2019 MACROECONOMIC OVERVIEW
Recession is ended in the first quarter of 2019. Turkish Economy contracted by 2.6% in annual terms in 1Q19. The economy is now technically out of the recession as the quarterly growth in seasonally and calendar adjusted terms turned into positive by 1.3% after the decline of three previous consecutive quarters. The sharp negative contribution of stocks (-6.3pp) prevented a better growth realization as it lowered the domestic demand further (-12.1pp) which could not be compensated by a robust contribution from net exports (+9.4pp).
Promising signal in IP in 2Q19. Industrial Production (IP) declined by 1.3% yoy in calendar adjusted terms in May. Hence, the annual contraction in IP (c.a.) decelerated further from -4.7% in 1Q19 to -2.6% in the first two months of 2Q19. Besides, May IP increased by 1.3% mom in calendar and seasonal adjusted terms, signaling that the moderation observed in April could be temporary. The improvement in high frequency indicators in June confirms the ongoing gradual recovery. Taking into account the positive base effects and better expectation on external and internal financial conditions in the second half of the year, we think positive growth is highly likely for 2019 under the assumption of no additional shocks. Thus, we maintain our GDP growth forecast at 0.3% for 2019.
Current account deficit (CAD) continued to retreat in 2Q19. Current account deficit materialized as 13bn USD (1.7% of GDP) in 1Q19. In the first two months of 2Q19, current account deficit was 1.15bn USD. Hence, 12 month cumulative sum of current account deficit retreated further to 2.4bn USD (0.3% of GDP) in May 2019, on the back of the contraction in import and still promising exports growth. Additionally, core current account balance (excluding energy and gold) gave a surplus of 42.2bn USD (5.9% of GDP), the highest level seen in the historical data. On the financing side, main items remained to be net error and omissions and CBRT reserves. We expect the 12-month deficit to close the year at near 1.4% of GDP. in the second half of the year
Budget deficit deteriorated further in 2Q19. Budget revenues decreased by 0.8% yoy, led by both poor performance of tax revenues(3% yoy) and the contraction in non-tax revenues(16% yoy), while budget expenditures increased by 17.4% due to current transfers, personnel expenses and high interest expenses in 2Q19. Thus, 12 month budget deficit reached 105.1bn TL (2.6% of GDP) meanwhile primary deficit was 14.2bn TL (0.4% of GDP). Looking ahead, despite the expected contingency reserves of CBRT to Treasury, taking into account the current worsening path, the elimination of one-off revenues observed especially in the second half of 2018 in cumulative terms and weak tax revenues, it would be difficult to attain the fiscal targets of New Economic Program. All in all, we expect budget deficit about 3.1% of GDP by end 2019, higher than government forecast of 1.8%.
Inflation slowed down in 2Q19. Annual consumer inflation was 15.72% in June 2019, down from 19.71% in March 2019 on the back of the ease in core inflation and normalization in food prices. Also, annual core inflation retreated to 14.86% from 17.53% on diminishing exchange rate pass through on lower demand. Looking ahead, the end of tax incentives and electricity price hike in July will temporarily push inflation upward. However, recent faster than expected correction in inflation and favorable base effects from June onwards till November will help inflation experience around 10% levels in September and October before having a reversal to near 15% by the end of the year. We expect that the consumer inflation could end the year at around 15.0%.
Central Bank (CBRT) remains prudent and will start easing cycle. The CBRT maintains its tight stance by keeping its policy rate (24%) unchanged. In absence of new shocks, inflation will start to come down fast (the end of tax incentives and electricity price hike in July will temporarily push inflation upward) given the favorable base effects, the recent improvement in core inflation and some ease in energy and food prices. We expect the CBRT will start the easing cycle in July meeting on faster than expected disinflation path and favorable base effects from now onwards till November.
Turkish financial assets underperformed in 2Q19. Turkish financial assets remained under pressure in the second quarter of 2019 due to some uncertainties stemmed from geopolitical, political and global factors. However, as of June, Turkish assets displayed some stabilization on the back of easing in geopolitical tension, decrease in political uncertainty and expectation of supportive external financial market conditions on dovish major central banks. After depreciating near 2.4% in 1Q19, TL depreciated further by 6.3% against the currency basket in 2Q19. 10-year TL benchmark bond yield which was at 17.92% at the end of 1Q19 decreased to 16.73% by end June especially supported by faster than expected disinflation path realization.
Rebalancing in the economy crystallized in 4Q18. Turkish Economy contracted by 3.0% in annual terms in 4Q18. The economy technically entered into a recession as the quarterly contraction in seasonally and calendar adjusted terms became deeper with -2.4% after the decline of 1.6% in 3Q18. The shrinkage in domestic demand reached the highest level since 2009 global financial crisis, while the contribution of net exports remained the main buffer with its peak in the series going back to 1998. All in all, the economy grew by 2.6% in 2018, down from 7.4% in 2017.
Some stabilization in IP realized in 1Q19. Industrial Production (IP) contracted by 5.1% yoy in calendar adjusted terms in February. Seasonal and calendar adjusted IP rose by 1.3% mom for the second month in a row, signaling a recovery of 0.7% in the first 2 months of the year compared to the last quarter of 2018. Both the slow-down in the contraction of IP trend and other preliminary indicators such as our Big Data Retail Sales Indicator, confidence indices, real imports and credit growth all show the recession would be short-lived. Our monthly GDP indicator also confirms this trend and nowcasts a contraction of 1.2% yoy in March (with 47% info), with some bottoming-out signals in economic activity. Though, the implications of the recent increased volatility in the financial markets and the likely extension of the tight monetary policy for a longer period of time could reduce the magnitude of the expected recovery in the coming quarters. Risks are now weighing on the downside for our 1% GDP growth estimate for 2019.
Current account deficit (CAD) maintained the correction in 1Q19. Current account deficit materialized as 27.2bn USD (3.5% of GDP) in 2018. In the first two months of 1Q19, current account deficit was 1.3bn USD. Hence, 12 month cumulative sum of current account deficit retreated further to 17bn USD (2.3% of GDP) in February 2019, the lowest level in the last 9 years on the back of the contraction in domestic demand and still promising exports growth. Additionally, core current account balance (excluding energy and gold) gave a surplus of 27.9bn USD (3.7% of GDP), the highest level seen in the historical data. On the financing side, despite the improvement in portfolio inflows due to the easing in external financial conditions, main items in yearly terms remained to be net error and omissions and CBRT reserves. We expect the 12-month deficit to close the year at near 1.5% of GDP.
