New economy team, same old uncertainties
We take the view, albeit with limited confidence, that the country’s new economic management team will give priority to correcting the macro imbalances in 2021, rather than stimulating domestic demand further. Under our base-case scenario, we expect economic activity to contract in 1H 2021 in sequential terms, the pressure on the balance of payments to ease and headline inflation to slow from May-June 2021.
That said, this outlook remains subject to the uncertainty around President Erdogan’s tolerance for high interest rates and slow growth, especially against the backdrop of an average real GDP growth rate of about 1.5-2.0% over the past three years and the reported decline in voter support for his ruling alliance during this period. It also remains uncertain whether President Erdogan will allow a further tightening of monetary policy in the near term in the case the predominantly upside risks to inflation materialize.
No comprehensive reform program
Notwithstanding the corrective steps taken so far, we note that the new economic management team appears to be far from pursuing a comprehensive and coherent program that would address the country’s fundamental vulnerabilities. Such a program should at least (i) comprise credible stress-testing of the banking sector’s balance sheet, following last year’s rampant credit growth and the impairment in the non-bank corporate sector’s balance sheet driven by the lira’s depreciation, and (ii) address the sharp deterioration in the public sector’s balance sheet (including that of the central government and the central bank) over the past couple of years.
In the absence of a comprehensive and coherent macro program, we find it unlikely that the rating agencies will consider upgrading Turkey’s sovereign credit rating in 2021.
Economic activity is likely to slow in the near term and the pressure on the balance of payments to ease
We estimate that full-year real GDP growth was probably 1.5% in 2020, although it was accompanied by significant imbalances, including a sharp loss of the central bank’s reserves.
The statistical carry-over to 2021 real GDP growth is likely to be strong, at around 4.5-5.0pps, but the partial lockdowns in response to a renewed wave of virus infections, alongside the tightening of monetary policy that has taken place since August, might lead to a contraction of domestic demand in 1H. We are working with a real GDP growth forecast of 3.4% for 2021, which embeds a technical recession in 1H and a rebound in 2H.
Against this backdrop, we expect the current account deficit to narrow in 2021 to 1.4% of GDP from an estimated 5.4% of GDP in 2020, also supported by a potential turnaround in tourism receipts in 2H.
As the constructive market sentiment toward the new policymaking team continues in the near term, cross-border capital inflows will also support the balance of payments.
CBT reserve accumulation in doubt
However, it remains to be seen whether the balance of payments dynamics and the residents’ currency preferences will allow the central bank to replenish its reserves in 2021. The central bank’s net foreign assets, adjusted for its forward book, appear to have stabilized at -$57-58bn since end-October, but they are sharply down from about $18bn at end-2019.
The central bank said recently that its loans to exporters (which are repaid in FX) will amount to $21bn in 2021, but we think the extent to which these loans will be reflected in the central bank’s reserves will ultimately be determined by the balance of payments dynamics. Although cross-border capital inflows have picked up since early November, the dollar equivalent of the residents’ FX denominated deposits increased to $208bn from $199bn during the same period, reflecting the residents’ ongoing lack of confidence in the country’s policies and institutions.
We think the central bank will be able to announce a transparent program of FX purchases if and when it becomes more comfortable with cross-border capital inflows and reverse dollarization.
Headline inflation will remain elevated in 1H 2021, and the risks to the outlook are primarily to the upside
Headline inflation was 14.6% at end-2020, up from 11.8% at end-2019, driven mainly by food and core prices. We expect headline inflation to start declining from May-June and end the year at 12.2%. The risks to the inflation outlook are primarily to the upside, driven by still-strong aggregate demand, lagged pass-through from the lira’s past depreciation and international food and commodity prices.
We also think the government’s decision to increase the minimum wage by 22% on 28 December will add 1.5-2.0 pps to headline inflation in 2021. The MPC’s interim target is to lower inflation to the central bank’s forecast of 9.4% by end-2021 (compared to Turkey’s official inflation target of 5%).
Given the challenging inflation outlook, we think that the policy rate should be higher than its current level of 17.00% (perhaps by 50-150bps) in order to strengthen the attainability of the interim target by end-2021, but we do not think the MPC will deliver the required tightening unless there is significant market pressure. In our view, the most likely scenario is that the MPC will keep the policy rate unchanged at 17.00% through mid-2021 and ease gradually to 14.00% in 2H.
March is a crucial month for Turkey’s relations with both the EU and the US
The EU stated in December that its stance on the conflict with Turkey in the Eastern Mediterranean will be synchronized with incoming US President Biden’s stance on Turkey’s purchase of Russian S-400 missiles.
It remains to be seen how President Erdogan will address these challenges which, we think, are also intertwined with Turkey’s economic challenges.
Published on 8 January, excerpt from Emerging Markets Quarterly: Q1 2021
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