Turkey: Country outlook
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- Economist Intelligence Unit
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Turkey: Country outlook
FROM THE ECONOMIST INTELLIGENCE UNIT
POLITICAL STABILITY: Recep Tayyip Erdogan, the president, and his conservative Justice and Development Party (AKP) have dominated Turkey's political scene since 2002. During this period they have tightened their grip on authority, replacing Turkey's parliamentary system with an executive presidential system in 2018. The economy has become less stable as a result of political tensions, fraught international relations and unorthodox economic policies. This has jeopardised the hard-won improvements in macroeconomic stability on which the AKP built much of its previous electoral success.
ELECTION WATCH: Mr Erdogan was re-elected president in June 2018, with 52.6% of the vote. At the parliamentary election, held at the same time, the Islamist-rooted AKP lost its absolute majority, although it secured a coalition majority with the small right-wing Nationalist Action Party (MHP). The election process appeared to be mostly free but largely unfair: opposition candidates received little or no domestic media coverage.
INTERNATIONAL RELATIONS: The AKP and Mr Erdogan are seeking to bolster Turkey as a regional power in the Middle East, on a par with other majority Sunni countries, such as Saudi Arabia and Egypt. This more assertive foreign policy--including regarding Azerbaijan, Syria and the eastern Mediterranean--has also helped the AKP to distract Turkish citizens from other domestic economic and political woes. This approach receives wide domestic backing.
POLICY TRENDS: The economic downturn in 2020 led to the biggest credit growth boom in a decade, facilitated by Turkey's state banks and a politicised central bank. This has kept inflation high, owing to lira depreciation against all other major currencies. In November 2020 Mr Erdogan made a step towards policy normality and transparency by appointing a former finance minister, Naci Agbal (who is known for championing orthodox monetary policies), as central bank governor. However, he was replaced in March 2021, adding to the unpredictability of Turkey's policies and damaging financial market sentiment. The new governor, Sahap Kavcioglu, a former member of parliament and official of Halkbank, a Turkish state bank, is a critic of Mr Abgal's policies. Mr Kavcioglu has stated his commitment to reducing inflation, but his appointment has triggered expectations of early rate cuts. Although the new central bank governor looks set to loosen policy, The Economist Unit does not expect cuts as large as the market fears.
ECONOMIC GROWTH: Turkey's economy grew by 1.6% in 2020, making the country one of only two of the G20 major economies that recorded growth amid the coronavirus pandemic (the other one being China). In 2021 we expect further modest economic growth, of 3.9%. Economic activity appears to have held up well in the first quarter of 2021. In the second quarter indicators of economic activity benefited from a strong base effect. However, there are downside risks to our forecast stemming from a volatile lira, high interest rates, high inflation (with negative consequences for input costs for businesses), rising risk premiums and the continuing effects of the pandemic. Turkey's vaccination campaign has slowed, and insufficient supply of vaccines may persist for another few months. As at May 26th 14.4% of the population was fully vaccinated, which is comparable with France (15%) or Italy (18%), but well below the UK (34.8%) and the US (39.4%). Further uncertainties stem from Turkey's macroeconomic imbalances, the country's economic policy, geopolitics and the coronavirus situation globally. Despite its structural shortcomings, Turkey's catch-up potential is considerable, and the economy is competitive, which underpins our view that growth will be 3.8% in 2022. In 2023, when the next general election is scheduled, we expect a stronger credit impulse to reappear and forecast real GDP growth of 3.4%. In 2024-25 we forecast average annual growth of 3.4%, which we believe is close to Turkey's medium-term potential.
INFLATION: Inflation averaged 12.3% in 2020 as a result of excessive lira depreciation against the US dollar and the euro. Although bases of comparison will be favourable and monetary policy has tightened since late 2020, rising global prices, persistent inflationary expectations, potential monetary loosening and further expected lira depreciation will keep inflation high in 2021, at an average of 14.5%--well above the central bank's 5% target. In 2022 we expect inflationary pressures to remain elevated, at 10.1%, mainly because of continued lira volatility. We expect inflation to dip in 2023 as price controls are imposed ahead of the election, before picking up again in 2024-25.
EXCHANGE RATES: Overall, the lira depreciated by about 19% against the dollar on average in 2020, despite central bank interventions. The lira was bolstered by the appointment of a new central bank governor, who promptly embarked on an explicit tightening of monetary policy. However, since Mr Agbal's sudden dismissal by the president in March, the lira has weakened again, and is currently trading at around TL8.5:US$1. His successor as governor, Sahap Kavcioglu, has increasingly sought to reassure markets that interest rates will not be cut prematurely. However, investors remain wary, owing to Mr Erdogan's known preference for low rates. We expect the lira to end the year at TL8.79:US$1. In 2022-25 we forecast that the lira will continue to follow a depreciatory path (weakening by 1.6% in nominal terms on average) amid elevated current-account deficits and high inflation in Turkey, together with a gradual normalisation of monetary policy in the US and the euro area.
EXTERNAL SECTOR: The current-account deficit amounted to 5.2% of GDP in 2020. Still-subdued domestic demand and pressure on the lira will temper imports in 2021, while tourism earnings will partly recover. The current-account deficit will narrow sharply, to 2.2% of GDP, this year as the economy begins to rebalance. Attracting sufficient capital inflows to cover the deficit and service foreign debt, without further drawdowns of already inadequate foreign-exchange reserves, will be complicated by the renewed uncertainties relating to monetary and foreign policy. We expect conditions for borrowing from abroad to deteriorate, given the widespread lack of investor confidence.
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