Budget deficit expanded in 1Q19. Budget revenues increased by 30%, supported mostly by the non-tax revenues which grew by 196% (tax revenues rose by 6%), while budget expenditures increased by 35% due to high current transfers, personnel expenses and investment expenditures in 1Q19. Thus, 12 month budget deficit reached 88.4bn TL (2.3% of GDP) meanwhile primary deficit was 3.3bn TL (0.1% of GDP). Looking ahead, the extension of tax incentives and expected poor performance of tax revenues on the poor economic activity could weigh on the budget performance. On the other hand, the extension of zoning reform till July 2019 and the likely introduction of extended paid military service together with the measures taken by government to save could provide some buffer against further deterioration. All in all, we expect budget deficit about 2.5% of GDP by end 2019, higher than New Economic Program (NEP) forecast of 1.8%.
Inflation slowed-down in 1Q19. Annual consumer inflation was 19.7% in March 2019, down from 20.3% in December 2018. Also, annual core inflation retreated to 17.5% from 19.5% on diminishing exchange rate pass through on lower demand. Looking ahead, still alive cost push factors, lack of improvement in core inflation trend (still hovers near 14%) and recent volatility in exchange rate pose some upside risks on inflation while likely lower than expected demand on the back of tighter both internal and external financial conditions and extended tax incentives could provide some buffers. We expect that the consumer inflation could end the year at around 15.5%.
Central Bank (CBRT) remains prudent. The CBRT maintains its tight stance by keeping its policy rate (24%) unchanged on the back of likely upside risks on inflation, still alive cost push factors, lack of improvement in core inflation trend and recent volatility in exchange rate. We expect the CBRT continue with the tight stance for a longer period of time due to the recent upside risks on inflation as it could postpone the easing cycle to 4Q19 when the recovery in inflation will be more obvious.
Turkish financial assets underperformed in 1Q19. Turkish financial assets showed some stabilization on the back of the right steps in both monetary and fiscal policies and relatively calmer global market conditions in the last quarter of 2018. However, due to some uncertainties on the back of local and global factors, the assets underperformed in 1Q19 compared to 4Q18. After appreciating near 20% in 4Q18, TL depreciated by 4.3% against the currency basket in 1Q19. 10-year TL benchmark bond yield which was at 16.4% at the end of 4Q18 increased to 17.9% by end March.
2018 MACROECONOMIC OVERVIEW
Rebalancing in the economy crystallized in 3Q18. Turkish Economy grew by 1.6% in annual terms in 3Q18. Seasonally and calendar adjusted quarterly growth rate turned to be negative with -1.1%, which signals that the adjustment in the economy becomes faster. Domestic demand gives the lowest contribution to growth since 2009 with only 0.4pp contribution to growth and if stocks are also included, its contribution becomes sizably negative with 5.2pp. Private consumption grew only 1.1% in annual terms; while investment expenditures contracted by 3.8%, mainly on machinery and equipment. All in all, the adjustment in domestic demand was compensated by a sharp reversal of external demand (6.7 pp contribution), due to sizable contraction in imports and relatively stronger performance of exports.
Adjustment in economic activity gains momentum in 4Q18. Industrial production (IP) contracted by 6.1% during October-November period after its 1.6% growth in 3Q18. The continuation of the sharp worsening especially in the intermediate goods seems to weigh on production in the coming months. Besides, the worsening performance of the exporting sectors could be a risk factor, given the continuation of the sizable fall in intermediate goods imports. On the other hand, the recent supportive policies and some stabilization in loans contraction could provide some buffer against further deterioration. Our monthly GDP indicator nowcasts a contraction of 1.3% yoy growth in December (with 47% info) which is still consistent with our 3% 2018 GDP growth estimate but with some downside risks. We maintain our 2019 GDP growth forecast at 1%.
Current account deficit (CAD) continued to shrink in 4Q18. Current account balance (CAB) gave its fourth consecutive month’s surplus in November, bringing the 12-month deficit to 33.9 bn USD (4.3% of GDP) down from 45.9bn USD (5.5% of GDP) in 3Q18. The cool-down in the economy, still supportive tourism revenues and recent ease in oil prices are the main reasons on the continuation of the shrinkage in the deficit. On the financing side, the main items in yearly terms were CBRT reserves and net error and omissions, while there was an outflow in portfolio flows and net other investment. We expect the 12-month deficit to close the year at near 28.3bn USD (3.6% of GDP) and continue to decline further to USD 16.4bn (2.2% of GDP) by end 2019.
Budget figures closed 2018 in line with the Government’s targets. Budget expenditures remained strong mainly due to high personnel expenditures and goods and service purchases, while revenues continued to be supportive on one-off revenues such as zoning reform, tax amnesty and paid military service in 4Q18. Hence, Central Government budget gave a deficit of TL 72.6bn (1.9% of GDP) by end 2018, while primary balance gave a surplus of TL 1.3bn (0% of GDP). Looking ahead, the extension of tax incentives, expected poor performance of tax revenues on the cool-down in the economy and initially unbudgeted compensation for the employees could weigh on the budget performance. On the other hand, the extension of zoning reform till July 2019 and higher than expected profit transfer from the Central Bank (CBRT) could provide some buffer against further deterioration. All in all, we expect budget deficit at 2.2% of GDP by end 2019, slightly higher than New Economic Program (NEP) forecast of 1.8%.
Turkey’s external debt stock to GDP increased in 3Q18. Turkey’s external debt stock to GDP ratio increased to 53.8% in 3Q18 compared to 51.9% of 2Q18 and 53.4% of 4Q17 due to the higher decline in nominal GDP despite the deleveraging in both short and long term debt. Also, EU-defined public debt to GDP ratio rose to 32.6% in 3Q18, up from 29.2% of 2Q18 and 28.3% of the end of 2017.
