Edge of recession versus recession

As GDP goes, based on the unadjusted yardstick that compares one quarter to the same quarter of the previous year, Q4 2018 will end up with minus 1.752 percent, more likely than not. Of course, even three percent is in the cards according to some analysts, but I don’t think so. Under ordinary circumstances, Q1 2019 could be slightly worse. This makes two GDP contraction quarters in a row. Not that this is the metric whereby we evaluate whether an economy is in recession or not, but it is the flattest, the most obvious criterion still. If we look at data form a seasonally and calendar effects adjusted quarter-on-quarter growth viewpoint, Q1 has been negative already. So, it is either recession plain and simple or edge of recession. The real question is how soon there might be an exit, and whether financial markets will behave before the light in the tunnel is reached. The real economy is in a nosediving downswing. Nevertheless, we knew that already, right?

Loan growth versus publ c spend ng

S&P thinks problem loans have already reached 10 percent if restructured loans are added in, and this ratio might double up next year. Well, this has always been so in a sense because had it not been for bad loan sales, we would have seen NPL ratios that exceeded 6 percent ages ago. On the one hand, this approach is a bit ‘purist’; it never becomes real. On the other hand, it reflects underlying risks. It depends on the approach banks use to classify risks, standard approach or not. Asset quality is in jeopardy, but just by how much? It might double up perhaps. Well, I think it depends on how the exchange rate and interest rate developments unfold. I have tried to link these developments with the Fed and other global issues in the last couple of weeks. Now, the NPL ratios mentioned therein are so high that book values would be hit hard. However, this was a prospect in December 2008 also, but it didn’t happen. True, at that time the policy rate was so high that there was a lot of room to cut it down, which happened, and banks made a lot of capital gains from that. Global interest rates were being cut down also. Now it is exactly the opposite. Bad loan sales were a novelty at that time, but now the market is so fed up with those that the most recent sale only recorded 7 percent of book value, an incredibly huge discount. How can loans grow? By mid-December private commercial banks’ loan growth is minus 19.4 percent annually and public banks have posted minus 2 percent growth, which brings the lot to a minus 11.2 percent. The nosedive is so huge that even in June these rates were almost exactly the opposite, i.e. positive 14.2 percent in the last week of that month. Pushing interest rates down artificially won’t work. There is no way it can work in any possible world.

Hence, excepting a few cosmetic and temporary cuts, there isn’t much hope on the credit front for the next quarter. This leaves us with public spending. There we will see a lot of action ahead of elections. I don’t expect any serious cut in expenditures before the elections, and I am almost sure nobody does. Non-interest expenditures showcased a real (inflation-adjusted) 6.4 percent surge in November, for instance. Tax revenues only went up by 1.5 percent by the same metric. The budget deficit itself doubled up annually. One-offs helped rescue the budget; at least the deficit didn’t get out of hand. Income tax can’t be promising, unless of course there are large salary increases in January, but then there will also be larger public deficits because salary increases have to start with state employees. Transfers will climb upward because corporates won’t pay social security premia. Everybody will pay nothing if you allow them to do so anyway because the Turkish ‘bourgeoisie’ – if it ever existed is known for that kind of behavior. With the contraction we are now passing through, budget revenues can barely keep themselves stable in real terms.

In effect, the budget deficit is now TRY 54.5 billion year-todate, up from TRY 26.5 billion in 2017. This is a 106 percent increase, and we may not be at the end of it. Interest expenditures rose obviously, but also there were tax cuts offered as incentives. Hence, we are back to the old days when who pays taxes and who benefits from incentives defined the political economy. SCT and VAT did ‘contribute’ negatively in November. Not only are people not spending but also there are price reductions in consumer durables, adjustments in SCT on gasoline prices and so on. Hence, corporate taxes behave, but consumers’ contribution to taxes fall. Interest expenses will remain high in the coming years. In fact, I

don’t expect inflation to fall below 17 percent in 2019, even barring another currency shock, although inflation may visit 15 percent in the summer. Therefore, interest rates and financing costs may not fall significantly for the next couple of years. Unless rebound occurs rather fast on account of global developments, exports and rising capital inflows, and soaring tourism revenues, an optimistic scenario, non-tax revenues will take the lead. I think the speed of increase in the budget deficit will fall, and finally after the elections the deficit itself could be curtailed a bit; but just one bit.

