Fed, CBT, incentives: a new stimulus package?
All extant growth estimates bear an upside risk as Q2 unfolds, and as Q3 looks promising. Agriculture has its greatest weight in GDP in Q3, and this seasonality will help this year. Furthermore, there is a highly favourable base effect. It looks like 7% GDP growth in Q3 will not surprise anyone, and Q2 tends towards 5% again. All in all, if Q4 is not a total disappointment, 4.7% GDP growth, even 5%, is on the cards for 2017. We also reiterate that CPI inflation will end up with a high single-digit figure, like 8.5-9.5%, barring any exogenous shock. Loan growth, adjusted with currency, is below 20% now. It has begun to fall from incredible 40% and higher annualized growth rate heights to reasonable levels. Ultimately, what has been targeted through a tight monetary policy-loose fiscal policy mix has been achieved not only thus far, but looks to have secured the rest of 2017 too. Company profits are in general better than expected so far, and the stock exchange – albeit with a strange twist of decoupling from the rate of interest – hits a new all-time peak. The current account is under control with an expected $35-37 billion, corresponding to c. 4% of estimated 2017 GDP. Reserve depletion looks to have come to a halt, and bank profits have surpassed past expectations. On the other side of the coin, budget deficits soar, and it is clear that both the Treasury’s debt turnover ratio and the deficit-to-GDP ratio already rose, to the extent a massive upward revision of the official debt limit is on the cards.
Long-feared Fed hike a non-event
The much feared Fed hike looks to have been a non-event, and even the prospect of the Fed’s “relatively soon” balance sheet contraction does not change an iota. The Fed’s balance sheet might shred off $270 billion of securities and $180 billion of MBS going forward one year, but the euro is still strong against the US dollar. Either markets are blind or they price in every single possible development in advance so there is almost perfect foresight. Uttering that kind of financial market rationality is beyond the limits we are ready to admit. Hence, we feel a certain uneasiness, especially regarding the euro/USD parity and global stock exchanges. However, it looks clear that the turning of the tide is not an unanticipated event. Also, even forward guidance could help the euro/USD parity to remain under control should the cross trend up further north, bordering 1.20. That much would be an exuberance of some sort, we think. However, technically speaking there is no strong resistance that could prevent the euro/USD cross to reach 1.20 in a short span of time. That can in fact happen any time before September because the name of the game after the Fed is “sell the dollar and buy everything else.” Somehow, either because market plays do not believe in a swift seachange scenario as the US economy performs worse than expected or because they somehow perceive the Fed’s announcements as “dovish” and the ECB’s likely course as “hawkish,” the euro is set to re- main strong in relation to the US dollar in the short-run.
Successful policy mix
On the other hand, the Central Bank of Turkey did not move. Regulation changes that allowed banks to include their fixed assets, i.e. real estate etc., in their capital regardless of time restrictions on their duration in the portfolio and liquidity provision have again provided banks with some room for manoeuvre. Both the regulatory authority and the central bank try to pave the way for further loan growth, albeit at a lower rate. An interest rate cut would be premature, however, and the central bank has refrained from so doing. The weighted average funding rate/net-funding mix suggests that while providing ample liquidity the central bank has managed to keep its funding rate high. In fact, there is c. 150 bps difference between CPI inflation and the average funding rate, which is sufficient enough a buffer to absorb currency fluctuations. We find that policy mix successful.
Law change to boost borrowing
H1 2017 net government borrowing has already reached TL 46.5 billion, of which TL 26.7 billion is domestic borrowing and TL 19.8 billion from overseas. This amount is very high indeed, and not only has the overall debt roll-over ratio hit 114%, but also the current yearly debt limit allowed by law has been used. Now, a 10% increase in the aforementioned limit does not require a change in the law, but the government is planning to resort to a legal change – for the first time since 2009 – to allow a probably much higher borrowing limit increase. In 2009, as a response to the global crisis, it was allowed that the debt limit was set at five-fold of what it had been in 2008. There is no global crisis now, but in H1 2017
public expenditure gained speed at such a pace that a legal limit change has become mandatory. This alone puts a cap on any politically motivated or intended interest rate cut in our opinion. The central bank’s most recent no-change decision strengthens this view. The 10-year bond rate hovers around 10.60% whereas the benchmark rate stands at 11.50%. Actually, there is a 91 bps difference between the short and long rates, and this is only normal since the late liquidity rate still stands at 12.25%. The degree of inversion of the Turkish yield curve gives us a measure of the current prudent and tight monetary policy stance. True, annual inflation will go down in the next print these days, but the central bank does not consider temporary and base-effect driven annual declines as formation of a downward trend. Consensus has won again.