Inflation slowed-down faster than expected in 4Q18. Annual consumer inflation closed the year at 20.3%, down from 24.5% in September 2018. Also, annual core inflation retreated to 19.5% from 24.05% on the back of cyclical factors such as currency appreciation, maintenance of tax reductions and price discount campaigns, and weak demand. Looking ahead, higher-than-expected minimum wage hike could bring an additional 1pp upward risk on our baseline scenario, though the price reductions in utility prices could eliminate that impact. We estimate that the headline inflation could stay above 20% in the first half of the year, before decelerating much faster afterwards on base effects and lagged effects of the poor demand. We maintain our year-end inflation estimate at 16% for 2019.
Central Bank (CBRT) maintains its tight stance. The CBRT maintains its strong stance by keeping its policy rate (24%) unchanged as the inflation outlook is still not promising. High volatility in the markets, uncertainties over the pricing behavior and cost push factors, likely upside risks on food inflation and tobacco prices will probably keep inflation increasing in 1Q (but to a lower extent, by around 1-2pp). We think that the CBRT should wait for June when the negative output gap and diminishing exchange rate pass-thru might result in a deeper decline in the headline inflation, to start a gradual easing cycle as inflation expectations are still above the CBRT’s interim targets.
Turkish financial assets stabilized in 4Q18. Followed by the extreme volatility on both local and external factors mainly till September, Turkish financial assets started to show some stabilization on the back of the right steps in both monetary and fiscal policies and relatively calmer global market conditions. After depreciating near 32% in 3Q18, TL appreciated 13% against the currency basket in 4Q18. 10-year TL benchmark bond yield which was at 17.9% at the end of 3Q18 decreased to 16.4% by end December.
Growth performance in 2Q18 signaled the adjustment is underway. Turkish economy grew by 5.2% (YoY) in 2Q18, down from 7.4% (YoY) in 1Q18. The slow-down in the economy hints the expected rebalancing with a much lower domestic demand contribution supported by a positive contribution from net exports. Private consumption grew by 6.3% yoy in 2Q, led by services and durable goods consumption. Investment expenditures also decelerated by growing 3.9% yoy in 2Q on top of a broad-based worsening in subcomponents. On the other hand, Government consumption accelerated by growing 7.2% yoy in 2Q. In sum, domestic demand gave 4.2pp contribution to growth, including the negative contribution of stocks by 1.7pp; while external demand contribution turned into positive with 1pp after near 3.5pp negative contribution in the previous two quarters. On the supply side, services sector still remained robust with 4.3% growth, while the deceleration in industry and construction was noteworthy with 4.3% and 0.8% growth rates, respectively (down from 8.1% and 6.6%). Agricultural sector, on the other hand, contracted by 1.5%, a negative signal for 3Q when its share is the highest seasonally.
3Q activity data shows the adjustment is getting faster. Industrial Production (IP) grew by 1.7% yoy in calendar adjusted terms in August. Accordingly, in July-August period annual IP growth decelerated to 3.7% from 5.2% yoy in 2Q18. The slowdown was broad-based, but getting clearer in intermediate and durable consumer goods production. As financial conditions became tighter more obviously starting from April; the lagged effects will certainly weigh more from onwards. The decline in manufacturing PMI to 42 (the lowest level since 2009), worsening in capacity utilization and electricity production, the sizable deceleration in credit growth and ongoing strong fall in intermediate goods imports all signal a much more rapid slow-down. Thus, the cool-down in economic activity will become much clearer in the second half of this year as statistical base effects and tightening financial conditions will affect domestic demand negatively. We expect GDP growth to come down to 3.0% in 2018, with downside risks accumulating for 2019.
Current account deficit (CAD) started to shrink in 3Q. CAD is down to USD51.1bn (6.2% of GDP) in annual terms in August from 57.5bn in 2Q18 (6.5% of GDP) after the first surplus in August since 2015 and the largest monthly current account surplus on record. Also, core CAD, excluding net energy and gold imports, decreased to 0.2bn USD in the same period from 5.8bn USD, which implies a cool-down in economic activity through domestic demand. The main financing items in the July-August period were net error and omissions and CBRT reserves while there was an outflow in portfolio, deposits and credits. Specific to August, the CBRT decision to lower required reserve ratios and change the coefficients of ROM to provide FX liquidity for banks led its reserves to decline fast. Expected slow-down in the economy, continued normalization in gold imports and recovery in tourism revenues could help CAD decrease at the end of year to near USD 40bn levels (5% of GDP). The adjustment would be much more obvious next year and could bring the deficit down to USD 20bn (3% of GDP) by end 2019.
Budget figures deteriorated further in 3Q. Budget expenditures remained strong mainly due to high personal expenditures and goods and service purchases, while revenues continued to be supportive on one-off revenues such as zoning reform, tax amnesty and paid military service. As of September year-to-date revenues increased by 20% in annual terms and expenditures expanded by 24%. Hence, 12-month cumulative budget deficit reached TL 72.5bn and budget deficit to GDP ratio stood at 2.0% in 3Q18. Primary balance of -0.1% GDP remained at the same level with 2Q18. We expect budget deficit to deteriorate further and close the year at slightly above 2% of GDP. Turkey’s New Economic Program (NEP) suggests an aggressive fiscal consolidation plan in the short term. The Government relies more intensively on the expenditure side (1.3% of GDP savings) while envisages extra revenues equivalent to 0.4% of GDP in 2019. Though, as we assume lower growth rates in the medium term, we think that a higher deficit path compared to the Government estimates is more likely.
Turkey’s gross external debt stock decreased in 2Q. Turkey’s external debt stock to GDP ratio decreased to 51.8% in 2Q18 compared to 52.9% of 1Q18 and 53.4% of 4Q17 thanks to the decline mostly in the long term debt (10bn USD decline in total). On the other hand, EU-defined public debt to GDP ratio rose to 29.2% in 2Q18, up from 28.4% of 1Q18 and 28.3% of the end of 2017.
Climbing cost-push factors and ongoing pass-thru led inflation to hit worrying levels in 3Q. Annual inflation climbed to 24.5% in September (the highest figure since June 2003), up from 15.4% in June on top of rapid exchange rate pass-thru after sharp currency depreciation, climbing cost-push factors and high food inflation despite favorable seasonality. Also, core inflation accelerated to 24.05% from 14.6% in June with broad-based worsening. Domestic producer prices (PPI) also surprised on the upside by hitting 46.2% in annual terms in the same period, which will keep cost push factors well alive over consumer prices in the short term. Risks are now clearly on the upside for inflation in the short term, given the lagged effects of exchange rate pass-thru, latest utility price hikes and climbing cost pressures. However, after the upside surprise on inflation data in September, Treasury and Finance Ministry announced a new set of measures to fight inflation. Depending on the success of the program, there could be downside risk on our year-end forecast. Assuming no additional negative currency shock, we estimate the year-end inflation to be near 24% in 2018.
