MEDIUM TERM PROSPECTS FOR TURKISH ECONOMY 16 OCTOBER 2017 WASHINGTON, DC

MEDIUM TERM PROSPECTS FOR TURKISH ECONOMY 16 OCTOBER 2017 WASHINGTON, DC

Medium Term Prospects for Turkish Economy Government officials in Turkey announced the new Medium Term Economic Program for the period 2018-2020. The program includes targets for some main macroeconomic indicators and tries to give an idea about the stance of fiscal policy over the next three years. The government projects that the economy will achieve a 5.5% annual GDP growth over the next three years and the unemployment rate which is currently at 10.2% will go down to 9.5% by 2020. The program estimates that the current account deficit, which is forecasted to reach 39.2 billion dollars by the end of this year, will show a small increase during the program period and will be 41.9 billion dollars by the end of 2020. The government has a fairly optimistic target for inflation in the medium term, which currently stands, at double-digit levels. According to the new economic program the inflation rate will gradually go down and will reach to 5% by 2020. The solid fiscal balance and low government debt have been one of the strongest aspects of Turkish economy over the past several years. The medium term economic program forecasts that the precautionary stance in fiscal policy will continue over the next three years and public sector borrowing requirement as a percentage of GDP which is estimated to be 2.4% this year will gradually go down during the program period and will be 1.3% by the end of 2020. The new economic program for Turkey presents a positive picture in the medium term with relatively strong GDP growth, declining inflation, and strong fiscal balances. The question is whether the government will be able to achieve these targets and whether the projections for different macroeconomic indicators are consistent with each other. Turkish economy realized a very rapid recovery after the 2007-2008 global financial crisis due to its strong banking sector and low indebtedness of households and private sector. According to the recently revised data the average annual GDP growth during the period Caspian Policy Center www.caspianpolicy.org info@caspianpolicy.org 1

2010-2016 has been 6.7%. After experiencing a negative GDP growth in the third quarter of 2016 due to the July 15 th failed coup attempt, the economy showed a strong recovery during the first half of 2017. The economy grew by 5.1% in the first half of this year and it is estimated that the second half GDP growth will at least as good as that of first half. The incentives that are provided by the government played a very important role in the strong GDP growth observed in the first two quarters of this year. Besides increasing expenditures, the 12 10 8 6 4 2 0-2 Quarterly GDP Growth 2012Q1 2012Q2 2012Q3 2012Q4 2013Q1 2013Q2 2013Q3 2013Q4 2014Q1 2014Q2 2014Q3 2014Q4 2015Q1 2015Q2 2015Q3 2015Q4 2016Q1 2016Q2 2016Q3 2016Q4 2017Q1 2017Q2 government introduced a tax cut for the furniture and white goods industries to stimulate domestic demand and provided large incentives for firms that will generate new employment. The fiscal capacity of the Credit Guarantee Fund (KGF) which is a state institution that provides access to financing for SMEs that cannot benefit from bank loans due to insufficient collateral, by assisting them as a joint guarantor was largely increased. The volume of total credit that has been extended in the context of the KGF has exceeded 200 billion Turkish Liras and this gave a significant stimulus to private investment spending particularly in the second quarter of this year. All these government incentives have made a large contribution to economic growth in the first half of the year but at the expense an increased budget deficit. In the first half of 2017 the domestic debt rollover ratio has reached to 114% which is the highest level seen over the past decade. Although the budget deficit is still not at an alarming point and the government debt to GDP ratio is at low levels the increased public sector borrowing requirement is putting an Caspian Policy Center www.caspianpolicy.org info@caspianpolicy.org 2

upward pressure on interest rates and this poses a threat for future economic growth. The 5.5% annual GDP growth forecast over the next three 120,0% 100,0% 80,0% 60,0% 40,0% Domestic Debt Rollover Ratio 103,0% 92,0% 82,0% 76,0% 114,0% years is not an unrealistic 20,0% assumption but this might 0,0% cause a further deterioration in government budget and the targets for fiscal balances may not be achieved. Another important point about the new economic program is about the forecasts for current account deficit. Despite the relatively strong economic growth forecast the government expects to see a very small increase in current account deficit in the medium term. It has been seen in the past that there is a very strong positive correlation between economic growth and current account deficit for Turkish economy. For instance, in 2017 the GDP growth is expected to be 5.5% and the new economic program estimates that the current account deficit will be 39.2 billion dollars by the end of the year. The Annual Current Account Deficit (Billion Dollars) current account deficit was 32.6 billion dollars in 2016 40,0 35,0 30,0 30,3 32,6 35,6 37,1 when the economy grew by 25,0 20,0 3.2%. This provides us evidence that with current economic conditions a 5.5% GDP growth may cause a current account deficit that is larger than the projected one unless the economy is hit by a positive external shock like a further decline in oil prices. Therefore, in order to achieve the economic growth targets that are Caspian Policy Center www.caspianpolicy.org info@caspianpolicy.org 3

mentioned in the program the government needs to formulate a growth path that will ensure a limited increase in current account deficit. The program includes some macroprudential policies that aim to increase exports and national savings which will lead to a structural improvement in current account balance. Whether GDP growth and current account deficit targets will be achieved at the same time depends on the success of these policies. Projection about the inflation rate is another important aspect of the medium term economic program. Inflation reached to double digit levels at the beginning of this year and still shows persistence. Depreciation of Turkish Lira that has been observed over the last 12 months, increase in food prices, and the recovery in domestic demand might be listed as some factors that caused the inflation rate to reach the double digit level which was last seen in 2012. The government expects that inflation rate will gradually decline over the next three years and will be 5% in 2020. The support of monetary and fiscal policies is a necessary but not a sufficient condition 14,00 12,00 10,00 8,00 6,00 4,00 2,00 0,00 Annual Inflation Rate January February March April May June July August September October November December January February March April May June July August September for fighting with inflation in Turkey. If the government wants to achieve the 5% inflation target there needs to be some structural changes especially on the supply side. The economic program includes some measures particularly for reducing food prices and creating a positive contribution to inflation target from this side. Whether the government will be able to achieve medium term inflation targets will significantly depend on the success of these policies and the stance of monetary and fiscal policies. To sum up, the new medium term economic program presents an optimistic outlook for Turkish economy over the next three years. However, some macroeconomic targets that are Caspian Policy Center www.caspianpolicy.org info@caspianpolicy.org 4

listed in the program may be achieved at the expense of other targets. The government should set a strong structural reform agenda in order to give a solid signal that all these targets are consistent with each other. Caspian Policy Center (CPC) is an independent, nonprofit research think tank based in Washington D.C. Economic, political, energy and security issues of the Caspian region constitute the central research focus of the Center. The Caspian region, at the crossroads of the East and the West, is increasingly becoming a crucial area of global interest with its rich natural resources, geopolitical rivalry and economic development. Established in 2016, the Center aims at becoming a primary research and debate platform in the Caspian region with relevant publications, events, projects and media productions to nurture a comprehensive understanding of the intertwined affairs of the Caspian region. With an inclusive, scholarly and innovative approach, the Caspian Policy Center presents a platform where diverse voices from academia, business and policy world from both the region and the nation s capital interact to produce distinct ideas and insights to the outstanding issues of the region. Caspian Policy Center www.caspianpolicy.org info@caspianpolicy.org 5