The data released this week for inflation, which jumped to 9.48 percent from 7.29 percent in November of last year, must have rung alarm bells for the ruling Justice and Development Party (AK Party) government in Turkey.
It seems double-digit inflation is now almost certain by year-end. Coupled with that, the whopping current account deficit (CAD) and rising unemployment figures show that the prospect of keeping voters’ confidence looks gloomy for the AK Party government.
However the AK Party government is blessed with no formidable opponent who can exploit the lackluster performance of the Turkish economy. The main opposition Republican People’s Party (CHP) is constantly preoccupied with internal fighting and divisions. It lacks the enthusiasm, manpower and dynamism to raise these issues in public and offer credible alternatives to the government’s current economic policies. The number two opposition party, the Nationalist Movement Party (MHP), cares more about rising Kurdish nationalism than the economy, and the same goes for the smaller Kurdish party as well.
Of course the economy is not at all bad, especially when compared to many countries in the EU. The current economic outlook of the country allows the government to successfully argue that consumers are much better off today than a decade ago, and many economic indicators at the macro level are quite positive. During the budget deliberations in Parliament, which are still going on, Finance Minister Mehmet Şimşek capitalized on these figures in his opening remarks while acknowledging shortcomings his government has been trying to address for some time.
If we look at the situation from the glass half-full perspective, the government did quite an impressive job, especially in sharp contrast to European peers on the continent. For example, 4.2 million jobs have been created in Turkey since 2007, while the EU-27 lost 1.6 million in the same period. The budget deficit relative to gross domestic product (GDP) was 2.9 percent in 2010 and is expected to drop to 1 percent by the end of the year. The government estimates it will have a budget deficit of 0.8 percent of GDP next year. The same figure for developed countries is quite high. Japan estimates it will have a 9.1 percent budget deficit to GDP, while Ireland will have 8.6 percent. It will be 7.9 for the US, 7 percent for the UK, 6.9 percent for Greece and 5.2 percent for Spain.
Public debt relative to the GDP is also quite high in the eurozone, which is expected to rise to 90 percent by the end of the year. This figure is 100 percent for the US. By next year, the public debt with respect to the GDP will climb to 238 percent in Japan, 189 percent in Greece, 121 percent in Italy, 115 percent in Ireland and 94 percent in Belgium. As for Turkey, the public debt is estimated to be 39.8 percent by yearend and will drop to 37 percent next year.
The banking sector is also very healthy. The size of the credit market was TL 525.9 billion in 2010. This figure had already been exceeded by August 2011 with a record TL 645.9 billion. Despite the expansion, the rate of defaults on loans dropped to 2.8 percent in August 2011 from 17.6 percent in 2002. Banks are also well capitalized. Though the law dictates that banks maintain 8 percent of total assets in capital reserves, Turkish banks had 16.6 percent in reserves in August 2011.
Household debt is also low in Turkey. By the end of 2009, household debt relative to the GDP was 15.4 percent, while it was 58.6 percent for the EU-27 on average. More importantly, only 1 percent of this debt was tied to foreign currency as of August 2011, minimizing the risk of currency fluctuation on household debt. Secondly, the bulk of household debt has fixed interest rates rather than variable rates, as was the case in Spain. The cost of raising capital domestically also dropped in Turkey. The interest rate for Treasury bonds in the domestic market was 62.7 percent in 2002. It dropped to 8.3 percent as of October 2011. The real interest rate dropped to 1 percent from 25 percent in the same period. The Treasury’s international bonds in euros had a 5.4 percent interest rate in October 2011. This was 10.2 percent at the end of 2002.
From a glass half-empty angle, Turkey’s CAD surged by 79.1 percent in September compared to the same period of 2010, reaching the highest level in the ninth month of the past 18 years, at $6.76 billion. The CAD was 6.5 percent of GDP last year, and it was expected to climb to 9.4 percent by yearend. This is not sustainable and exposes the economy to great risk. The government has done a poor job of addressing the CAD during its term in office, and only recently have we seen some action targeting the root causes of the problem. The economy grew mostly on strong consumer demand and a great appetite for investment, which have further fueled the CAD. External factors did not help, either. For example, exports to countries where Turkey maintains a positive trade balance, such as those in Africa and the Middle East, dropped, while imports from countries like China and India, with which we have a negative balance, have surged.
The price hike on energy, especially gas and oil, pushed the CAD to higher figures in this energy-dependent country. For example, the bill for energy imports was $9.2 billion in 2002. It will hit $50 billion by the end of the year. The CAD since 2002 has totaled $273 billion, while Turkey has paid $270 billion for energy imports in the same period. Although Turkey ranked second in peak demand for natural gas and electricity after China in the last decade, the government was somewhat slow in addressing energy shortages and adopting diversification schemes. Even without energy imports, the CAD relative to GDP is 4.2 percent. In the meantime, high energy costs continue hurting the competitiveness of Turkish companies in international markets.
The AK Party government also failed to increase the savings rate in Turkey, which is another contributor to the CAD. While public savings have increased to 2.9 percent of GDP, private savings dropped because of easy access to credit markets and low interest rates. The national saving rate was 18.6 percent in 2002. Today it is 13.3 percent. The government did not do a good job in identifying high value-added industries to reduce the CAD but instead relied mostly on less competitive industries for exports. The budget allocated to R&D is still low, a little over 1 percent of current GDP. Labor market reform that focused on developing human capital was not handled very well. Tax reform was not undertaken, and indirect taxation has continued to be a burden to many. The expansion of the tax base by reducing the unregistered economy has failed to produce any results so far.
Private sector debt has increased to $202 billion -- 65 percent of Turkey’s total debt -- from $26 billion in 1996 and is exposed to currency risks. The financial liability for private companies was $20 billion in 2003. Today it is $120 billion. This creates vulnerability for banks because a possible crisis in real industry may have an impact on banks’ balance sheets in the future. Last but not least is the rising unemployment, which was 9.2 percent as of August. But unemployment among young people aged 15-24 is at 18.3 percent in 2011.
Depending on how the government fares in responding to these challenges in the economy, the AK Party will either face a voters’ backlash or another landslide in local elections in 2013.