Central Bank (CBRT) kept its stance tighter against worsened inflation outlook in 3Q. The Central Bank (CBRT) surprised on the upside and hiked its policy interest rate (one-week repo) by 625bps to 24.0% in September meeting. The decisions from the CBRT do not only contribute to fight against inflation and inflation expectations but also supports financial stability by decreasing the pressures over the currency. Thus, the CBRT reinforced its stance on inflation worries in the short term and took a solid step to restore credibility against rapidly worsening inflation expectations. Though, given the upside surprise on inflation data in September, the potentially high deviation in future inflation expectations might need to be tackled by even tighter monetary policy.
Turkish financial assets started to stabilize in September. After the high volatility on the back of rising concerns over deepening macro imbalances, elevated uncertainty on corporate defaults, escalation in geopolitical risks and the overall worsening in global financial markets in the eve of tightening financial conditions and uncertainties from trade protectionism, Turkish financial assets started to stabilize on the back of the right steps in both monetary and fiscal policies. After depreciating 44% till the end of August compared to the end of 2Q, TL appreciated close to 9% against currency basket in September. 10-year benchmark bond yield which was at 19.25% at the end of 2Q18 climbed up to 21.8% by end August, but then eased to 17.9% by end September.
Robust growth performance continued in 1Q18. GDP grew by 7.4% (YoY) in 1Q18 mainly supported by the boost in private consumption and the recovery in investment. Private consumption grew by 11.0% yoy in 1Q, up from 6.6% in 4Q17 and 6.1% in overall 2017, supported by all subcomponents except for durable goods. Investment expenditures also picked-up by 9.7% yoy growth in 1Q, up from 6.0% in 4Q17 and 7.3% in 2017, on the top of acceleration in construction and ongoing moderate rise in machinery investment. On the other hand, government consumption receded to 3.4% growth in 1Q, down from 5.0% 2017. Thus, domestic demand gave 10.9pp contribution to growth with contribution of stocks by 1pp, while external demand continued to drag down growth by 3.6pp with almost no contribution from exports. On sectorial side, main subsectors kept the high momentum with a positive differentiation from construction whose growth rate rose to 6.9% from 5.8% in 4Q17.
2Q activity data signals a clear moderation. The Industrial Production (IP) grew by 6.4% yoy in calendar adjusted terms in May but the highest monthly deterioration of 1.6% since September 2016 signals the increasing likelihood of a more rapid adjustment than expected. The monthly deterioration in IP was broad-based as capital goods production took the lead (0.7 negative contribution to overall decline) and followed by nondurable consumer goods (-0.5 pp cont.) and intermediate goods production (-0.3 pp cont.),respectively. Accordingly, annual IP growth in the first two months of the 2Q18 decelerated to 6.1% compared to 10% yoy in 1Q18. Hence, May data is still mirroring a positive outlook for growth but signaling a loss in pace. In the sectorial details, both domestic demand and export oriented sectors registered a slow-down but the higher adjustment in exporting ones implies a gloomy outlook for exporters. Also, as financial conditions had become tighter more obviously starting from April; the lagged effects will certainly weigh more from onwards. Thus, the cool-down in the economic activity to become much clearer in the second half of this year as statistical base effects and tightening financial conditions will affect domestic demand negatively. We expect GDP growth to come down to 3.8% in 2018, with downside risks accumulating for 2019.
Deterioration in current account deficit (CAD) continued in 2Q. Current account deficit (CAD) recorded USD57.6bn in annual terms in May (6.6% of GDP, up from 6.3% of GDP in 1Q18), the highest figure since March 2014. However, core CAD (exc. gold and net energy) has started to decelerate which implies a cool-down in economic activity through domestic demand. Though, increasing oil prices will continue to weigh on the energy bill, thus eliminate the positive impact from lower import demand this year. On the financing side, slightly higher than half of the deficit being financed by short term flows raise concerns over the quality of finance. Expected slow-down in the economy, normalization in gold imports and ongoing recovery in tourism revenues will help CAD to decrease at the end of year to USD 54bn levels (c.6.6% of GDP).
Budget figures deteriorated further in 2Q. In the second quarter of 2018, expenditures remained strong, while revenues continued to be supportive. The revenues increased by 18.2% yoy to TL353.6bn while the expenditures expanded by 23.2% yoy to TL399.7bn in June.Hence, the 12m sum budget deficit reached TL 68.2bn and budget deficit to GDP ratio rose to 2.0% in 2Q18 (up from 1.6% in 1Q), while primary surplus of -0.1% GDP decreased significantly due to high retirement bonus payment in June (down from 0.2% in 1Q18)). We expect budget deficit to deteriorate further especially in the third quarter of this year before closing the year at around 1.9% of GDP.
Turkey’s gross external debt stock decreased in 1Q. Turkey’s external debt stock to GDP ratio decreased to 52.9% in 1Q18 compared to 53.4% of 4Q17 and up from 47.3% by end 2016 mostly due to better growth performance in the first quarter of 2018 although there was a pick-up in both short and long term external debt. On the other hand, EU-defined general government debt stock to GDP ratio slightly rose to 28.4% in 1Q18, up from 28.3% of 4Q17 and the end of 2016.
Historical high food inflation and ongoing pass-thru led inflation to hit the highest level in 2Q. Annual consumer inflation hit 15.4% yoy in June, the highest level since December 2003, up from 10.2% in March due to the broad-based acceleration in core prices and exceptional food inflation as a result of bad weather conditions. Also, the acceleration in exchange rate pass-thru led core inflation to jump up to 14.6% yoy in June from 11.4% in March. Annual domestic producer price inflation skyrocketed to a new peak of 24% in June from 14.3% in March, keeping the cost push factors on the upside. Looking ahead, depending on the level of correction in food inflation and the likely removal of the adjustment in fuel prices, the peak in the headline could still be in July. Assuming no additional negative currency shock, we estimate the year-end inflation to be around 14.0% in 2018.
