When the IMF issued a public warning about the Turkish economy last month, one of President Recep Tayyip Erdogan’s senior advisers took umbrage. Cemil Ertem said its call to tame inflation and rein in spending were “failed economic theories” peddled by “dinosaurs”. He concluded: “We are going to do the exact opposite.”
That is precisely the scenario that worries many economists. Turkey defied expectations last year with an estimated 7 per cent annual GDP growth. It was helped by government incentives aimed at propelling the economy out of a decline after the violent coup attempt in July 2016. But that growth has come at a cost.
Recent weeks have seen a flurry of warnings about Turkey’s widening current account deficit and persistent double-digit inflation. The IMF cautioned that the country was vulnerable to changing global conditions.
Moody’s downgraded Turkish sovereign debt to two notches below investment grade, citing concerns about the country’s political climate and a heavy reliance on foreign financing. Goldman Sachs said Turkey was showing the “classic signs of an overheating economy”, warning that rebalance would require lower growth.
Now with elections in his sights, some investors fear Mr Erdogan is unwilling to tolerate a slowdown, an approach that some fear increases the risk of a hard landing.
The ruling Justice and Development Party (AKP) has built its political success on the back of increased prosperity.
With elections scheduled for March and November 2019, the president and his officials have made clear that they want 5.5 per cent growth this year.
“There is only one priority for Ankara and that’s growth at last year’s wild pace,” says Murat Ucer, adviser for Turkey at GlobalSource Partners, a consultancy. “There are big questions about whether that is possible. Even if it is possible, what kind of vulnerabilities would it create? In Turkey, there is a very clear trade off between growth and vulnerability.”
Last year confounded all expectations for the emerging market economy.
Following a sharp, one quarter contraction after the failed coup, the country bounced back. In the third quarter of last year, growth was 11.1 per cent — faster than any other G20 economy.
Such stunning figures were aided partly by the low base from the previous year.
But strong growth in Europe also helped to boost Turkish exports. Consumer spending and construction were fuelled by a government-backed loan scheme, employment incentives and tax breaks.
The worry now is that growth has created imbalances. Core inflation stands at almost 12 per cent. Data released last week showed the current account deficit widened to $7.1bn in January, with a rolling 12-month figure equal to 6.1 per cent of GDP at the official 2018 forecast.
To finance the gap, Turkey relies heavily on short-term flows of money that could quickly evaporate if sentiment towards the country shifted. For now, Turkey’s attractive returns and an appetite for risk among investors has kept the funds flowing. But the country’s uneasy relationship with the US, its military intervention in Syria and its tense domestic politics all pose risks.
So too do changing global monetary conditions as central banks move to normalise policy after years of historically low interest rates.
“When we are talking about how many hikes the [US Federal Reserve] will deliver, how soon ECB will end its easing, this is not a good moment for an emerging market economy to have a wide current account deficit and high inflation,” says Inan Demir, senior emerging markets analyst at Nomura. “It could be a big problem if global liquidity conditions deteriorate, or if Turkey has problems attracting external financing because of political or geopolitical risks.”
The concerns are exacerbated by anxieties about the country’s political leadership. Moody’s cited “faltering institutional strength” as a primary driver of its downgrade, singling out pressure on the judiciary and Mr Erdogan’s drive to expand his own powers.
A main worry among investors is the independence of the central bank, which Mr Erdogan frequently harangues.
The Turkish president has long been a fierce critic of high interest rates, taking the unconventional view that they lead to high inflation. Last month, he repeated this stance. “We will make no concessions, we will reduce rates,” he said.
So far, the bank has compromised by keeping rates on hold but compelling banks to borrow using the late liquidity window rate of 12.75 per cent.
The worry is that, if there is a shift in sentiment, the central bank will not be sufficiently quick on its feet. With the lira sinking to three-month lows against the dollar and all-time lows against the euro, Dutch lender Rabobank warned recently that the central bank “may opt for a relatively modest hike at the time when rates are already generally perceived as too low”.
Hatice Karahan, an economics professor and adviser to Mr Erdogan, plays down the prospect of a sudden halt in the flow of foreign funds. “Even in the worst-case scenario I would not expect any drying up in the capital flows,” she says.
In the event of a slowdown, she insists that the central bank will do whatever is necessary. “If they find that rate hikes are needed, then they do it,” she says.
Ms Karahan has earned the respect of international analysts, who see her as more mainstream than the IMF-bashing Mr Ertem or Yigit Bulut, another economic adviser, who once claimed that foreign powers were trying to use telekinesis to kill the Turkish president.
Many, however, question her influence. The concern is that, despite a cadre of well-respected technocrats across key ministries, more eccentric voices around the Turkish president will drown out their advice.
“Yes, President Erdogan has strong views about interest rates,” says Ms Karahan, adding: “I strongly believe that the central bank is independent.”
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