Turkey: Pro-cyclical economic policies have caused an overheating of the economy and rising country risk
Strong growth in 2017...
Real GDP grew by +7.4% in 2017, up from +3.2% in 2016. The sharp acceleration was in part a result of base effects since 2016 output was disrupted by the failed coup attempt in July, but the main drivers were strong wage increases in 2016 (+30%) and 2017 (+12%) as well as substantial pro-cyclical fiscal stimulus – including tax breaks for consumers and firms, a significant credit impulse from the government’s enlarged Credit Guarantee Fund, and publicly (co-)financed construction investment (+26% nominal growth in 2017) – which boosted domestic demand in 2017. Inventories added +0.8pp to growth in 2017. External trade activity was dynamic as well last year, with real exports rising by +12% and imports by +10.3% so that the contribution of net exports to full-year growth was marginal (+0.1pp). Noteworthy, while export expansion peaked in Q3 2017 and has since softened somewhat, imports have continued to gain momentum until early 2018.
...was accompanied by rising imbalances
However, the growth acceleration in 2017 came along with expanding macroeconomic imbalances. Fiscal stimulus has widened the fiscal deficit to an estimated -3% or so of GDP and private sector credit growth surged by more than +20% last year (compared to an EM median of around +5%). Moreover, as strong domestic demand has fueled import expansion, the current account deficit rose sharply from -USD33bn in 2016 (-3.8% of GDP) to -USD47bn (-5.5%) in 2017 and further to -USD52bn in the 12 months ending in January 2018. Furthermore, since the Central Bank of Turkey implemented only timid monetary tightening, annual consumer price inflation increased to 11.9% (core inflation 12.3%) at end-2017 before easing slightly to 10.3% (11.9%) in February 2018. Altogether, these indicators strongly indicate an overheating of the Turkish economy, driven by policy mistakes (pro-cyclical fiscal stimulus and insufficient monetary tightening).
Chart1 Rising GDP growth is accompanied by increasing imbalances
Soft landing in 2018?
In our central scenario, we forecast GDP growth to slow down to +4.6% in 2018, as a result of a neutral impact of inventories this year, an expected negative impact of net exports and the absence of base effects. However, the balance of risk to the forecast is more to the downside, as Turkey is now among the most vulnerable EM in the event of an external shock.
Corporate debt poses high risk
As persistent large annual current account deficits have been mostly financed through new short-term external debt, the debt burden of NFCs in Turkey has continued to rise and reached 69% of GDP in Q3 2017, a 29pp increase since end-2010, and is forecast to grow further in 2018. About 54% of that debt is FX-denominated, the second highest share among major EM. Even in the soft landing scenario, rolling over that FX-denominated debt is increasingly challenging amidst the current global liquidity tightening, and all the more if investor confidence in Turkey weakens and the lira slides.
Chart 2: Currency breakdown of NFC debt (% of GDP)