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October 11, 2012, Thursday

Is the new roadmap credible?

Roadmaps for the economy are one thing; making the economy conform to these roadmaps is another. Let's consider the last roadmap for the Turkish economy. I mean by this the Medium-term Economic Program (OVP) delivered each year in October and covering the three years ahead. In the first part of this document, the government announces the main macroeconomic targets, like gross domestic product (GDP) growth, inflation, unemployment, current account balance and budget deficit. In the second part, the policies to be followed are outlined as well as the reforms to be implemented, in order to achieve those targets. In last year's OVP, growth and inflation rates for 2012 were forecast at 4 percent and 5.2 percent, respectively, while the unemployment rate was forecast at 10.4 percent and current account deficit (CAD) ratio to GDP minus 8 percent. Given these parameters, the government had planned to maintain the budget deficit at 1.5 percent for 2012.

The year is not yet over, but the main macroeconomic indicators are already visible. Regarding growth and inflation as well as budget deficit, the targets will not be reached. The OVP of this year, published on Tuesday, recognizes this failure. Indeed, the new OVP forecasts GDP growth and inflation at 3.2 percent and 7.4 percent, respectively. The growth is lower, inflation is higher than predicted and the budget deficit will reach 2.3 percent instead of 1.5 percent due to lower growth. However, there has also been some happy eluding of targets; for example the CAD ratio will be lower than expected at 7.4 percent. Admittedly a better result, but do not forget that this achievement is a natural consequence of lower growth; less production means less importation.

Another pleasant surprise appears in unemployment, which decreased to 9 percent despite the low growth. We have here a small miracle that is very rare in economics. How has it been possible? What we know for the moment is that employment in the service sector increased much more than the value added during the past months. I believe that this is an exceptional and transitory situation, and I expect very soon the start of an increasing trend in unemployment.

These are the results of last year's roadmap. Could the new results be better? I do not think so. The government targets 4 percent growth next year, and 5 percent for 2014 and 2015. Several times in this column I have written that 5 percent is the estimated potential growth, so this is not an unrealistic target, but it is quite a challenging one. The challenge lies in the nature of the growth rather than in its size. Indeed, the government predicts that exports will continue to increase more than imports during the next three years. This means that domestic demand will be kept under control, the driving factor of the growth being exports.

Assuming a better international economic environment, this export-led growth strategy could work if a rapid improvement in the competitiveness of the Turkish economy occurs. Given the fact that the new OVP does not foresee a depreciation of the Turkish lira, this strategy could be realized if structural reforms in the labor market as well as the energy sector are implemented without delay. Now, critical moves in the labor market like severance pay reform or fiscal devaluation (see my articles on these subjects in this column) are notable for their absence, while there are only a few vague promises regarding cost-cutting and productivity-enhancing reforms in the energy sector.

I am afraid that once again we will be disappointed by the results of the new roadmap. If the growth rate continues to stay at low levels, neither budget deficit targets nor unemployment targets can be achieved. The planned budget deficit is 2.2 percent for 2013, slightly lower than this year's forecast. The task will be very hard since the expenditures should almost be stagnating in real terms, while tax revenues would be increasing accordingly to 4 percent growth. If growth is lower, the tax revenues will be lower, and the government would face a dilemma if it decided to stand behind its budget deficit target: It would be obliged to increase indirect taxes, as it did recently, or to decrease expenditures. I think neither of these things will be done in a year in which local elections are to be held. Obviously, the budget deficit will be higher than planned in this case.

The other critical issue is, of course, unemployment. The OVP forecasts a slightly decreasing rate, from 9 percent to 8.7 percent in 2015. One could say that this is not very ambitious. I agree; however, I still have doubts as to its achievability. First, the labor force increase, implicitly assumed, is too low (1.9 percent), corresponding to an increase of 520,000 in the labor force. The tendency points to an increase of approximately 600,000. Second, the job creation capacity of the growth is assumed too high: For a 4 percent GDP growth, the OVP forecasts a 2.7 percent increase in non-agricultural employment. This growth-employment interaction does not leave enough space for productivity increases. This is certainly not the right way to achieve rather high growth that, moreover, must be based on exports.

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