent declarations of Deputy Prime Minister Ali Babacan and Finance Minister Mehmet Şimşek about the virtues of low budget deficits. But in politics, flexibility can overcome principles when elections are at stake.

Worries on economic growth

Düşük büyüme Başçı'nın başını ağrıtabilir The publication of the December 2012 Industrial Production Index by the Turkish Statistics Institute (TurkStat) last Friday sparked worries about the state of growth of the Turkish economy. The seasonally adjusted Industrial Production Index decreased by 1.5 percent from November, and on a quarterly basis the index almost stagnated from the third quarter to the fourth. It was commonly agreed that the 2012 growth rate would definitely be lower than 3 percent by a few percentage points, but economists are now forecasting a lower growth of around 2.5 percent. Asaf S. Akat, a prominent economist, put it well when he said, “2012 appears as a lost year with regards to economic growth.” So what about this year's growth?
In my Dec. 31 column, “Two scenarios for the Turkish economy in 2013,” I wrote that despite the difficulty of predicting growth in 2013, I was rather confident regarding the 4 percent target announced in the official Medium-term Economic Program (OVP). I would like to remind readers that I was not alone in thinking that, and there was a very large consensus among international organizations as well as national ones regarding better growth prospects for this year. This confidence originated from decreasing interest rates, which are normally capable of reviving sluggish domestic demand, though I had expressed some reservations and had questioned the uncertain reaction of Turkish households to the decreasing interest rates. However, my criticism was not about the 4 percent growth forecast based on domestic demand but rather on the expectation of the government and the central bank of a continuation of the current account deficit decline in 2013 similar to 2012. Now, seeing some advanced indicators of growth for December and January, I am wondering if we have to reconsider our growth forecasts for 2013. I should admit that the decrease in industrial production in December increased my concerns about the revival of domestic demand. Indeed, in December we observed a sizable decrease particularly in the production of consumer durables, which are in fact more sensitive than other goods to a decrease of interest rates. One can say that it is maybe too early for the decreasing interest rates to affect the demand for consumer durables since there is always a time lag before the decrease has an impact. Nevertheless, I must point out that the decline in interest rates is not a recent event. I think that we have some good reasons to be alarmed. Let's examine more closely the signals given by different advanced indicators. The consumer confidence index has been on a path of growth for two months now: It increased by 4.4 percentage points from November to January. This increase in confidence is consistent with the consumer credit expansion that reached a yearly average growth of 20 percent. Let me remind readers that this expansion is considered by the central bank to be more than sufficient since the bank is targeting keeping the yearly consumer credit expansion at around 15 percent for the sake of its disinflation policy. However, firms are not as optimistic as consumers. The real sector confidence index lost 2.4 percentage points from November to December. The seasonally adjusted capacity use in the manufacturing sector, another advanced indicator, decreased in January from 73.6 percent to 73.1 percent compared to December. This decrease is also consistent with the decrease in real sector confidence. Let me also add that exports also seem to have lost their momentum; the seasonally adjusted growth rate of exports decreased by 2.8 percent from October to November, but imports increased slightly by 0.4 percent. So the signals of domestic demand are in opposite directions, and the signals on the foreign trade front are not encouraging. Certainly, we should at least wait for January's statistics before getting a clearer picture of the state of growth. That said, I think the available information summarized above is enough to allow me to express some reflections on an important consequence of low growth. Further loosening monetary policy would risk jeopardizing the 5 percent inflation target. If the Central Bank maintains its actual stance, the already existing signals of an upturn in unemployment would become more perceptible. This will increase, for sure, the political pressures on the central bank's management.