Tuesday, 24 Apr 2018

Turkey: double-digit growth, the tree that hides the forest?

For Turkish President Recep Tayyip Erdogan, the growth of 11.1% in the third quarter of 2017 makes Turkey the fastest growing economy in the world and nails its detractors.

But economists are worried that this growth – the highest in six years for Turkey, which is in front of India and China over the same period – hides potential risks.

Inflation has last month reached 12.98% and the Turkish lira has lost about 11% of its value since September while the current account deficit is widening.

With the explosion of the construction sector thanks to low-interest loans and high public spending, the economy is at risk of overheating.

“The economy is growing well beyond its long-term potential, which is the very definition of overheating, of which inflation at 13% is another sign,” says Selva Demiralp, associate professor of economics at Koç University of Istanbul.

Current inflation figures are very far from the central bank’s target of 5%.

– ‘Resistant’ economy –

Erdogan announced this week that Turkey will grow by 7.5 percent annually in 2017, an estimate that approximates that of many economists.

The popularity of the president since his party came to power in 2002 is largely based on the effectiveness of its economic policies that helped rebuild the economy after the 1999-2000 crisis.

With the current account deficit rising to more than 5% of GDP in the medium term, “uncertainties around the economy will continue”, according to Deniz Ciçek, an economist at QNB Finansbank.

But an economic adviser to President Erdogan, Hatice Karahan, Tuesday described the Turkish economy as being “very resilient”. It has indeed overcome many events in 2016, including a failed coup, with growth mainly driven by domestic demand.

Karahan admitted, however, during an interview with foreign journalists in Istanbul, that growth must be done in a way that also faces “the problem of unemployment”, which reached 10.6% in August, and that inflation is “clearly above objectives”.

– Volatility –

Another source of concern for Ankara is the trial, currently underway in New York, targeting a Turkish banker accused of violating US sanctions against Iran.

A former government ally who became the key witness in the trial, Turkish-Iranian gold magnate Reza Zarrab, pleads guilty in this case in which he also implicated Mr. Erdogan.

According to Mr Ciçek, “an unfavorable result in this case could further extend diplomatic relations with the United States, which would further increase the volatility of the financial markets”.

Deputy Prime Minister Mehmet Simsek assured the markets that Ankara would support Turkish banks to prevent any threat to the financial sector.

“There will probably be fines (against Turkish banks), but unless there is an investigation in Turkey, which will not happen, it will probably be just another storm Erdoğan and the (party) in power) will sweep away, “said Nigel Rendell, an analyst at Medley Global Advisors.

– Generalized crisis? –

A generalized crisis, however, is far from inevitable and the central bank will have the opportunity on Thursday to restore confidence in the Turkish lira with a much-awaited decision on interest rates.

An increase of 100 basis points is expected, but analysts believe that only an increase of 400 basis points would be enough to convince markets that Ankara is serious about fighting inflation and supporting the Turkish lira.

“If the rates are only increased by 100 basis points (…) we can be certain of a further weakness of the currency, even if there is no generalized crisis in the coming year” says Rendell.

Economists say the central bank’s room for maneuver is limited, with Erdogan routinely arguing against the logic of raising interest rates to counter inflation, while he himself calls for lowering them.

QNB Finansbank does not expect a crisis in 2018, even though the Turkish economy presents “a risk of slowing down”, according to Mr. Ciçek

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