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Turkey’s econ­omy is ex­pected to grow at a steady pace in 2014. Do­mes­tic de­mand should be the main growth driver as the ef­fects of the re­cent fis­cal and mon­e­tary stim­u­lus wane. With half of the pop­u­la­tion un­der 30 years of age, the ap­petite for con­sump­tion is for­mi­da­ble. Un­em­ploy­ment is high but fall­ing. In­creased in­flows of FDI are needed to ad­dress ex­ter­nal im­bal­ances. The gov­ern­ment’s in­abil­ity to re­duce the huge in­for­mal econ­omy lim­its pol­icy ef­fi­cacy. Turkey has seen im­pres­sive growth in the past decade with per capita GDP tripling and the num­ber of for­eign firms in­creas­ing more than five­fold. The boom was driven by buoy­ant con­sump­tion and rapid growth in con­struc­tion. All this was sup­ported by strong job cre­ation in both in­dus­try and ser­vices while labour­ers left the agri­cul­tural sec­tor. Turkey's eco­nomic boom, how­ever, was mainly pred­i­cated on a com­bi­na­tion of for­eign cap­i­tal in­flows, ul­tra-low in­ter­est rates, rapid credit growth and soar­ing as­set prices.

The euro­zone cri­sis, a dou­bling of in­ter­est rates and the im­pact of civil war in Syria were all drags on the econ­omy. Ex­ports still per­formed well thanks to a suc­cess­ful di­ver­si­fi­ca­tion away from EU mar­kets and to­wards the Mid­dle East. The econ­omy ac­cel­er­ated mod­estly in 2013 but the per­for­mance was be­low his­tor­i­cal trends.

The gov­ern­ment's in­abil­ity to make more progress in re­duc­ing the huge in­for­mal econ­omy weak­ens the ef­fi­cacy of pol­icy mak­ers. An es­ti­mated 53% of the work force was un­reg­is­tered in 2004 and the share in 2010 was still about 44%. Pol­icy mak­ers have also been slow to boost com­pe­ti­tion in or­der to cut en­ergy and other costs.

Eco­nomic prospects

Real GDP is ex­pected to grow by 4.0% in 2014, down from 4.1% in 2013. Do­mes­tic de­mand should be the main driver as the ef­fects of the re­cent fis­cal and mon­e­tary stim­u­lus wane. The econ­omy ex­panded by 4.4% in the fourth quar­ter in 2013, com­pared with the year-ear­lier pe­riod.

Prices rose by 7.5% in 2013 – well above the cen­tral bank's tar­get rate of 5.0%. In­fla­tion of 6.9% is fore­cast for 2014 but prices could rise fur­ther ow­ing to a fall in the value of the lira. In Jan­uary, the cen­tral bank an­nounced a ma­jor in­ter­est rate hike from 4% to 10% to halt the cur­rency's down­ward slide. The Turk­ish gov­ern­ment has op­posed the move.

With half of the pop­u­la­tion un­der 30 years of age, the ap­petite for con­sump­tion re­mains

healthy. In real terms, pri­vate fi­nal con­sump­tion rose by 3.6% in 2013. The same rate of growth is ex­pected in 2014.

Un­em­ploy­ment was 9.7% in 2013 and it will dip to 9.4% in 2014. The per­cent­age of job­less far ex­ceeds the na­tional av­er­age in ru­ral ar­eas and in the east where long-term un­em­ploy­ment is es­pe­cially se­ri­ous.

Turkey's work force is just 25 mil­lion – not much more than a third of the coun­try's pop­u­la­tion. This is partly due to the youth­ful­ness of the pop­u­la­tion but also struc­tural fac­tors, in­clud­ing a low par­tic­i­pa­tion rate among women. Un­em­ploy­ment among young adults is close to 25%. More than 40% of wage earn­ers in the pri­vate sec­tor re­port only the min­i­mum wage – a sit­u­a­tion that sug­gests a sig­nif­i­cant tax leak­age.

