Turkey’s battered economy is set to leave recession later this month thanks to a politically-driven surge in bank lending and public spending — but analysts warn that key vulnerabilities remain unaddressed and the recovery is likely to be shortlived.
Growth figures due to be published at the end of May are widely expected to show that the country emerged from its first contraction in a decade in the first quarter of 2019. The bounce has been mainly driven by President Recep Tayyip Erdogan’s bid to try to limit the economic pain for voters in the run-up to elections held in March, via a government spending splurge and a lending spree by state-owned banks.
But as the political stimulus push fades, analysts are forecasting that a “double-dip” recession will take hold in the coming months.
Mr Erdogan and his ministers took steps to try to limit the risk of a voter backlash in the early months of this year as nationwide municipal elections loomed and the economy reeled from the lira’s almost 30 per cent depreciation in 2018.
State banks which had scaled back their activity last year following the shock caused by the dramatic currency crisis were encouraged to sharply increase lending in the run-up to the elections, and they faced pressure to lower their rates. The government also adopted stimulus measures including tax cuts and employment incentives.
Although the steps failed to stop the opposition from claiming victory in Ankara, Turkey’s capital, and Istanbul, its largest city, they have had some economic impact. Modest but better than expected upticks in industrial production, retail salesand job creation have forced many analysts to revise their growth expectations upwards.
The country’s finance minister, Berat Albayrak, recently declared that the worst was now in the past. “The light at the end of the tunnel has begun to grow,” he told a Turkish broadcaster last week.
Goldman Sachs analysts Clemens Grafe and Murat Unur predict that the first-quarter figures will show a 1.3 per cent quarter-on-quarter expansion, after a contraction of 2.4 per cent in the preceding quarter.
The pair warn, however, that this “positive surprise” is not sustainable, and forecast another slump in growth.
“I think that in the second quarter, political uncertainty and financial market volatility will weigh again,” said Inan Demir, an economist at the Japanese bank Nomura. “It might be a sort of double-dip in economic activity.”
The path back to strong growth will be difficult and painful, analysts say, and Turkey’s policymakers have limited room for manoeuvre.
Inflation has remained stuck at close to 20 per cent in recent months. That problem, combined with renewed pressure on the currency, has forced the central bank to keep its benchmark interest rate at a sky-high 24 per cent, damping investment.
The capacity for government stimulus is limited given the sharply deteriorating budget deficit, which has endangered Turkey’s hard-won reputation for fiscal discipline during Mr Erdogan’s 16 years at the helm.
At the same time, the government stands accused of seeking to prop up the currency by burning through the central bank’s foreign currency reserves.
That move, combined with the risk of looming US sanctions and the fresh political uncertainty triggered by a rerun of the disputed Istanbul mayoral election, have spooked both foreign investors and locals; the lira has lost 12 per cent of its value against the dollar this year.
“The weaker lira and higher market interest rates will weigh on the near-term growth outlook,” said Ugras Ulku, an economist at the Institute of International Finance, a Washington-based think-tank. “Any further lira weakness will likely have a contractionary impact on activity through reduced corporate profits and the negative impact of a weaker lira on business and consumer sentiment.”
Selva Demiralp, a professor of economics at Istanbul’s Koc University, said the fundamental problem was Turkey’s large corporate debt burden and its impact on the banking sector, which is carrying an increasing volume of non-performing loans.
“Until we clear out these problems, we can’t say the Turkish economy has hit the bottom yet,” she said.
Turkish companies lapped up a wave of foreign capital that washed into emerging markets after the global financial crisis. But the debt — including $285bn in foreign currency loans — has become increasing difficult to service as the Turkish lira has weakened.
Mr Albayrak, the finance minister, promised a plan to tackle bad debt in the beleaguered energy and construction sectors, and to inject TL28bn ($4.7bn) into Turkey’s state banks. But the details have yet to be unveiled.
Ms Demiralp stressed the need to act quickly to clean up balance sheets. “These are necessary steps to re-establish confidence in financial markets and get the ball rolling again,” she said.
Turkey’s dependence on foreign financing makes it highly susceptible to shifts in investor sentiment. Market volatility in recent weeks has triggered renewed talk about the need to seek help from the International Monetary Fund — a prospect that Mr Erdogan has repeatedly ruled out.
Brad Setser, a senior fellow at the Washington-based Council on Foreign Relations, said Turkey’s position was “fragile”.
“If Turkey battens down the hatches, slows credit and accepts a period of deleveraging, then there’s a scenario where [it] can muddle through for the next year or so,” he said.
But, he warned, “if it continues to try to support activity by putting pressure on banks to increase lending, by trying to informally hold deposit rates down and lending rates down, and continues to use its reserves to limit depreciation pressure, it runs the risk of leaving itself vulnerable to a quite significant crisis”.
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