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December 31, 2012, Monday

Two scenarios for the Turkish economy in 2013

The year 2013 is difficult to predict for at least two reasons: First, the world economic atmosphere is full of uncertainties; and second, we do not know how Turkish households and enterprises will react to decreasing interest rates.

The United States is experiencing a moderate recovery, but its economy is still fragile. We do not know yet how the so-called “fiscal cliff” issue will be resolved. Certainly, a last minute compromise between Democrats and Republicans is quite likely. However, what the American economy needs is not a compromise on fiscal policy that would be tightened anyway to some extent in the case of a compromise, but instead it needs to accommodate fiscal policy with the announced decreasing budget deficit targets in the medium term. We also do not know if the money printing that will be pursued this year by the US Treasury will be effective in increasing the consumption appetite of over-indebted households. I would assume rather mild growth that would not contribute too much to world trade.

As for the European Union, predicting 2013 is not very difficult. In the best case scenario, it will still be in a slight recession, unless the Italians make a wrong choice in the coming elections and the Greeks are unable to correctly implement the recent belt tightening program. Even a slight recession in the EU is of course bad news for Turkish exports since the European market continues to still be the main market for them despite their declining share.

Another difficulty that makes predicting 2013 hard is the reaction of the Turkish economy to low interest rates. It is true that following the monetary easing of the Turkish Central Bank, loan interest rates have already decreased by a few percentage points, and some further decrease is expected. Nevertheless, let me provide a reminder that the real interest rates will still be at around the 3 to 4 percent level, and Turkish households that have rapidly increased their debt ratio during the high growth period may not have a high demand for new loans. Likewise, enterprises may not be very enthusiastic about new investments since they are reluctant to make use of cash reserves in new projects.

That said, I think a moderate revival of domestic demand will not be a problem. Indeed, a 2-3 percentage point increase in private consumption will be enough to add an extra point to growth, which will then raise it from 3 percent to 4 percent. As private consumption stagnated last year, a moderate revival would not be surprising. This moderate revival can also move investments to some extent. So the problem should be expected from the foreign trade side. Here appear the two scenarios I mentioned in the title.

The government as well as the central bank are confident about a revival in domestic demand, but at the same time they expect the continuation of the rebalancing in foreign trade. In other words, they expect, as was pointed out by the governor of the central bank, Erdem Başçı, recently, that exports will continue to increase more rapidly than imports in such a way that net exports will be contributing positively to growth. In this case the growth rate could easily reach 4 to 5 percent and the rise in unemployment can be stopped.

This is for sure an ideal scenario for the Turkish economy. But it cannot be taken as a given. This scenario has two implicit assumptions. First, there would be sufficient external demand for Turkish exports. Given the international context I mentioned above, we cannot hope for too much from the West. The unique hope can be put on the markets of the East and the South. The Iraqi market, particularly its northern part, presents important potential, but there are many possible setbacks because of the ongoing political conflict between Ankara and Baghdad. On the other hand, the Justice and Development Party (AK Party) government postponed many of the cost-cutting and productivity-enhancing economic reforms, which means that Turkish industry still suffers from a lack of competitiveness. The expected revival in domestic demand could cause, under these conditions, a stronger import increase rather than export and contribute negatively to growth.

Here we come to the second scenario. I believe that a comeback to the old growth regime based solely on domestic demand is more likely than the ideal scenario. So, in the second scenario growth could remain sluggish, less than 4 percent, and have at the same time an increasing current account deficit (CAD) again. In this case the government as well as the central bank will face a list of dilemmas: shoring up domestic demand and loosening fiscal and monetary policies, questioning the rebalancing process or accepting lower growth and increased unemployment, or pursuing the rebalancing process in order to strengthen macroeconomic fundamentals.

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