Eval­u­a­tion of market po­ten­tial

Turkey is cur­rently the world's 16th largest econ­omy. The gov­ern­ment's plan is for the coun­try to be­come one of the world's ten largest economies by 2023, the cen­te­nary of the foun­da­tion of the Turk­ish Repub­lic. How­ever, the in­creas­ingly un­cer­tain pol­icy en­vi­ron­ment could weigh on the coun­try's eco­nomic re­silience and long-term growth po­ten­tial.

Turkey must find ways to loosen the labour re­stric­tions that in­hibit em­ploy­ment in the for­mal sec­tor and make more progress in ed­u­ca­tional re­forms. In­creased in­flows of FDI are also needed to ad­dress ex­ter­nal im­bal­ances. More costly ex­ter­nal fi­nance will di­min­ish eco­nomic prospects. If the cur­rent pol­icy frame­work is main­tained, the rate of growth will likely con­verge to his­tor­i­cal trends, of about 4.5% per year.

Ris­ing en­ergy costs are an­other drag on growth that must be ad­dressed. Elec­tric­ity con­sump­tion is grow­ing by 8-10% per year and that trend is ex­pected to con­tinue for two decades or more.

Half a mil­lion new jobs need to be cre­ated ev­ery year just to keep the num­ber of job­less from ris­ing. In some Kur­dish re­gions in the south­east, un­em­ploy­ment is as high as 70%. Turkey's rel­a­tively youth­ful pop­u­la­tion could even­tu­ally pro­vide a pow­er­ful boost to the econ­omy if a suf­fi­cient num­ber of jobs can be cre­ated. The num­ber of young Turks is larger than the to­tal pop­u­la­tion of many Euro­pean coun­tries.

For­eign trade

Al­though their sig­nif­i­cance has in­creased over time, ex­ports still rep­re­sented just 18.6% of GDP in 2013. The ex­port base is too nar­rowly fo­cused, in terms of both its com­po­si­tion and des­ti­na­tions. In 2013, 38.8% of ex­ports went to the EU. Ba­sic man­u­fac­tures to­gether with ma­chin­ery and trans­port equip­ment made up 57.4% of ex­ports in 2013.

The value of ex­ports tripled in 2002-2010. Ex­ports (in dol­lars) de­clined by 0.4% in 2013 and growth of 8.9% is ex­pected in 2014.

The cur­rent ac­count deficit was 7.9% of GDP in 2013 and it will nar­row to 7.7% in 2014. The deficit re­quires about $5.0 bil­lion of for­eign fi­nanc­ing a month – over­whelm­ingly from short-term cap­i­tal flows. This is mainly to pay for en­ergy im­ports.

Busi­ness en­vi­ron­ment

The busi­ness en­vi­ron­ment suf­fers from var­i­ous weak­nesses. These in­clude the lack of a com­pre­hen­sive le­gal and leg­isla­tive sys­tem that pro­tects the rights of for­eign in­vestors, an in­flex­i­ble labour market, a low sav­ings rate and a large in­for­mal econ­omy. In an ef­fort to im­prove the in­vest­ment en­vi­ron­ment, the gov­ern­ment is of­fer­ing in­cen­tives to a num­ber of in­dus­tries in­clud­ing food, animal hus­bandry, green­house farm­ing, leather, ed­u­ca­tion, health­care, drug-mak­ing, rail­ways, sea trans­port and tourism.

The pri­vati­sa­tion of var­i­ous state-owned com­pa­nies ini­tially at­tracted a num­ber of in­vestors but many have lost in­ter­est as fears of an “eco­nomic bub­ble” have grown. The gov­ern­ment is also ex­per­i­ment­ing with new forms of pub­lic pri­vate-part­ner­ships to build hos­pi­tals and ports.

New laws are de­signed to ex­pand the tax base to the un­reg­is­tered econ­omy. Per­sonal in­come taxes have been sim­pli­fied and ex­tended. So­cial se­cu­rity has been re­formed to bet­ter en­sure fis­cal per­for­mance. Ex­cise taxes have been raised to meet the tar­get for the bud­get deficit.

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