A few months ago we were discussing the new system of compulsory education, summarized by the famous formula 4+4+4. This time, a new formula, 5+5+5, seems to be becoming an attractive subject of debate among economists interested in the Turkish economy. The formula expresses simply stabilizing inflation at 5 percent, achieving an average growth rate of 5 percent in the coming years and limiting the ratio of the current account deficit (CAD) to gross domestic product (GDP) at 5 percent.
We owe the formula to Turkish Central Bank Governor Erdem Başçı. Responding to a question from a journalist about his recent award as “the central banker of the year” by The Banker, Mr. Başçı said that “he will accept the congratulations only when the 5 percent inflation target is reached and is durable, when growth stabilizes around 5 percent and the CAD to GDP ratio decreases to 5 percent.” Giving the estimated potential growth rate of the Turkish economy at around 5 percent and giving estimations regarding the sustainable CAD to GDP ratio for the Turkish economy at something between 3 and 6 percent, I can say that the 5+5+5 formula is definitely the ideal mix for Turkish economy. Indeed, an average real growth rate of 5 percent will allow a per capita income at $25,000 by 2023 as was pointed out by Mr. Başçı in a recent conference. Stabilizing inflation at 5 percent would not be a definitive achievement regarding price stability but in any case, it can prevent the Turkish lira from becoming overvalued. Finally, the 5 percent CAD to GDP ratio could be considered quite sustainable given the potential of the Turkish economy to attract enough foreign direct investment.
Nevertheless, the critical question is if government and the central bank are capable of bringing about the 5+5+5 formula. I am rather pessimistic about it. During his presentation of the first Inflation Report of the year (Jan. 29) Governor Başçı insisted that the year end inflation would be very close (5.3 percent) to the target (5 percent), and it is expected to be 4.9 percent in 2014. I think that these forecasts are quite realistic. The central bank has developed and implemented new policy tools powerful enough to prevent excessive credit expansion as well as the overvaluation of the Turkish lira. Nowadays, private consumption and investment shows signs of revival. This year a mild positive contribution of domestic demand to growth must be expected. There is no reason, at least for the moment, to suspect a populist drift in the fiscal discipline given the budget performance of 2012 and the planned budget deficit for this year. I should add that no oil price shock is expected in the foreseeable future. So, we can feel enough comfortable regarding the 5 percent inflation target.
The problem lies regarding the growth and CAD targets. Governor Başçı forecasts a CAD around 6.5 percent for 2012 (down from 10 percent in 2011) and says that the deficit can go down to 5 percent this year. Regarding the 2012 deficit, there is a general consensus among forecasters that it will be less than 7 percent. But Mr. Başçı is too optimistic for 2013. Personally, I expect a reversal in the CAD decrease this year. The OECD also has the same expectation. The reason is simple: The almost common growth forecast at 4 percent and over for 2013 is largely based on the domestic demand revival. However, the sizable decrease in the CAD in 2012 was widely due to the positive contribution of net exports to growth. In 2012, exports grew about 11 percent, while imports decreased about 2 percent. So, the external adjustment was quite impressive but the growth rate was limited to less than 3 percent. Now, the question is, how can we go smoothly from a 6.5 percent CAD to 5 percent? Certainly not going back to a growth regime mostly led by domestic demand. I forecast a CAD to GDP ratio of around 7 percent this year.
To summarize, the Turkish economy faces a kind of “impossible trinity.” The inflation rate can be stabilized at around 5 percent with a growth rate close to 5 percent. But, the rebalancing process experience of last year shows that we have not yet discovered a way of keeping growth sufficiently high and based mostly on exports. As I have repeated frequently in this column, the Turkish economy is squeezed between a low but sustainable growth, in the sense of a sustainable CAD, and sufficient growth but an unsustainable CAD.