Industr al product on and unemployment

Industrial production is ordinarily a good indicator for GDP. The industrial production index fell by 1.9 percent in October, seasonally and calendar-adjusted month-on-month, and that means a cumulative 5.9 percent in the last three months. Now, November and December can be no better. Consumer confidence also fell by a hefty 8.5 percent. Hence, we are in negative territory. Furthermore, with the exception of a few sectors such as beverage, transport equipment etc. the deceleration is widespread across sectors. Crude steel production, as a case in point, dropped by 2.1 percent year-on-year in November. Electric arc furnaces dropped by almost five percent year-on-year. Automobiles are down by 10 percent year-todate and even light commercial vehicle production, which normally is a strong performer, fell by 3 percent. Sales also dropped on account of the lira depreciation. Prices of newly imported cars skyrocketed in TRY terms and car loan rates are very high. We are talking about decline rates of say 30-35 percent. Tax rate cuts can only be a remedy up to a certain threshold. In short, not only home sales and car sales - even domestically produced car sales - dropped visibly but also the industry as a whole is slowing down.

And so, as expected, unemployment is going up. It has been trending up now because the rise has been serial, i.e. it has been rising for the last five months, reaching to the peak level since March 2017. Now the head-on 11.4 percent unemployment rate isn’t dramatic but it is high even by Turkish standards. If we adjust for the labor participation rate we come up with very high rates, and under mild adjustment assumptions 18 percent is the ‘normal’ rate. Youth unemployment is now standing at 21.6 percent unadjusted. Nonfarm unemployment stands at 13.5 percent. One major problem isn’t new but it still persists: men participate at the rate of 73.5 percent whereas women’s participation rate is 34.9 percent only. Admittedly, the women’s labor participation rate was even worse a decade or so ago. Non-farm irregular or unrecorded employment is about 22 percent, but this is only a glimpse at the size of the informal sector. What happens to those guys when recession hits? Well, nothing might happen because informal sectors’ pay-checks should be lower. The real question is the extent of the wages & salaries increase come January. Inflation is above 20 percent. Nevertheless, a 20 percent pay-check rise overall would have significantly negative consequences on employment, and would keep inflation going. If not, then on account of negative loan growth, domestic consumer spending will be cut off further ahead of elections.

Edge of recess on?

How will this reflect on electoral politics? Hard to guess. It doesn’t automatically translate into votes even if people think the incumbent government is partly to blame for negative economic conditions. While some voters, who aren’t loyal to the party ticket but only to a more general political cleavage, say ‘right’ against ‘left’ etc., might migrate, they will migrate to the adjacent party. The movements are in the vicinity of a neighborhood. This makes both MHP and İYİP key players. If İYİP has a hold on the previous 10 percent or so it gathered in June this year, it may play a role and make a difference, coupled up with CHP. On the other hand, elections will be held under conditions of economic duress. Nevertheless, let’s remember that even if conditions improve a bit ahead of elections, say access to credit at lower interest rates or a hefty public employees pay rise in January etc., people’s perceptions could change. It depends on by how much the feeling of ‘the worst is over’ will weigh in the minds of the AKP electorate. Then, there is the MHP, which could rally a good part of previous AKP voters who might refrain from repeating the same pattern. In toto, I don’t think much can change. I would opt for the upper band of the polls to assess the vote potential of the incumbents, and that is slightly above 40 percent perhaps.

The real solution lies in international politics. Because recession is now a foregone conclusion, although we are still ‘on the edge of it’ because statistics are published after the fact, the solution in the very short run lies in financial stability. Secure financial stability, don’t toy with interest rates, and if CDS is rendered stable at a lower point, then maybe financial inflows will increase a bit for a couple of months, making the exchange rate less vulnerable. Then, of course, the ex ante real TRY rate should be attractive enough not to trigger a shift to FX assets, either FX deposits or FX-denominated domestically issued bonds. The latter had better be issued in small amounts, otherwise we might begin dollarizing domestic debt also, not only corporate debt from overseas that lie at the core of the problem now. Public finances can wait for two more quarters so the problem there can be addressed to. Not an urgent matter.