Turkey regular economic note

Turkey Regular Economic Note 2014-2  Weaker domestic demand is projected to slow real GDP imports offset the positive impact of the recovery in the EU and growth to 2.4 percent in 2014 from 4.0 percent in 2013. the increase in tourism revenues. Adjusted for net gold sales, the CAD stood at $51.4 billion (6.3 percent of GDP) in 2013, marginally  Turkey’s fiscal and financial sector buffers are sufficient to below the 2012 level. Net FDI inflows amounted to only 15 percent ward off further possible shocks to investor confidence in of total current account deficit financing in 2013 whereas the share of portfolio and other short-term inflows in total financing reached spite of the country’s large external financing needs. 46 percent. Rollover rates for external debt of financial and non- financial companies (excluding Eurobond issuances) remained  Measures to promote transparency and good governance in high at 208.8 and 99.8 percent, respectively. Although borrowing the short term can help build investor confidence. Renewed costs increased in the wake of tighter global liquidity and domestic structural reform will be critical to maintain competitiveness political uncertainty, Turkish firms’ access to external financing and return to stronger growth over the medium term. remained solid. Economic growth recovered in 2013 thanks to strong domestic Exchange rate depreciation kept inflation well above the demand. The economy expanded by 4.0 percent y-o-y in 2013 Central Bank’s (CBRT) 5 percent target. The 12-month inflation up from 2.1 percent in 2012, on the back of stronger private rate increased to 7.9 percent in February compared to 7.0 percent consumption, public investment and inventory build-up. The in the same month of last year. Over the same period, 12-month contribution of domestic demand to headline growth was 6.4 core inflation (CPI-I, which excludes food, tobacco, alcohol, gold percentage points (pps) while net exports subtracted off 2.3 and energy prices) rose sharply from 5.8 percent to 8.4 percent, pps. Notably, after declining for six consecutive quarters, private the highest level in six years. As illustrated by an 11.9 percent y-o-y investment grew by 3.6 percent in the third quarter and 4.9 percent increase in durable goods prices, exchange rate pass-through was in the fourth quarter. In seasonally adjusted terms, there was some one of the main factors behind these increases. momentum loss in the final quarter of the year with q-o-q growth easing 0.5 percent from 0.8 in the third quarter and 2.0 percent in After substantial volatility at the end of 2013, financial markets the second quarter. Meanwhile, per capital GDP reached $10,782 have calmed down since the central bank’s interest rate increase up from $10,459 in the previous year. in January 2014, along with a return to more conventional monetary policy. In the wake of heightened domestic political The current account deficit (CAD) widened significantly in uncertainty, the Turkish lira depreciated by 14.8 percent between 2013 mostly due to a large decrease in net gold exports. December 17th and January 27th and reached a record low of 2.34 The CAD amounted to $64.9 billion (7.9 percent of GDP) in 2013 per US dollar. The CBRT’s initial response to capital outflows was up from $48.5 billion (6.2 percent of GDP) in 2012, as large gold to increase the number of additional monetary tightening days Figure 1. GDP growth and contributions Figure 2. The current account deficit and composition of financing million $ Percentage Current Account Deficit 80000 0.20 FDI and Long-Term Inflows 70000 0.15 Portfolio and Short-Term Inflows 60000 0.10 50000 0.05 40000 0.00 -0.05 30000 -0.10 20000 Net Exports -0.15 Domestic Demand 10000 GDP Growth -0.20 0 -0.25 -10000 20 9 Q2 0 2 0 3 4 0 3 20 09 Q4 0 2 0 3 4 09 1 2 20 8 Q 1 1 2 10 3 4 1 3 4 1 2 20 7 Q 1 13 3 4 1 1 20 1 Q2 12 1 20 1 Q3 4 1 1 20 08 Q 1 1 20 07 Q 20 9 Q 20 8 Q 20 8 Q 20 Q 20 10 Q 20 12 Q 20 7 Q 20 7 Q 20 13 Q 20 0 Q 20 Q 20 2 Q 20 2 Q 20 0 Q 20 11 Q 20 Q 20 3 Q Q 20 3 Q 20 1 Q Ap 09 Ap 08 Ju 09 Ja 09 Ju 08 Ja 08 Ap 07 Ju 07 Ja 07 Ap 10 Ap 12 14 Ju 10 Ja 10 Ju 12 Ja 12 Ap 13 O 09 Ju 13 Ja 13 O 08 O 07 Ap 11 O 10 Ju 11 Ja 11 O 12 O 13 O 11 n r ct n n n n r ct r ct r ct l n n n 0 r ct l r ct l r ct l 0 0 1 1 l l l 1 Ja 20 Source: TÜRKSTAT Source: TÜRKSTAT  Selected Economic Indicators   2013 2014 2015 2016 2017 Real GDP growth rate (percent) 4.0 2.4 3.5 3.9 4.2 Consumer price inflation (end period, in percent) 7.4 7.8 6.2 5.0 5.0 Public sector primary balance (in percent of GDP) 0.9 0.6 1.2 1.0 0.9 Gross public debt (in percent of GDP) 40.0 39.1 37.8 36.6 35.1 Current account balance (in billions of US dollars) -64.9 -50.6 -56.9 -57.0 -58.4 Current account balance (in percent of GDP) -7.9 -6.4 -7.0 -6.8 -6.7 Gross external debt (in percent of GDP) 47.3 48.4 49.1 49.5 49.8 Foreign exchange reserves (in billions of US dollars) 110.3 