AKP’s economic management will firmly stick to the path it calls the “New Economy Model” until the May 14 elections, adding to it enormous sums of electoral spending and similar voter-pleasing measures, which are exclusively distortive. What will happen until the elections in 2023 will determine the priorities in the economy after the election, depending on who wins the power; or how it is shared between competing alliances. This will undoubtedly make 2023 a difficult year with high uncertainty, potentially exhibiting Dr Jekyll and Hyde features pre- and post-election.
More than a year spent under the New Economy Model sheds lights on what the government’s priorities will be until mid-May. If we take what they have done as a guarantee of what they will do it, it is realistic for AKP to prioritize growth in the January-May period. After the third quarter of 2022 growth lost momentum, but as of December, it seems to pick up, again, driven by domestic demand. As the global recession deepens, the way to achieve growth in the Turkish economy will be to stimulate domestic demand. After 4Q2022, when quarter-to-quarter growth will have turned slightly negative, support to domestic demand through monetary and fiscal policy will most likely lead to an annualized growth of 4.5% in the period until the 2023 election.
It is debatable whether such front-loaded growth focused on the minimum wage increase, weakening foreign demand and domestic demand will be a remedy for the stagnation observed in employment in recent months.
The expansion we have seen in loans in the last weeks of 2022 will accelerate. While private banks continue to focus on consumer loans, public banks will start an offensive in corporate loans. The increase in public spending for various subsidized loan programs, as well as direct-to-voter porkbarreling will likely lead to a budget deficit of 4% and above by end-2023, expressed as a share of GDP. We observe that the Treasury ended its relative 4Q2022 fiscal prudence, initiating an expenditure wave since the beginning of January, as judged by the decrease in its deposits held at the CBRT.
The primary policy objective remains to keep the TL steady as much as possible. What everyone is wondering is whether there will be a new attack on TL as a result of steadily accumulated risks in all facets of the economy? Recall that there is no portfolio inflows, no direct investment with the exception of foreign housing purchases, while tourism revenues decrease through April-May, and swap/deposit type of “donations” from Erdogan’s friends are already mostly in the accounts. For the rest for 2023, the game plan is to cover potential current account financing shortfalls with sovereign foreign borrowing at very high interest rates, and natural gas debt “deferrals” granted by Putin, which can rise to more than 20-25 billion dollars.
From this point of view, it is possible to expect a new attack on the TL at any moment, which CBRT is trying to fend off with new “regulations” adding to de facto capital controls regime prevailing in the financial markets.
Growth prioritization will stoke inflation and current account deficit
Acceleration in growth will undoubtedly have negative effects on inflation and current account deficit over this period.
On the back of a positive base effect and the exchange rate stability, the expected decline in inflation will be limited by the strengthening domestic demand. By May 14 election, April 2023 CPI inflation will have declined to approximately 45%. While the decrease in energy prices in recent months and strength of TL are positive factors in terms of dis-inflation, wage increases announced at the end of December and the possibility of their repetition in April will undoubtedly keep price pressures alive. It is unrealistic to expect a meaningful decline in food inflation anyway. On the other hand, it is not possible for the “price freeze” campaigns on various products announced by the chain markets (after the draconian collusion penalties they received from the Competition Board) to be effective. It should not be forgotten that there is no effort to fight inflation beyond the base year effect and inflation expectations are already out of control. A road accident in TL will directly and rapidly pass through to inflation.
In terms of balance of payments dynamics, a widening in the current account deficit and steadily worsening financing quality until the election are reasonable scenarios. Against these threats, net foreign exchange reserves of the central bank are at minus $44 billion, excluding swaps. Gross reserves of the central bank, which have been stuck at $128 billion for weeks and represent the ammo it has in its disposal to fend off attacks on the currency, will of course remain the focus of attention until the election. The magnitude of withdrawals from Currency Protected Deposits and whether these funds will be directed to foreign exchange demand, or consumption thanks to cheap loans, is also important to watch in terms assessing CBRT’s capacity to defend the exchange rate.
The outlook is negative for the current account deficit. In the count-down to elections, when growth is accelerates, exports will slow mainly due to modest foreign demand and partially because of overvalued TL, while the rate of increase in imports will remain relatively strong. In addition to the pressure on imports of intermediate goods created by domestic demand on the production side, gold imports are expected to accelerate in an extremely negative real interest rate environment. Before the positive base effect in energy prices is reflected through energy imports (usually with a 3 month delay due to prevalence of contract rather than spot buying), foreign trade deficit will increase in the January-April period, translating into a current account deficit of around 20 billion dollars in the first four months.
The current account deficit, which was around 1% of the GDP at the end of 2021, increased to 5% in 2022, or approximately 48 billion dollars and is expected to continue at that level in the first quarter of 2023, will create a significant TL pressure that the government will try to shoulder until the elections. Around 50% of the financing came from net errors and omissions of unknown origin last year, and it is extremely doubtful whether such funding will continue until the 2023 election, creating significant vulnerabilities in exchange rate management.
At the end, the AKP government is skating on thin ice leading up to the elections, and if things do not go as expected; i.e., if domestic investors start to turn to foreign currency again, Erdogan’s game plan will be shattered. Even if he averts a BoP crisis, Erdogan is handing down a creaky economic structure to the next administration after the election.
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