Turkey’s painful economic growth

In 2020, the year of a massive global health shock, Turkey's economy made history by posting 1.8 percent growth, placing it second globally after China, the government proclaimed after the data was released on Monday.

Conjuring up success for Turkey’s economy in 2020 is all about coming up with a sentence like this, because a currency crisis, an interest rate shock and a meltdown in foreign exchange reserves accompanied the expansion.

Creating such a combination of self-inflicted damage to the economy is a rare skill for economic policymakers.

The current account surplus in 2019 turned into a deficit of 5.1 percent of GDP last year. The 2019 surplus, which former Treasury and Finance Minister Berat Albayrak presented as a success, was caused by another currency crisis the previous year and economic contraction.

Unsurprisingly, the current account balance turned negative once again in 2020 as the economy began to grow, due to inherent structural problems and misguided policies.

Turkey’s per capita income slipped to $8,599 last year, the same as it was more than a decade ago. The decline was not caused by the 2020 pandemic - per capita income has been sliding since 2013, when it peaked at $12,582.

The budget deficit to GDP ratio totalled 3.4 percent last year. This is actually a convoluted success, because in many developed and developing economies increased public expenditures due to direct income transfers have at least doubled budget deficits in terms of GDP.

But the Turkish government chose not to focus its pandemic support policies on making direct transfers to those burdened by the lockdown measures. Hence the widening of the budget deficit to GDP ratio was limited.

In Turkey’s case, economic growth was created by encouraging people to spend more with the help of cheap loans from state-run banks, employing negative real interest rates and depleting foreign exchange reserves to create the impression of a more stable lira.

Demand created by such unbalanced growth, combined with the depreciation of the lira and high input costs, sent inflation out of control. The government stepped on the stimulus accelerator in the third quarter of last year, so much so that the central bank was forced to raise interest rates sharply in the remainder of the year to slow things down and re-balance the economy.

Still, the economy grew by an annual 5.9 percent in the fourth quarter. Looking at the data, there were no unexpected surprises. A second-quarter economic contraction of 9.9 percent was revised up to 10.3 percent, while growth of 6.7 percent in the third quarter was updated to 6.3 percent. It is necessary to look at the details of the seasonal and calendar-adjusted series in terms of understanding the causes of growth that are now extending into 2021.

The first striking point is that 15.9 percent quarter-on-quarter growth in the three months to September, which compared to the previous quarter’s sharp contraction, slowed to 1.7 percent, which by itself is strong considering that the government introduced a second lockdown due to the pandemic. It showed the degree to which the government accelerated growth previously and how the effects of that stimulus persisted in the final quarter. Other highlights of the data include:

- Agricultural production turned negative quarter-on-quarter in the final three months of the year, posting a contraction of 0.1 percent.

- Industry grew strongly. Output expanded by 2.3 percent quarter-on-quarter after a 30.8 percent jump in the three months to September.

- There was significant contraction in the construction sector. After growth of 3.6 percent in the third quarter, the industry contracted by 11.4 percent in the final three months of 2020.

- Household consumption declined by a quarterly 0.8 percent after surging by 21.9 percent in the third quarter.

- Public spending continued at full speed, posting quarterly expansions of 3.7 percent and 3.6 percent in the second and third quarters of 2020, respectively.

- The momentum in investment growth vanished. After jumping by 20.2 percent in the third quarter, it contracted by a quarterly 2.7 percent in the final three months.

- Exports increased by 19 percent quarterly in October to December from the previous quarter. Imports rose by just 0.2 percent due to slowing domestic demand.

This week’s growth numbers suggest that the economy will expand by an annual rate of between 4 percent and 5 percent in the first quarter of this year.

Potential foreign policy shocks, especially related to the Halkbank case in the United States and possible U.S. sanctions in response to Turkey’s purchase of S-400 missiles from Russia, will prevent the lira from strengthening below 7 per dollar sustainably.

The central bank will continue to keep interest rates relatively high throughout the year. Rate cuts may only come in the fourth quarter as inflation starts to slow, likely from May.

The IMF is forecasting that the Turkish economy may grow by 6 percent this year, raising its expectation from a previous 4 percent. That estimate seems realistic, as do forecasts for inflation of around 11 percent and a current account deficit of 4.5 percent of GDP.