Macroeconomic Stability and Growth Perspectives of the Turkish Economy

1. Macroeconomic Stability and Growth Perspectivesof the Turkish Economy Prof. Dr. Seyfettin Gursel Betam, Director Bahçeşehir University Center for Economic and Social Research PEI Turkey Forum 2010, İstanbul

2. Outline • Strong recovery • Can high growth be sustainable? II.a-High growth is sustainable in the short run II.b- Low growth regime in the medium term • Long term growth perspectives PEI Turkey Forum 2010, İstanbul

3. I. Strong recovery • Consumption driven recovery • Investment followed with one quarter lag • Inventory changes played a crucial role • Fiscal stance remained tight • Net Exports returned to its structural negative contribution PEI Turkey Forum 2010, İstanbul

4. I. Strong recovery • Very strong start but rapid decrease of QoQ growth • Sudden acceleration from Q1 to Q2 PEI Turkey Forum 2010, İstanbul

5. I. Strong recovery Two facts should be pointed out about 2nd quarter growth 1) Fiscal stance has been relaxed 2) Contribution of Net Exports turned positive (a temporary reversal?) PEI Turkey Forum 2010, İstanbul

6. II. Can high growth be sustainable? Yes, in the short run (6 to 9 months), because; • Political stability is secured • Consumption will be increasingfollowing its structural growth path • Private investment will be encouraged by high growth perspectives and increasing capacity utilization. • Enough room for fiscal expansion No change in Central Bank policy interest rate is expected and Istanbul Stock Exchange (ISE) is expected to follow an increasing trend. PEI Turkey Forum 2010, İstanbul

7. II.a- High growth is sustainable in the short run Political stability is secured • A strong “Yes” (58%) in the 12th of September Referendum suggests that AKP government will maintain its majority in the parliament after the general elections, expected to be held in May-June 2011 • Indeed, a 9 percent difference between AKP and CHP votes in the elections is enough to secure a majority to AKP in the parliament. • Surveys estimate AKP votes to be around 40% and CHP votes to be around 28% at best. • Strong recovery is filling AKP’s sails. • Threats to AKP’s ruling that stemmed from the Army and the High Court is out of agenda -- at least in the medium term. PEI Turkey Forum 2010, İstanbul

8. II.a- High growth is sustainable in the short run Consumption willfollow its structural growth path, moving upward • There is still room for consumer confidence to get stronger • Political stability perspective is likely to boost consumer confidence • Credit crunch is over, credit availability is increasing, thanks to strong capital inflows PEI Turkey Forum 2010, İstanbul

9. II.a- High growth is sustainable in the short run Consumption willfollow its structural growth path, moving upward PEI Turkey Forum 2010, İstanbul

10. II.a- High growth is sustainable in the short run Consumption willfollow its structural growth path, moving upward • Average real consumption growth between 2003 (1) and 2010 (2) is 3.9 %. • Consumption growth is expected be arround4 % for the next few quarters. PEI Turkey Forum 2010, İstanbul

11. II.a-High growth is sustainable in the short run Strong recovery of private investment will continue • Capacity utilizationis still low, but rapidly recovering • Investors’ confidence came back. • Political stability perspective is likely to boost investor confidence • Credit crunch is over, credit availability is increasing, thanks to strong capital inflows PEI Turkey Forum 2010, İstanbul

12. II.a- High growth is sustainable in the short run Enough room for fiscal expansion: 2 remarks should be pointed out • Public debt ratio will be decreasing • Strong increase in tax income due to high growth & moderate increase expenditures Allows for a limited amount ofelectoral spending in 2011 PEI Turkey Forum 2010, İstanbul

13. II. Can high growth be sustainable? No, not in the medium term (1 to 2 years) Because of weaknesses in two macroeconomic fundamentals; inflation and current account balance • Price stability is not achieved yet • Structural current account deficit (CAD) can reachunsustainable levels due to energy price hikes A low growth regime (~4%) is very likely in the medium term PEI Turkey Forum 2010, İstanbul

14. II.b- Low growth regime in the medium term Price stability is not achieved yet • The inflation gap between Turkey and developed countries is still high (~5%) as well as the nominal interest rate differential PEI Turkey Forum 2010, İstanbul

15. II.b-Low growth regime in the medium term CAD can reachunsustainable levels due to energy price hikes • Structural current account deficit is widening with increase in energy prices, except during recessions PEI Turkey Forum 2010, İstanbul

16. Exchange rate risk is low, as well as default risk II.b- Low growth regime in the medium term CAD can reach unsustainable levels with the appreciating TL • Capital inflows cause an appreciation in TL(stability paradox) • Appreciation of TL causes imports to increase and exports to decrease by eroding Turkey’s competitiveness,worsening the CAD. PEI Turkey Forum 2010, İstanbul

17. II.b- Low growth regime in the medium term Turkish industry suffers from low competition power due to • Relatively developed welfare state (high labor costs) • Bad quality of tax system (indirect tax weight too high, no room for cost reduction) • Insufficient high tech content of exports (poor human capital at average) • TL prone to appreciation (stability paradox) CAB adjustments done through exchange rate shocks, lowering average growth rate

18. II.b- Low growth regime in the medium term Low growth is unavoidable because, • Domestic demand driven growth will reach its limit closing the output gap; so TRCB policy rate will start to increase. • As long as price stability is not achieved monetary policy will be tight and interest rate differential cannot be reduced; so “hot money” inflows, appreciating TL, will be the main tendency. • Until the price stability is reached, exchange rate cannot be used as a competitiveness tool; so Net Exports’ contribution to growth will remain negative. • Widening CAD will provoke an exchange rate shock, sooner or later causing more pressure on the interest rates. A severe correction of ISE ballooned by high growth optimism is very likely to occur after general elections. PEI Turkey Forum 2010, İstanbul

19. III. Long term growth perspectives Let’s make three remarks before discussing the structural issues of growth, • Low growth (~4%) is sufficient for moderately increasing equityvalues • But not sufficient for social cohesion as unemployment and poverty would be increasing • Also, not sufficient for rapid catch up with EU, making Turkey less attractive and more problematic for membership Political instability risk would be increasing. PEI Turkey Forum 2010, İstanbul

20. III. Long term growth perspectives In order to put Turkish economy on its potential growth path, estimated at 5-6%, one needs the realization of two basic factors • Making Turkish industry more competitive • Profiting from the opportunity offered by energy rich neighbors PEI Turkey Forum 2010, İstanbul

21. III. Long term growth perspectives Making Turkish industry more competitive needs: • Cost reducing reforms (labor market, energy saving, market efficiency..) • Productivity enhancing reforms (education, R&D) • Policies to develop new brands and new goods to export • A more stable real exchange rate A powerful government within a stable democratic regime PEI Turkey Forum 2010, İstanbul

22. III. Long term growth perspectives Profiting from the opportunity offered by energy rich neighbors • Beside competition reforms,a complementary way to reduce the CAD and increase growth is to havean export boom to Russia, Iran and Iraq. PEI Turkey Forum 2010, İstanbul

23. Long term growth perspectives This export boom involves political as well as strategic issues; • Partly out of control of Turkey (embargo on Iran, stability of Iraq) • Partly implying very painful and risky strategic choices for Turkey (How to do strategic partnerships with these countries without loosing EU perspective and Nord Atlantic Alliance) PEI Turkey Forum 2010, İstanbul

24. Thank you PEI Turkey Forum 2010, İstanbul