The unsustainable twin deficit state in economy
It is a widely expressed opinion that the state of a country’s economy expressed as twin deficit, where there is a deficit in both the current account and budget, is not “sustainable.” Indeed, Turkey’s current deficit was 3.6 percent of the national income in the crisis year of 2000, while the ratio of public sector borrowing requirement (PSBR) was 8.7 percent of the national income. Subsequently, with the austerity programs of the IMF, PSBR remained below the average growth rate, which led to a decrease in the ratio of public debt to national income over the years. Between 2005 and 2018, the ratio of PSBR was one percent on average.
In the same period, our current account deficit started to grow gradually. The positive perceptions of Turkey’s economy in the 2002-2008 period, later on the abnormal increase in global liquidity, has pushed Turkey into permanent high current account deficit
territory. The average current account deficit for the entire period was five percent. Following the crisis triggered by the exchange rate increase in August 2018, we experienced a rapid decline in the current account deficit. The 12-month current account deficit, which was $57 billion in June 2018, has been reset as of June this year. If oil prices continue to fall and tourism revenues continue to rise, we may see a $5-10 billion surplus in 2019 total.
On the other hand, there has been an abnormally rapid increase in the budget deficit in the recent period. At the end of the first 7 months, the budget deficit increased by 53 percent compared to the same period last year, reaching TRY 69 billion. Moreover, this figure does not reflect the total public sector deficit. The deficit would be much higher if the increases in the duty losses of public economic enterprises, other public institutions and especially public banks were included. On the revenue side, one-off revenues should not be taken into account when making future budget projections. For example, in the first 7 months of the previous year, while the Treasury portfolio and participation revenues, which were one of these revenues, amounted to TRY 14.5 billion, they increased to TRY 62 billion in the same period of this year!
The only reason for the excess budget balance in July was the transfer of TRY 22.3 billion from the reserve funds of the Central Bank, shown under the “Treasury portfolio and participation revenues.” With the amendment made in July, all of the reserve funds allocated from the Central Bank’s annual profit were transferred to the Treasury except for the last year. This corresponds to a total of TRY 40.8 billion.
One of the key problems of Turkey’s state budget is a low rate of direct taxes in total tax revenue, such as income and corporate tax. This has inevitably led to the budget being financed by indirect taxes such as VAT and SCT. A significant portion of these duties are on imports and VAT. Thus, interestingly, budget revenues increased due to an increase in imports and a massive deficit in budget was avoided while the current account deficit has soared. However, in the current situation, due to the ongoing recession both in imports and domestic economic activities, the real revenues of the treasury have decreased considerably. The rate of increase in total tax revenues in the first 7 months of 2019 was only 4.8 percent. Considering that the average inflation rate in the first 7 months was 18.6, this means a very serious real decrease.
As a result, we will see a serious deterioration in budget figures while the current account balance will have a surplus this year. While the government will try increase loans by lowering policy interest rates the increase in public sector borrowing requirement will put upward pressure on interest rates.