Central Bank (CBRT) kept its stance tight against worsened inflation expectations in 2Q. The Central Bank of Turkey (CBRT) increased its funding rate by 500 bps to 17.75%, simplified its policy framework and provided some supporting liquidity measures since its March meeting. Thus, the CBRT reinforces its stance on inflation worries in the short term and takes a solid step to restore credibility against rapidly worsening inflation expectations. Given the surprising June inflation data, the likely high deviation in future inflation expectations has to be tackled by tighter monetary policy. Thus, the Central Bank needs to be more effective to anchor inflation expectations by promising a higher real interest rate in an extended period of time.
Turkish financial assets performed worse in 2Q. TL depreciated due to increasing volatility in global financial markets on the back of continued monetary policy normalization and escalated concern on trade wars, geopolitical risks, higher than expected inflation realizations, deterioration in CAD and doubts on CBRT’s independence in 2Q. Thus, TL depreciated by 12% to 4.94 against US dollar-Euro currency basket by the end of 2Q from 4.41 by the end of 1Q. 2-year benchmark bond yield which was at 14.07% at the end of 1Q18 climbed up to 19.15% in 2Q18.
Robust growth performance continued in 2018 with some moderation. According to the most recent figures from the Turkish Statistical Institute, year-on year economic growth was 7.3% in the fourth quarter of 2017. The growth was supported by the still high domestic demand contribution while net export dragged down the growth. Private consumption was leading domestic demand while investment continued to be also supported by machinery and equipment. The economic activity is expected to remain strong on high inertia in the first half of 2018. We expect growth to remain close to 6% in 1Q18. Current high momentum, still solid exports, expected recovery in tourism revenues and continuing policy impulses may remain supportive on activity, while more rapidly than expected tightening financial conditions could drag down growth with a stimulating impact coming from negative base effects in the second half of the year. We maintain our growth forecast at 4.5% this year, though with uncertainties which could weigh on the downside.
1Q activity data signals a slight moderation. Industrial production (IP) grew by 9.9% yoy (cal. adj.) in February, keeping the high momentum as the overall increase almost stayed the same at 10.9% yoy in the first two months of the year (vs. 10.7% in 4Q). In seasonal and calendar adjusted terms, monthly decline continued in February but to a marginal extent compared to January, signaling only a limited cool-down in economic activity. In the details, ongoing higher contributions from intermediate and capital goods on production demonstrates further support towards a balanced growth in medium to long term as current productive capacity could be boosted more after recent investment incentives. All in all, recent slow-down in manufacturing PMI in April (still above 50, signaling expansion), deceleration in electricity production, moderation in economic sentiment and normalization in credit growth are the signals that the economic activity is losing pace; while still robust global growth could remain supportive, though with uncertainties on recent protectionism measures and geopolitical risks.
Deterioration in current account deficit (CAD) continued in 1Q. Current account deficit (CAD) expanded to USD11.2bn in the first two months of 2018 from USD5.2bn in same period of last year. Growing energy bill, still high net gold imports and solid domestic demand continued to weigh on the deterioration in CAD. Hence,12-month cumulative deficit posted USD53.3bn (6.1% of GDP, up from 5.5% of GDP in 2017) in February, the highest figure since April 2014. Slightly higher than half of CAD was financed by portfolio inflows while FDIs remained weak in the first two months of 2018. Concerns on CAD accelerated further after Moody’s downgrade due to doubts on external debt sustainability. Considering the economic activity in the first half of the year will stay robust, CAD will deteriorate towards 6.5-7% of GDP till September. Base effects, expected normalization in gold imports and ongoing recovery in tourism revenues will help CAD to decrease at the end of year at USD 56bn levels (c.6.4% of GDP).
Budget figures continued to deteriorate in 1Q. In the first quarter of 2018, the increase in spending suppressed the increase in revenues. The revenues increased by 15.7% yoy to TL167bn while the expenditures expanded by 17.7% to TL188bn. Tax revenues maintained its positive performance on top of high inflation, robust activity and higher than expected tax amnesty revenues. Though, still high expenditures and lower privatization revenues than the last year resulted in TL20.4bn deficit in the first quarter of this year, compared to TL14.9bn deficit in the same period in 2017. Thus, budget deficit to GDP ratio slightly worsened to 1.6% (up from 1.5% in 2017), while primary surplus of 0.3% in 2017 slightly declined to 0.2% of GDP in the first quarter. We expect the budget deficit to deteriorate further especially in the second half of this year on top of expected slow-down in economic activity and close the year at 2.2% of GDP.
Turkey’s gross external debt stock continued to grow in 4Q. Turkey’s external debt stock to GDP ratio increased to 53.3% in 4Q17 compared to 52.6% of 3Q17 and up from 47.3% by end 2016 mostly due to the pick-up in the long term external debt of the private sector. On the other hand, EU-defined general government debt stock to GDP ratio slightly rose to 28.3% in 4Q17, up from 28.2% of 3Q17; though it remained the same as the end of 2016.
High food inflation and ongoing pass-thru absorbed favorable base effects in 1Q.Annual consumer inflation still remained at two-digits in March, retreated to 10.2% from 11.9% in December thanks to favorable base effects. Core inflation declined to 11.4% in March from 12.3% at the end of 2017 thanks to easing cumulative impact of exchange rate pass-through, yet the recovery is still limited on recent depreciation pressures year-to-date. Domestic producer prices, whose annual inflation realized as 14.3% in March will keep upward pressures on consumer prices. Looking ahead, as favorable base effects fade away as of April and currently overshooting currency results in additional pressures on core prices, risks remain tilted to the upside on inflation in addition to still positive output gap and high inertia (backward and forward looking).
Central Bank (CBRT) stays on hold and keeps the tone tight in 1Q. The Bank maintained its policy tone but this time also stressed the inertia in inflation outlook and the high levels of core inflation in the March meeting. Given the high levels of inflation and inflation expectations, pricing behavior carries the risk of further inertia, which requires the CBRT to keep its tight policy stance. Thus, we expect monetary policy to remain tight and hold its funding rate at 12.75% throughout the year unless the negative differentiation on Turkish financial assets persists.
2017 MACROECONOMIC OVERVIEW AND 2018 OUTLOOK
2017 started with several concerns on the World economy as the election of Trump in the US was expected to initiate several restrictions on global trade. Though, as it is understood that preelection commitments of Trump could only be applied over time with sizable flexibilities, risk appetite has reemerged with a more synchronized and balanced growth outlook throughout the world. This drove capital inflows to developing economies at least during the summer, when Turkey also benefited a lot.
