Without a doubt, 2016 was a tough year for Turkey. Inan Demir, Senior Emerging Market Economist, explores a year of multiple terror attacks, a dramatic coup attempt and sub-three per cent growth rate. Will Turkey be more resilient in 2017?
The upheaval in Turkish politics is far from over and it will continue to be a key source of uncertainty for 2017. Even though President Erdogan and the ruling AKP won the referendum to switch to an executive presidency with a narrow margin, the market's hope for a calming of tensions and a softer, more conciliatory rhetoric towards both domestic and external audiences did not materialise. These expectations were crushed as President Erdogan's first speech after the referendum featured a promise to bring back the death penalty by holding a referendum on the issue, if necessary. This could lead to a suspension of EU membership talks and very complicated long-term consequences for the country. There is also a very good chance that we will see an early election or a cabinet reshuffle.
2016 was not a good year for the Turkish economy. Growth weakened substantially due to the failed coup attempt and even with the bounce in activity in the fourth quarter, the full-year growth rate is likely to be 2.2 per cent. The recovery prospects are not bright either. Although the weaker currency will help net exports, it will also keep private investment spending depressed due to its negative impact on corporate balance sheets. GDP growth will stay at 2.5 per cent in 2017, not a bad outcome in cross-country comparison but slow by Turkish standards. We also see the current account deficit widening to 5 per cent of GDP in 2017, despite the lack of acceleration in GDP growth. This is largely due to the lack of improvement in the merchandise trade balance and the drop in tourist arrivals.
Inflation and monetary policy
We see inflation reaching double digits in the first half of 2017, before ending the year at 8.4 per cent. Against this inflationary shock, the Turkish central bank is still reluctant to deliver decisive, orthodox hikes to battle inflation, preferring adjustment through unconventional measures. The problem with this strategy is that it is not robust against external shocks. In the absence of a more permanent improvement in risk-reward profile, Turkey remains vulnerable to high inflation.
Vulnerability to Trumponomics
Although Turkey does not stand to suffer from protectionism or immigration restrictions, higher US yields and a stronger dollar would likely hurt Turkey via the external financing channel. The impact of higher yields is reasonably straightforward: USD163bn (19% of GDP) of Turkey’s external debt will be maturing in the next 12 months and higher core yields will make it more costly to refinance. Less visible but equally – if not more – important is the impact of the stronger dollar. 57 per cent of Turkey’s external debt is denominated in dollars whereas only 42 per cent of export revenues are in dollars. In a world where the dollar is strengthening against the major currencies, Turkey would be in the unenviable position of trying to service dollar-denominated debt by generating export receipts denominated in other currencies.Read more