Increase in Gulf-based FDIs
Another development catches the eye. Although the sums are not large enough to attract undue attention, it is still important to note that FDIs from the Gulf countries rose by 377%, from $111 million to $552 million in the first five months of 2017. FDIs from the near and Middle East combined reached $824 million, showcasing a 189% increase. As such, near and Middle East ventures to Turkey-based companies with foreign capital participation reached 19.047 whereas firms with EU partners stand at 22.088. Total FDIs are $3.6 billion, and real estate purchases stand at $1.5 billion in the same period. These numbers give us a hint as to the changing nature of foreign capital inflows and company equity participations. Electricity, gas and water utilities attracted $810 million, nearing the capital raised by financial intermediation.
Tax rebates or incentives?
There are two questions. The first is: what comes next? There are already elements of an an- swer piling up rapidly. The tax rebates-cum-possible VAT scheme changes and other tax incentives provide one answer. The 180-day plan provides a more cumulative second answer. Given that there are still TL 44 billion to be spent in the Credit Guarantee Fund, and that the 180-day plan might provide further stimulus, we are already hitting TL 100 billion. Indirect VAT incentives etc could theoretically provide much further ground. Consequently, albeit via different mechanisms a general business friendly incentive plan is being scheduled for 2018. Should a weighted average of loan growth – admittedly at a lower rate, tax and other incentives and suchlike inject another c. TL 200 billion, the first half of 2018 could be secured. This will be exactly the riskiest period in terms of global corporate debt market screening because the new pricing many have envisioned starting from last year would finally occur at that moment. Is this doable? There are risks, and monetary and fiscal policies can become somewhat incongruent at this juncture if fiscal policy goes on unhindered at a very loose mood. We also know that taxes have not been fully collected, and that almost everybody, including no lesser a figure than US President Donald Trump, aims to lower corporate income taxes, which stand at 20% in Turkey. In fact, the VAT collection ratio is at its lowest level since 2006, at a mere 32%. Better lower taxes than not be able to collect them at all! There can be room for manoeuvre there too if incentives can be channelled through indirect routes, and do not automatically translate into high fiscal deficits and a higher borrowing requirement for the second year in a row. The second question concerns politics. We do not see how it will be possible to continue providing in-cash and in-tax stimulus to the economy until the 2019 elections. One logical solution to this conundrum could be early elections of course, and judging only by the magnitude of total incentives that kept the engine going so far, we could not discard that possibility out of hand.
Fiscal stimulus to prolong
Remember January 2014? After the summer stress, came the exact moment of revelation. The Fed was moving ahead, decisively curtailing asset purchases. True, the latest non-farm employment data was a bit of a curiosum, but we did not expect any further delay or setback in the Fed’s actions, given that the unemployment rate had been falling despite the fact that nonfarm data and PMI etc. were still heading north. At that time, Turkey was not only in the “Fragile 5,” but also the outlook had recently been further tainted by the event risk – partly incurred – and the growth story had been blurred. Indeed, after a few months of indecision, many an investment bank had issued calls to sell Turkish assets. Revisions were on the downside in terms of growth and earnings expectations, and steadily trending up when it comes to inflation, exchange rates and rates of interest. The year of Black Swans had finally begun! Indeed, we have witnessed similar episodes after 2012, but in the end the economy proved resilient and profits rose. True, the underlying structural dynamic had lost momentum, but which country did not? Each time the economy looked prone to either an exogenous shock or an internal risk, a new driver has been found. We do not claim this is going to go ad infinitum, but we have begun to distinguish elements of a renewed indirectly fiscal – and definitely not in terms of a loose monetary policy – stimulus that could prolong the day, and bring in a 4-4-8 formation for 2018. In this formula, the 4s are for GDP and the CAD, and the 8 means CPI. Let us elaborate that idea further. Because it is much easier to portray a gloomy picture, we look instead for alternative road maps that can provide useful and positive landmarks.