Despite the ongoing volatility, 2017 proved to be a year during which global trade has gained momentum with a relatively better outlook on regional basis. The US economy continued with high job gains, while the recovery in Europe turned out to be more synchronized. Chinese economy maintained its structural transformation but thanks to supportive fiscal measures it attained higher-thanexpected growth rates, which also benefited other emerging economies that export commodities. Increasing demand across-the-board also helped commodity prices escalate, supporting the demand to increase further. Overall, global economy managed to grow around 4% in 2017 and is expected to sustain these levels in the coming years.
Although growth became promising, inflation stayed at muted levels possibly as a result of the digital transformation in the economy. Thus, 2017 continued to be the year of normalization in monetary policies at a very gradual pace. The Federal Reserve (Fed) hiked its policy rate twice as it had initially communicated and started to shrink its balance sheet as of October. European Central Bank (ECB) enhanced its forward guidance and announced that it would lower its monthly asset purchases to EUR 30 billion as of the start of 2018.
The tighter monetary policy of the Fed was accompanied with higher interest rates in the shorter end of the US yield curve but weak inflation releases resulted in more stable long term interest rates. Hence, a yield curve becoming more horizontal started to feed expectations on a more gradual rate hike scenario from the Fed, which kept risk appetite in global financial markets strong. Though, higher than expected inflation releases associated with the upward revisions on growth expectations thanks to the tax reform and recovering global economic activity might result in a more hawkish monetary normalization of the Fed, which could have an impact on risk perception, triggering further volatility in financial markets.
In the coming period, both the pace of global demand and the mood in financial markets will be key for the continuation of capital flows to developing economies, which prove to be in a better position compared to previous years as their economies are now well-prepared to shocks from past experiences and relatively reshaped strengths.
2017, for Turkey's economy was a year of efforts to compensate for the negative repercussions of 2016. In addition to the measures taken at the end of 2016, the implementation of the Credit Guarantee Fund (CGF) created a strong growth path. Turkey's economy grew 7.4% in the first three quarters of the year; and will likely have grown close to 7% throughout 2017. Apart from solid domestic demand where investment expenditures also started to contribute, net exports also made a positive contribution thanks to the recovery in tourism revenues and the higher growth rates in Europe. A similar scenario in 2018 is likely in which net exports continue to contribute positively but with a limited extent, while domestic demand maintains a strong trend.
On the other hand, high growth rates, lagged impact of currency depreciation and relatively higher oil and food prices were the factors that pushed up inflation in 2017. Annual consumer inflation ended the year at 11.9%, up from 8.5% in 2016. Bearing in mind the cumulative effects of the depreciation of the Turkish lira, expected strong economic activity and 2,450 18.8 min 4 banks cost push factors will likely keep inflation high, close to two-digit levels in the first three quarters of 2018 before falling towards 9% at the end of the year.
As a result of increasing volatility in Turkish Lira and deteriorating inflation outlook, the Central Bank of Turkey (CBRT) took several steps to fight against this trend by increasing its average funding cost (~450 bps during the year) and also using noninterest financial instruments like holding foreign exchange deposits against TL deposits auctions, rediscount credits and TL - settled forward foreign exchange sale auctions. Sizably worsening in inflation expectations and excess demand will likely to require monetary policy to remain tight at least throughout 2018.
In terms of external balance, after declining to USD 32.6 billion (3.8% of national income) at the end - 2016, current account deficit went up to USD 47.1 billion in 2017 due to higher energy prices, strong gold imports and solid domestic demand. The current account deficit closed 2017 at around 5.5% of national income.
On the fiscal policy front, 2017 was a year of counter-cyclical policies, which resulted in a worsening in budget performance. Although the recovery in domestic demand and the extension of tax amnesty supported tax revenues, relatively higher government expenditures resulted in a pick-up in central government budget deficit, up to c.1.5% of national income in 2017 from 1.1% in 2016. The ratio of primary surplus to the GDP also deteriorated (YE2016: 0.8%; YE2017: c.0.3%). Fiscal policy is expected to remain accommodative in 2018 to keep growth momentum strong against the unfavorable base impact of 2017. The efforts to earn more revenues to spend more are consistent with the Medium Term Plan (MTP) targets that the budget deficit to GDP ratio will be close to 2% during the forecast period. Preferring direct tax hikes to generate more revenues strengthens the combat against high inflation. For example, the increase in corporate tax on companies would serve for this aim.
As a result of the deterioration in budget performance, Treasury’s borrowing requirement increased in 2017 compared to previous years. Apart from the increasing need, Treasury also benefited from the positive global mood during the summer months in 2017, conducted a front-loaded borrowing and ended the year with a surplus of TL 23 billion including currency gains. Thus, Treasury's domestic debt roll-over ratio rose to 125% from 90% in 2016. On the other hand, the ratio of EU-defined public debt stock to the GDP remained almost flat with its YE2016 value, and stood at 28.3% in the third quarter of 2017. The ratio was 28.2% at the end of 2016.
In terms of recent developments in politics, after the constitutional referendum on April 2017 resulted in favor of the executive presidency, Turkey will start to be governed by presidential system in which the President will be the head of the state and also the government and can sustain party membership. The post of the Prime Minister will be abolished. The President can appoint and dismiss senior public executives. The number of Members of Parliament (MPs) will increase to 600 from 550 and the minimum age to become a candidate in parliamentary elections will be reduced to 18 from 25. In the meantime, the Parliament will adopt new laws in line with the amended constitution including the election law.
2016 MACROECONOMIC OVERVIEW
2016 saw the precursors of a series of conjunctural changes in the world and national economy, whose effects will become more evident in 2017. While the growth in the world economy remained almost flat, the inflation took an upturn around the globe, driven by oil prices that got stronger particularly in the second half of the year. This drove capital inflows to developed countries, while leading emerging countries like Turkey to live through a rough year owing to the specific risks entailed.
