On Thursday three important pieces of economic data were released: unemployment in August, central government budget balances in October and the current account deficit (CAD) in September. There are two bad pieces and one good piece of news here, with critical implications for Turkish political life.
Let us begin with the bad news.
The Turkish Statistics Institute's (TurkStat) Household Labor Force Survey of the period July through September confirmed the turning point in the unemployment I suggested in my column on Oct. 15 (“Unemployment can be headache for government”). Indeed, the unemployment rate increased for the second period in a row: From June to July it rose from 8.9 percent to 9.1 and now, from July to August, it has risen to 9.2 percent. According to an estimate by Bahçeşehir University's Center for Economic and Social Research (BETAM), the non-agricultural unemployment rate stayed at 11.4 percent -- though this follows an increase from 11.2 percent to 11.4 percent in the July period. Obviously, the current weak gross domestic product (GDP) growth, estimated at around 3 percent, is not creating the jobs necessary to compensate for the labor force increase. As long as the government fails to find a way to maintain a higher growth rate in the economy than currently, it will face the politically adverse effects of increasing unemployment, slowly but decisively.
The second bad piece of news is about the fiscal stance. October budget figures continued to reveal the dangerous path in which fiscal policy has been engaged since economic growth decelerated earlier this year. In October the budget deficit reached TL 4.4 billion, while the balance excluding interest payments -- the primary balance -- turned into a deficit. This balance saw a surplus in October 2011. It would be better to compare the first nine months with the same period last year. Within a year, budget revenues increased by 11.2 percent. If we assume an average inflation of 8 percent by year-end, the real increase in revenues appears quite limited: approximately 3 percent, consistent with the growth rate. However, the consistency disappears completely regarding public expenditures, which saw an 18.1 percent increase. Here we have a real sizable increase, and the dangerous path emerges at this point. Most of the public expenditures, comprising employee salaries and social aid programs, are very rigid. In other words, it is very difficult to cut them in tough times. Indeed, to maintain budget discipline, it would be necessary to limit spending increases to 11-12 percent, parallel to the increase in revenues. The government could not -- and probably does not want to -- respect this limitation. Personal salaries and expenditures rose by almost 19 percent alongside a dramatic increase in social aid programs: Health, pensions and social aid expenditures, counting for 20 percent of the budget, increased by almost 28 percent in the first 10 months compared to the same period of last year. That is the cost of full health coverage, increasing retirements and the widening support for poor. Reinforcing the welfare state is certainly a valuable policy, but only under the condition of avoiding an abandon of budgetary discipline. Increases in welfare spending should be compensated by cuts in other public spending if necessary. But that does not seem to be the case at the moment.
The good news is about the CAD. It continued to shrink in September, reassuring financial markets and Fitch Ratings, who recently upgraded Turkey to an investment level. This year the CAD will probably top out at $50 billion. The estimations for its peak were around $65 billion a few months ago. The rebalancing process is well under way. I forecast a 7 percent share of CAD in GDP, a ratio that was above 10 percent at the end of last year. Nevertheless, we should not forget that this achievement is partly due to the lower growth than expected. Unfortunately, there are no miracles in economics.
How will Justice and Development Party (AK Party) leaders react to this annoying economic outlook as election days are approaching? Frankly speaking, I do not know. But I do know, elsewhere, that the options are quite limited. There is no more space for an increase in value added tax (KDV) or similar indirect taxes. On the other hand, the tax base can easily be enlarged. The Ministry of Finance already made the required legal preparations, but Prime Minister Recep Tayyip Erdoğan seems to be hesitating to approve them. This option will certainly not be popular among AK Party supporters.
The government can also reconsider the labor market and other structural reforms that have been postponed. It also has the option of returning to democratic reforms and accelerating a peaceful solution to the decades-long “Kurdish problem.” Doing so can reverse increasing military spending and reinforce the European anchor that would help boost investor confidence. Let's keep our hopes up that it will do so.