Last Wednesday economic columnists had the occasion to discuss the state of the Turkish economy with Deputy Prime Minister Ali Babacan for three hours. I was one of them.
The crucial question I had in mind before the discussion started was to what extent the Justice and Development Party (AK Party) government is prepared to experience a low growth regime, which, I believe, the Turkish economy is headed toward. If radical structural reforms are not implemented rapidly, and if they are sparingly implemented for the moment while the difficult ones are postponed, it will be very difficult for Turkey to shift its economy from a domestic demand-led growth to a more balanced growth. Turkey can achieve its estimated potential growth rate of around 5 percent during the coming decade if and only if it is capable of basing its growth more on productivity gains and less on capital accumulation. So, productivity-enhancing reforms are the key to achieve this.
For the moment Turkey is trying to realize the first step of this growth regime shift through what we call “a soft landing.” Let’s recap, once more, the meaning of this. The current account deficit (CAD), accompanied by the high domestic-led growth, reached 10 percent of Turkey’s gross domestic product (GDP) last year. Obviously this kind of growth was not sustainable. So, a new macroeconomic setup was implemented by the central bank and the government. The aim was to decelerate the strong increase of banking credits, to stabilize the Turkish lira at a relatively competitive level with the help of monetary and macro prudential measures while keeping fiscal policy tight. What was expected from these measures were a lower CAD-GDP proportion of around 8 percent through a positive contribution of net exports to growth, a decrease of inflation to under 7 percent and finally a controlled decline of the economic growth rate to around 4 percent.
Disinflation as well as CAD targets seem to be quite attainable, particularly with the help of decreasing oil prices. But the ultimate test for the soft landing would be, for sure, the growth performance. Babacan declared a firm standing on the target of 4 percent. It is reassuring to hear from the main actor behind the government’s economic policies -- he is the head of its Economy Coordination Board (EKK) -- that 4 percent economic growth is to be attained this year, but I have to note that everybody does not agree with him. The last growth forecasts from the Organization for Economic Cooperation and Development (OECD) and the World Bank are 3.3 and 2.9 percent, respectively. Our estimation at Bahçeşehir University’s Center for Economic and Social Research (BETAM) is quite similar: We forecast for the first half of the year a growth rate of 3.5 percent. The problem here is that, even with 4 percent growth, unemployment can hardly be kept at its relatively high level of 10 percent, but with a lower growth you can be sure to have an increase in unemployment. The last labor market statistics covering the period of February-March-April gave the signals of a stop in the decreasing pattern of unemployment.
Of course all these forecasts could be mistaken. The first official growth figures will be published by the end of June. But let’s ask the fateful question right now: Would the increase of unemployment, if it occurs, be politically acceptable? I do not think so. A low growth regime might not be just a transitory process. The growth rate could continue to stand under 4 percent in the coming years if the domestic-led growth is definitely abandoned and if the productivity-enhancing reforms are not rapidly implemented. And do not forget that Turkey will enter into a long-lasting electoral period with three successive elections by the end of next year.
An alternative, at least for the short run, is a loosening of monetary and fiscal policies. Personally I think that there is some room for a limited relaxation and if I understand correctly, the central bank is ready for such a move. But what about the fiscal policy? Babacan seems very decided to keep it quite tight. During the discussion he argued that given the limited share of the public sector in the Turkish economy (around 15 percent), a widening of the budget deficit would have also a limited impact on growth. But on the other hand, if this widening is interpreted by the economic actors as the sign of abandoning budget discipline, the loss of confidence resulting from such an interpretation would have a strong negative impact on growth through expectation channels; as they will be worsening, it will be very likely to have higher interest rates and less investment.
Mr. Babacan may be right. But one should remark that low growth means less tax revenue. The budget figures for the first five months of this year show that the increase of these revenues has been heavily decelerated in real terms, consistently with the lowering growth. However, the non-interest expenditures are continuing to keep their momentum. If the budget deficit is still under control for this moment, this is because of the decrease of interest payments. Despite this panacea, we can easily foresee a larger deficit than last year if expenditures momentum is not stopped. This will be a very interesting economic test for the Turkish economy as well a political one for the AK Party government as fiscal orthodoxy is criticized more and more nowadays in Europe and around the world.