The Turkish Business Cycle

There are in fact two global scenarios for 2019. There are also two alternate paths for Turkey, mostly depending on which global scenario will unfold. These paths won’t look like each other, so they are worth mentioning. We may pose the pay-offs in the matrix form and look at the expected outcomes in an elementary vein. The first global scenario is something like this: the ECB won’t move except the oft-repeated balance sheet contraction and the Fed will come to a halt after two or maybe even one rate hike. Risk appetite for EM assets won’t dissipate, and in fact some EMs will be still in vogue. True, the trade dimension and the weakening European economic performance may be negatives in this scenario, and the global cycle may have already peaked if we push this logic a bit further, but from a financial viewpoint neither the debt nor asset side will be hurt much further. With EMs relatively intact after this point, this is as far as it gets. The second scenario is the opposite. The Fed will continue because the American - and therefore the global business cycle upturn is still not out of steam. In this case, costs will go up along with U.S. interest rates. Some analysts claim that the current relatively mild assessment of things to come is kind of irrational exuberance. This means that future hawkish Fed moves have been too easily dismissed and the ‘business as usual’ behavior has been rekindled too soon. If rate hikes will continue throughout 2019, then any EM central bank’s - especially Turkey’s - possible rate cut drives will have to wait not only until the end of Q2 2019 as envisioned but maybe until Q4 2019. Growth scenarios vary accordingly.

‘Muddl ng through’ and the sh n ng path after m d-2019

This is a joke of course and no path will ever shine as if nothing has happened. Nevertheless, ‘muddling through’ is good enough in the short run. As we speak, Turkey is in near-recession. Near-recession is also sort of a neutral term because we don’t exactly know what will happen next. In Q4 2018, however, GDP growth will be negative, probably between -1.75 and -2 percent. This is growth measured with respect to the same quarter of the previous year, unadjusted. The Q3 2018 print posted a 1.6 percent decline yearon-year, unadjusted. However, the seasonally and calendar effects-adjusted quarter-on-quarter data reveal a 1.1 percent contraction. Had we been reporting growth on the same basis as the U.S., we would have already seen negative growth in Q3. Hence, depending on how we look at data, there lie more likely than not two or even three consecutive quarters contraction ahead. What is certain though is the collapse in domestic demand. Whatever growth there may be will be based on net exports plus public spending. Since there is a commitment to discipline public finances, but also because the commitment will be honored only after the elections probably, we will mostly rely on exports.

Now, if the first global scenario unfolds, because the Fed will no longer be a burning issue, funding costs of banks and corporate roll-overs won’t rise much. They have already increased. Because domestic demand is falling, inflation will also fall barring any exchange rate and oil price shock. As inflation will tend to 15 percent by mid-2019, nominal interest rates will adjust. If there is no major political tension, like the one we have been through this summer, then there is a chance the economy will automatically reboot by the summer. In this case, the normal assumption would be expecting a rate cut from the CBRT by late Q2 2019, i.e. in May for instance, by 100 basis points, say. Not that everything will return to the previous ‘normal’ course of events. Nonetheless, the cycle would run its course, and the worst will be over by Q3 2019. Base effects will also help, both on the inflation, domestic spending, industrial production, loan and GDP growth fronts.

The portra t of the cycle as a ‘normal cycle’?

Is this a normal business cycle? Well, technically it might look like one after the fact. However, it isn’t a normal cycle when we look at the deeper causes of the malaise. In Q3 2018, the four-quarters moving average growth is down to 0.6 percent, hinting at around two percent GDP growth for all of 2018. It also suggests a 1.85 percent nowcasting-prolonged negative two percent for H1 2019. In the end, we might end up with slight-

ly negative or near-zero growth for 2019 in its entirety, but the problem lies elsewhere. What if the cycle redresses itself according to the normal business cycle chronology by mid-summer? Could the economy return to the pre-stagflation-cum-recession operating mode? My answer is no. Just how the new course will be amended and bent towards non-construction capital accumulation one can’t easily guess. On the other hand, a modest revival in domestic consumption is one thing, the source of the said revival is another. Investments will be the last to recover, and construction investments definitely so.