108.9 109.8 115.6 122.3 Source: World Bank staff projections, TURKSTAT, CBRT, Undersecretariat of Treasury and intervene in the exchange rate market by selling more than Looking two to three years ahead, Turkey may have to settle $9.5 billion (between December 17th and January 28th) despite a for a period of modest growth, as higher global interest rates relatively low level of net reserves ($41.5 billion as of end-February). and risk re-pricing increase the cost of external financing. In Yet, these measures failed to contain market pressures and in late our baseline scenario, we assume Turkey is able to finance a current January the bank returned to a more conventional monetary policy account deficit of about 6.7 percent of GDP, albeit at higher cost. framework, increasing its policy rate (1-week repo) by 550 basis Assuming only modest declines in global energy prices, this deficit points. As a result, the weighted average cost of CBRT funding level is in line with a growth rate of close to 4 percent in the medium increased from 7.2 percent before the hikes to the current level of term. Meanwhile, inflation is projected to ease towards the official 10.2 percent. Financial markets have settled following this decision target of 5 percent in the medium term, helping limit real exchange with the lira appreciating to around 2.14 per US dollar in the rate appreciation. aftermath of the local elections. Should depreciation pressures re- emerge, we think that the CBRT has still room for further tightening. Turkey’s dependence on external financing and the corporate The fiscal deficit narrowed considerably in 2013 and early sector’s large open foreign exchange position are the main results for 2014 indicate continued improvement. In line risks to the baseline economic outlook. Turkey’s external with the budget target, the central government budget deficit financing needs amount to about $210 billion (27 percent of GDP) narrowed to 1.2 percent of GDP in 2013 from 2.1 percent in 2012. in the coming 12 months and are likely to remain high over the Tax revenues increased by 8.8 percent y-o-y in real terms in 2013 medium term. Further depreciation of the lira could strain the accounting for almost 80 percent of the deficit reduction. Solid balance sheets of corporates with large FX liabilities which in turn budget performance has continued in the first two months of could have spill-over effects on the banking sector and the labor 2014 and the year-to-date budget surplus reached TL3.6 billion market, especially through the construction sector. These two risks ($1.6 billion). The expected slowdown in domestic demand is likely are largely offset by solid fiscal balances and a well-capitalized to affect revenue performance and budget balances could thus banking sector, keeping the risk of an imminent crisis low. deteriorate going forward. However, the special consumption tax increase at the beginning of 2014 will limit this deterioration while Measures to promote transparency and good governance low public debt levels should allow the government to absorb could help build investor confidence and lower risks in the short shocks to domestic demand. term, while over the medium term renewed structural reforms Economic growth is likely to slow significantly in 2014, with will be critical for growth. Recent government efforts to increase high inflation but a narrower current account deficit. Political transparency have focused on independent financial audit and uncertainty, the sharp depreciation of the lira, and monetary and investor protection, but additional steps are needed to strengthen macroprudential tightening have negatively affected consumer the rule of law and public sector governance. Medium-term confidence since the beginning of the year. Thus, private structural reforms have been outlined in the Government’s 2014- consumption is estimated to lose considerable momentum, 18 Development Plan and comprehensively cover competitiveness, while the incipient recovery in private investment is likely to be inclusion and sustainability challenges. Particular efforts are needed interrupted. The weaker lira and a further pickup in EU demand to increase Turkey’s attractiveness to FDI, given the country’s should help support exports but this is unlikely to offset the financing needs and the potential for technological upgrading that slowdown in domestic demand. All in all, we forecast growth to foreign investment can bring. Additionally, important reforms on ease to around 2.4 percent in 2014, with a reduction in the current the government’s agenda this year include the adoption of a new account deficit to 6.4 percent of GDP. Inflation is projected to stay Employment Strategy to make labor markets more flexible and the above the target interval, driven by the exchange rate pass-through enactment of a new income tax law to simplify the tax system. and increases in unprocessed food prices.