Growth isn’t the main problem; sustainability is
We had two main conjectures in H1 last year. Primo, the Credit Guarantee Fund would work and growth would be high. Just how high, we didn’t know. Admittedly, the 11.1 percent GDP growth print in Q3 2017 changed the panorama, and most commentators began to post forecasts that exceeded 6.5 percent, including us. Over 7 percent growth was penned in later in the year. Anyway, I think even the recent 7.4 percent 2017 year-end GDP growth is subject to upward revision, and it could go up to 7.6 percent. I have also written on a few occasions, albeit with some minor differences, that the new series was controversial perhaps, but it couldn’t be that controversial. It measures what is to be measured better than the old series, so to speak. As the industrial production series were unveiled on March 16, 2018, we have been able to see that more clearly. Secondo, a year ago I toyed with the idea that the lira could hover around 3.55 for a few months, and it did happen. Of course, I have never claimed that any temporary equilibrium would be persistent. I think the lira will depreciate against the basket at least on a par with inflation this year and based on yearly averages since the ‘taper tantrum’ of 2013, 4.30 against the USD would be a reasonable forecast for the end of 2018. Hence, I am not surprised at all. Even to be consistent with the uncovered interest rate parity, the lira would depreciate at the same rate as inflation, i.e. around 9.5 percent this year. As I will explain in the next paragraph, what matters is the capital adequacy, asset quality and the funding costs of Turkish banks, and that’s about it. Assets and debts aren’t subject to the same regime. These are two different capital markets.
From the information given by Mr. Simsek, I gather that the real sectors’ FX-indebtedness is a cause for concern, especially because some firms carry not properly hedged short positions, and the duration of such debt is falling. Now that the overseas corporate debt market isn’t what it was before, costs tend to rise also. In contradistinction with this view, there is the consideration that banks are in a better position. Hence, if some firms’ direct access to foreign cred- it is constrained through administrative measures, they will be channelled toward local – at least public - banks for credit. Obviously, the funding cost of banks also tend to increase both because deposits carry high rates and overseas funding is more expensive but compared to medium-size firms their costs would be still lower. Furthermore, banks have adequate capital, both Tier-1 and CAR, and they can manage FX risks better. Still, banks will have to be given incentives so they can supply more. Interest rates can’t fall. This means the risk profile of firms should be adjusted through incentives. Otherwise, banks will have to charge even higher credit interest rates to cover both the idiosyncratic and market risks. Nevertheless, they are sure of rolling-over their syndications without being subject to a quantity rationing.
What does the GDP print tell us? The the publication of the March 16 industrial production series was long overdue. Construction and other series will also be rendered compatible with the new GDP measurement. As such, some of the discrepancies between sectoral and GDP data will become less flagrant, if they won’t completely disappear. Just how the new GDP series have been netted off from inflation is also a concern because with the new measurement it is only possible to impute ‘contributions to growth’ and they aren’t directly measurable. The series use records, and they aren’t production. However, as discrepancies slowly die off, we will see that the new series are more likely to win the index number tournament. After all, it is only a measurement among possibly many. Nevertheless, I tend to think they will prove to be a better yardstick as time passes by. So, growth isn’t the main issue here; sustainability is.
In Q4, private consumption remained the main driver with 6.6 percent YoY, accounting for 4.1 percent of GDP growth. Total domestic demand contributed 7 percent to the 7.3 percent GDP Q4 print because public expenditures and fixed capital formation added 1.1 percent and 1.8 percent respectively. Net exports were negative, and whatever slack is left by exports was compensated for by inventory accumulation. Capacity utilization is still high, nowcasting exercises point to ongoing momentum, and January industrial production is still strong YoY with 12.9 percent. Clearly, although confidence indices indicate a slowdown in consumption demand, the Q1 2018 GDP print will be quite high. Possibly we will see yet another above 7 percent growth. Now incentives matter, and without any guarantees and incentives it is difficult to achieve such high
rates. If incentives aim at the longrun, then its costs will run their course first, which might cause further deterioration in fiscal balances. Anyhow, I tend to think the key lies with the banking sector’s ability and willingness to shore up credit growth at no less than FX-adjusted 15 percent, and that should suffice to bring the 2018 GDP performance close to 5 percent, even slightly higher. The negative base effect of Q3 will show. Unless a hefty shock hits the exchange rate in a rather unanticipated vein, the banking sector’s sound capital adequacy will offer a buffer zone against CAR erosion. It is higher by 1.6 percentage points than Q4 2015, and this is largely sufficient to absorb any currency shock CAR-wise, because CAR is mostly affected by exchange rate depreciation. Since the interest rate is locked-in due to both inflation and developments in the global financial market, it is once again the “rate (price) versus quantity” balance that will shape the remaining 9 months of the year.