At the onset of 2016, the US Federal Reserve (the Fed) finally started hiking rates; however, the ensuing concerns that the structural transformation of the Chinese economy would end up in a slowdown that would be highly above the anticipations, the poor data from the US and the Brexit referendum for the UK to leave European Union pushed concerns over global growth in the first half of the year. This led developed economy central banks such as the European Central Bank (ECB) and The Bank of Japan (BoJ) to take further expansionary steps and to carry on with their supportive monetary policies. Hence, the optimism that resulted from the anticipated high global liquidity prompted capital flows in favor of emerging economies.
In the second half of the year, growth concerns were eased with the good data coming from the US and China, combined with the expectation that the Brexit would extend over a long period of time, while the US presidential election gained the forefront. The upturn in oil prices and Trump’s US election win brought along a series of changes and volatilities. In this sense, the global economy is undergoing the start of a new conjunctural change. In particular, inflation projections that got higher in the US since end-September, which were further strengthened following the outcome of the Presidential election, caused remarkable rises in bond prices in developed countries. This triggered the reversal of the risk appetite, which was in favor of emerging economies in the first half of the year in general, along with capital outflows from these countries. While these developments are not expected to have a significant effect on the Fed’s policy decisions, the Fed increased the interest rates once again by 25 basis points after a one-year gap. The Fed released projections implying at a tighter interest rate path in 2017, which resulted in the expectation that there may be three rate hikes instead of two during the course of the year.
In the period ahead, the rise in oil prices that is supported by the low base effect and anticipated to become more marked with the OPEC decision to cut production, coupled with growth and budget deficits that will gain speed with the possible economic policies to be introduced in the Trump era, could accelerate inflation and keep bond rates high in the US. This is likely to weigh upon Turkey’s risk premiums, as it will affect the risk appetite towards emerging economies.
In 2016, the Turkish economy remained resilient in spite of the deteriorated risk perception towards emerging economies in the second half of the year and although it was negatively decoupled from other emerging economies owing to political and geopolitical developments. In the case of Turkey, the events that followed the July incident instigated negative decoupling for Turkish financial assets and the depreciation of the Turkish currency gained speed in this period.
One of the most noteworthy events of last year was the revision in the national accounts data. Turkish Statistical Institute (TurkStat) made the revision at the time of its publication of the third quarter data on December 12th. As a result, real growth rate for the period from 2010 through 2015 was revised from 5.2% to 7.4% after the global crisis. The rise in value-added was largely observed in the upward revision to the investments item, while the sectorial production details revealed higher contributions rather in services and construction industries. As the first-half growth rate for 2016 was revised from 3.9% to 4.5% in the new series, the third quarter saw an annual contraction for the first time since 2009, which was 1.8%. At the last quarter, a limited recovery started, driven by the measures adopted by the economy administration.
Thanks to supportive incentives, there has been a momentum particularly in consumer loans. The public sector also increased its expenditures, sustaining its support to the economy. On the other hand, merely moderate recuperation in the industrial production in the October-November period, the weak consumer and real sector confidence, and the manufacturing industry PMI that still lagged below the 50-threshold indicated that the recovery in the fourth quarter was somewhere between weak to moderate.
On the inflation front, although the annual inflation went down to 7% in November due to weak food prices; exchange rate passthrough on import prices, higher energy prices and increased taxes levied on passenger car and alcohol/tobacco prices prevailed the effect created by weak demand conditions, and drove the inflation quickly to 8.5% at the end of the year. At year-end 2015, inflation rate was 8.8%. Remaining high, the inflation further worsened longterm expectations and made inflation rigidity even clearer.
In terms of external balance, after declining to USD 32,3 billion (3.8% of national income) at end-2015, the 12-month cumulative current deficit went up to USD 33,7 billion in November 2016 despite weak domestic demand countered by external factors. The current deficit will probably close the year around this level. Increased oil prices and the currently ongoing shrinking contribution from the services balance acted as external factors and caused the current deficit to pick up.
Backed also by the rapidly declining inflation led by food prices, the Central Bank of the Republic of Turkey (CBRT) introduced the simplification steps in relation to the monetary policy as of March, which it had announced in August 2015. In this frame, the upper band of the interest rate corridor was reduced by 250 basis points from 10.75% to 8.25% in the March-September period. This way, the CBRT pulled the average funding cost to 7.8% in September, leaving the one-week repo rate intact, which had reached 9% at the onset of the year. However, the CBRT later halted rate cuts in October due to the depreciation in TL and increased volatility, and increased the one-week repo rate by 50 basis points and the upper band by 25 basis points in a surprise move for the markets in November. Hence, the CBRT carried its average funding cost to the order of 8.3% at the end of 2016.
The developments in the world economy and the CBRT’s actions have been decisive on the market interest rates. After starting the year around 11%, two-year benchmark bond rate dropped to below 9% at the end of June, backed by the worldwide optimism in the first half of the year. However, the globally higher inflation projections that drove the interest rates in developed countries upwards from the dip they had descended to, and increased emerging market risk premiums. Accordingly, the benchmark rate closed the year at 10.7%. On the other hand, the Turkish lira depreciated by 11% on average against the US dollar and the EUR-USD currency basket throughout the year. The loss was even sharper on the basis of yearend figures. TL closed the year at 3.52 against the US Dollar, depreciating 21% compared to end-2015.
In a year of continued high tax and non-tax revenues performance, the realizations of the central government budget turned out to be more positive than the targets in the Medium Term Plan (MTP). Although the ratio of the central government budget deficit to the GDP showed limited deterioration from 1.0% at the end of 2015 to 1.1%, the decline in the ratio of primary surplus to the GDP was more pronounced (YE2015: 1.3%; YE2016: 0.8%). On the other hand, the ratio of EU-defined public debt stock to the GDP remained almost flat with its YE2015 value, and stood at 27.4% in the third quarter of 2016. The ratio was 27.5% at the end of 2015.
2015 MACROECONOMIC OVERVIEW
In 2015, Turkey’s economic performance remained resilient and converged to its potential despite increased volatility in domestic and overseas financial markets, and despite the uncertainties resulting from the renewal of elections. On the global front, while growth lacked pronounced recovery, decelerated Chinese economy, plummeted oil and other commodity prices, and the strong appreciation of the US Dollar fuelled concerns in financial markets, driving capital flows in a direction to the detriment of emerging economies.