If, on the other hand, the global scenario number 2 unfolds, the Fed will continue hiking. There will be a repletion of 2018 from an EM perspective. Growth will be subdued, the automatic recovery I have mentioned might be delayed, cash and non-cash bank syndication roll-overs may become even costlier, and the corporate sector will be a net FX debt payer next year. Interest rates may not fall except sporadic episodes. Winter might endure longer than anticipated. The observation to the effect that the GDP cycle isn’t as deep as in 2001 and 2009 will be small consolation because stagnation would be prolonged. In both cases, however, I don’t see a collapse similar to either 2001 or 20082009. The greatest danger lies in the possibility of a European meltdown curtailing demand for Turkish exports. Because even with a bright export perspective investments won’t pick up easily, this could cause a major bottleneck and could hamper the re-equilibration process. Turkey needs a strong export performance and higher tourism revenues in 2019.

Still, I would opt for Scenario 1. The Fed will come to a halt, ECB won’t hike, the trade war will have little negative impact on global trade, at least in 2019, and the automatic built-in business cycle mechanism will work. As inflation falls to around 15 percent in August 2019, possibly rising to 17 percent afterwards only to fall again in Q1 2020, interest rates will adjust. The credit mechanism will gradually pick up. Even if earnings will less than fully adjust to inflation, there will still be room for consumer spending. Return to positive growth in H2 2019 wouldn’t necessarily be the end of recession or something, because potential growth is about 5 percent and any growth significantly below potential could be seen as a sign of recession, at least stagnation. However, it is better than nothing.

Not do ng anyth ng s the best strategy, perhaps

This is impossible, and not only because there are elections in March but also because any economic administration has to do something. However, neither the way Treasury auctions nor the FX-denominated bond issuance for individual investors look like moves in the right direction. FXbonds will have a maturity of one year and a coupon period of six months. So, they are shortterm, which is okay. Demand will be driven with the intermediation of large banks and state banks. Since yields for EUR and USD issuances would be 2.5 percent and 4.0 percent, subject to the same tax rates as FX-deposits and carrying similar returns, there is no reason why they will attract hitherto ‘idle’ resources. The maturity is short for bonds, but it is much longer than the optimal – from the viewpoint of the individual holder, duration for FX deposits. Should they address the same holders, i.e. drawing from the already existing pool of FX deposits, there will only be a dislocation of extant savings, from deposits to bonds. However, bonds are issued by the Treasury, deposits fund bank assets. Would that push FX deposit rates up and, eventually, TRY deposit rates up because it might cause a slight increase in the demand for FX deposits (from banks)? It depends on the amount to be issued. On the other hand, I fail to understand how the extant pool of bank deposits lay ‘idle’. There can be no such thing from a balance sheet perspective. Deposits can’t be viewed as non-core the same way as non-core bank assets, eg. real estate can be in some instances.

The ideal policy would be to stand still until late Q2 2019. Any rate cut before that time frame, assuming the first global scenario holds obviously, would be premature. The whole gist of the first, ‘muddling through’, scenario depends on the stability of the lira. From a Taylor Rule perspective, near-recession calls for rate cuts, but from a financial stability and inflationary outlook vantage point it doesn’t. Because the current account deficit tends towards $30 billion, and is likely to drop further in 2019, it might be tempting to cut rates, but this isn’t so. We have seen that even when the deficit is curtailed the lira can depreciate fast.

The lira is still fragile, as we have seen in the last couple of weeks. Technically, it went down to 5.10-5.15 against the USD as envisioned, but it jumped up again. True, there is also the opinion that anywhere below 5 wouldn’t be optimal, but still it could stay around 5.15. The temporary cut in withholding tax collected from TRY deposits has ended, and perhaps rightly so. However, the purely technical analysis standpoint is a very short-term perspective, and might change easily as observed. If I were a central banker, I would act conservatively and stay put for at least a few months more. At the very least, one needs to see which one of the global scenarios unfolds.