Now, the industrial production series has been renewed. The new release sets the Q4 industrial production growth at 10.5 percent as opposed to 7.5 percent of the old series. The IP/GDP correlations would have hinted at even higher GDP growth, and if the correlation strengthens in Q1 2018, we may see the slowdown effect more visibly, which again would probably be neutralized by inventory pile-up. This implies that there is still a discrepancy between monthly data and quarterly GDP prints. Hence, the story told by the two IP/GDP graphics will probably be smoother in Q1, as it was in Q4. In other words, when industrial and capital goods production head north sharply one would expect much higher growth, but the final result is less steep. Accordingly, when IP goes down, the GDP impact might turn out to be lower. One other thing: net exports don’t help this time around despite soar- ing European demand because imports are going up at an even higher rate. If this continues, and if the terms of trade continue to worsen, it will be difficult to expect help from net exports this year. However, the potential growth rate has automatically been updated with the new series although it is unknown exactly what it is. In other words, if we accept the view that the Turkish economy has grown at an average rate of 6.8 percent in the last 7 years, the latest print would still be above it. I am not sure whether the average per annum figure can be seen as a proxy for potential growth, but the series is rather short. Hence, let’s take it as the average of the entire series – although the choice of the base year, i.e. 2009, is problematic and conjecture that it is somewhere between 5 and 6 percent rather than 4 and 5 percent of the old series. Anything that slightly exceeds 5 percent would fit the bill, and we may be able to claim that the economy is set to grow around its long-term trend or potential rate in 2018.
The idea that anecdotal evidence doesn’t square with growth rates exceeding China demands an explanation. There is one already. The 2016 minimum wage hike spread over the spectrum and wages, and we see that ‘impact multiplier’ in the productivity and real wage graphic. Ordinarily, there have been prolonged episodes during which the real wage exceeded productivity growth. This is key to electoral success. The rest is the ideological dimension – religion-cum-nationalism - but it doesn’t determine anything at the margin. The 10 percent margin is determined by the economic factor, and in fact even the base-line political alliance has been shaped by it. Now, the minimum wage-led surge in real wages – I don’t even add transfer expenditures, public or private - has created a cycle in the series. This is the reason why in 2017 productivity is above the real wage, but in fact it is only the result of the impact multiplier dying off slowly. If you instil a shock to the system, it will come back with a vengeance in terms of formal jobs lost at the expense of informal ones, inflation and so on. Hence, in the second half of 2017 – with the Credit Guarantee Fund’s money largely spent in H1 2017 - people came to believe that ‘growth wasn’t in their pockets’ because it went to profits, and nominal pay increases were swiftly eroded by rising inflation. That there is high growth doesn’t automatically imply that everyone will equally benefit from it. Neither does it show that the unemployment rate would fall simultaneously.
From the looks of the politico-ideological landscape, and the economy and banking performing adequately, with the help of public expenditures and public banks’ lending, it shouldn’t be hard to win the elections. 2019 is another matter though, and it is too soon to tell. However, unless there is ‘tail risk’ occurring, the picture can’t change easily. Then, is it true that everything is determined by the economy in the long-run? Economics is never ‘pure’ so to speak. It is political and cultural economics, factors that shape both attitudes towards risk, work and technological innovation. In the longrun, exports will possibly depend more and more on Europe, as the table portrays. Once upon a time MENA’s share was rising in total exports, but no more. It is down to below 20 percent, and Europe’s share is trending up to 60 percent, even higher than a decade ago. That should be telling, and ought to show how intricate are relations with the EU. Despite day-to-day rhetoric and political cycles, geography and history may have already sealed this relationship for good.