In spite of the limited acceleration of developed economies in the reporting period, global growth lost pace due to emerging economies. While the US economy nearly matched its growth rate of the previous year, growth in the Euro zone picked up. On the part of emerging economies, economic slowdown led by China resulted in continued high volatility in global markets, combined with sustained portfolio outflows from these countries throughout the year. As global markets were engulfed in a yearlong discussion about the US Federal Reserve’s (the Fed) liftoff, the Fed raised interest rates in December, thus initiating the normalization process. As weak global growth, appreciated Dollar and absence of supply-driven problems pulled commodity prices down, the same situation aggravated the concerns for commodity exporting countries.
While the bad weather in the US in the early months of the year had a negative impact on growth, the recovery in subsequent months brought the unemployment rate down to 5% at the end of the year. Low commodity prices coupled with the appreciated US dollar resulted in a year-end inflation of 0.7%, notably below the 2% inflation target. The Fed, despite low inflation, projected that the inflation would converge to the targeted levels in the medium term, and increased the rates by 25 basis points to the 0.25%- 0.50% band in its December meeting.
Although economic growth gained momentum in the Euro zone as compared with the previous year, unemployment rates remained high. As inflation stood at a low 0.2% at the end of the year, the European Central Bank (ECB) disclosed new steps for loosening its monetary policy further in its December meeting. Accordingly, ECB announced a 6 month extension of its monthly asset-purchasing program of USD 60 billion to March 2017, and further lowered the already negative deposit rate.
The developments in the Chinese economy were the other important factors that aggravated the volatility in global markets in 2015. While the transformation intended to drive consumption in the economy brought about lower growth rates, steps aimed at the liberalization of financial markets resulted in rigorous sales, in turn leading to a deteriorated risk perception towards emerging economies.
Although the Chinese government devaluated its currency, Yuan, in August, 2015 was the scene to the weakest portfolio inflow to emerging economies after 2008. According to the IMF World Economic Outlook projections revised in January 2016, global growth slipped down from 3.4% in 2014 to 3.1% in 2015. As growth rate dropped from 4.6% to 4.0% in emerging economies led by the Chinese economy, developed economies showed a limited acceleration from 1.8% to 1.9%.
Despite the deteriorated risk perception towards emerging economies and although it has occasionally decoupled negatively from its peers due to political and geopolitical developments, the Turkish economy continued to perform moderately owing particularly to the support from consumption. Economic growth was 3.4% year-over-year in the first three quarters of 2015. While growth was completely driven by domestic demand, external demand contributed minus 0.7 points to growth due to the economic problems experienced by our export partners such as Iraq and Russia, in spite of weak imports and the positive contribution of stronger EU demand to exports. While the declined euro/dollar parity resulted in feeble exports throughout the year, low oil prices produced a sustained downtrend in current account deficit during the course of the year. Cumulative current account deficit, which stood at USD 46.5 billion at the end of 2014, descended to about USD 32 billion in 2015. After going down from 5.8% at year-end 2014 to 5.5% as at the third quarter of 2015, the ratio of current account deficit to GDP slid down to nearly 4.5% at the end of 2015. The reason behind this decline was the reduction in the net energy bill by roughly USD 16 billion (ratio to GDP: 2.2%).
Inflation remained high throughout the year due to food prices that floated at high levels despite favorable weather conditions, combined with the strongly depreciated Turkish Lira as a result of domestic and external uncertainties, and the secondary exchange rate effects that persisted. Having completed 2014 at 8.2%, inflation rose to 8.8% at the end of 2015. Core inflation that excludes food and energy prices, on the other hand, picked up remarkably to reach 9.5% by year-end 2015 with the effect of exchange-rate pass-through, after declining from 8.7% at end-2014 to 7.0% during the course of the year. Food inflation and energy inflation were 10.9% and 3.2%, respectively, at year-end. Inflation remained high in spite of the positive impact of declined energy prices, thus further impairing long-term inflation projections, and resulting in a more remarkably rigid inflation.
The Central Bank of the Republic of Turkey (CBRT) reduced the one-week repo rate (policy rate) by 75 basis points to 7.50% in the first quarter, in view of the developments in inflation, for which it had revised its projections positively given the rapidly declining energy prices at the onset of the year. Due to the subsequently increased volatility in domestic and external financial markets and deteriorated outlook of inflation, however, the CBRT kept the interest rates constant in the rest of the year. The Central Bank preserved the width of the interest rate corridor, keeping the borrowing rate (lower band) at 7.25% and the lending rate (upper band) at 10.75%. On the other hand, the CBRT paved the way for a higher average funding rate by way of liquidity management and caused higher borrowing costs overall. Having declined to even 7.62% in the first quarter, the CBRT average funding rate topped 8% as of April and climbed to 8.8% at the end of the year.
Aiming to simplify its monetary policies, the CBRT issued a roadmap in August, which stated that it would monitor global monetary policies and narrow the width of the interest rate corridor around the policy rate. In its December meeting, the CBRT indicated that it had a second prerequisite to initiate these steps: persistence of the decline in volatility observed in the markets following the Fed’s decision. Hence, the Central Bank adhered to its tight monetary stance discourse, paying regard to elements that would drive inflation upwards such as the minimum wage hike enforced as of the start of 2016 and other price increases.
The developments in the world economy and the CBRT’s actions have been determinant on the market interest rates. After dropping down to 6.8% at the end of January 2015, twoyear benchmark bond rate hiked to 10.8% at the end of the year, as a result of the uncertainties in the second half of the year occasioned particularly by the renewal of the elections and the increased volatility in global markets triggered by China. Besides, TL depreciated by 25% against the US Dollar and by 13% against the EUR-USD currency basket on average throughout the year.
In 2015 that realized two general elections, the public finance performance did not exhibit a significant change as compared with 2014.
The realization of the central government budget in 2015 turned out to be more positive than the targets in the Medium Term Plan (MTP) revised in October. The budget deficit was TL 22.6 billion, remaining below the MTP target of TL 24.5 billion, while the primary surplus was TL 30.4 billion, which was above the MTP target of TL 29.5 billion. In a year of high tax revenue performance, the ratio of the central government budget deficit to the GDP was circa 1.2%, whereas the ratio of the primary surplus to the GDP was about 1.6%.
On the other hand, the ratio of EU-defined public debt stock to the GDP, although showing an uptrend during the course of the year, declined in the last quarter of 2015 according to the Government’s projections and registered 32.6%. The ratio was 34.6% as of September 2015.