Turkish Economy Has Surpassed Pre-Crisis Levels, In Recovery Mode

Jan. 9.11 | About: iShares MSCI (TUR)

Turkey's economy slowed in the third quarter, and the pace of GDP growth slipped back to a calendar adjusted 6.4% year on year in the third quarter, down from the China like 10.2% pace registered in the second one. The key to the slowdown was the deterioration in external trade: exports dropped by 2% year on year, the sharpest contraction since the third quarter of 2009, while import growth remained in double-digits for a fourth consecutive quarter (albeit slowing marginally to an annual increase of 16.9% from 18.8% in the second quarter).

Final domestic demand growth, on the other hand, strengthened to 11.2%, its fastest pace of advance in more than four years. Private consumption growth was strong, and surged by 7.6%, but the heavy lifting seems to have been done by investment (much of it in construction), with an increase in gross fixed capital formation of 31.3%. Even if the underlying housing boom offers the explanation for much of this growth, capital goods investment was also strong, as shown by the fact that the import of capital goods rose by an annual 31.3%.

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In fact, the most worrying part of the Q3 performance was not the fall in exports, it was the surge in imports, and the impact this is having on the trade and current account balances. Correcting this disturbing trend must now be one of the most important policy priorities for Turkish decision makers. Consensus forecasts now suggest Turkey could well grow by an annual 7% this year (up from an earlier expectation of 6%) and this does not seem to be at all unreasonable,

Whatever the weaknesses, the big picture story is that Turkey’s economy is once more growing dynamically and reaching new highs. Real economic gains are being made and we now are seeing increasing evidence of a true recovery which goes well beyond the confines of a simple statistical rebound.

But a dose of realism is called for. Despite the fact that the economy will in all probability now grow by at least 7% in 2010, in 2011 Turkish growth rates will undoubtedly continue to drop back from the very high level seen in the first half of this year. However, if this weakening in headline GDP numbers is simply the result of a deteriorating net trade position then we will have the worst of both worlds, as debt driven consumption growth will be faster than desirable, while the export sector will continue to weaken, even as import substitution undermines the domestic industrial sector. Unchecked this could lead to the same sort of manufacturing industry job loss we have seen across Southern Europe over the last two decades.

On the other hand, the Turkish economy is likely to continue turning in an impressive performance, one which will stand out among regional peers since sustainable trend growth in Turkey remains high. If adequate steps are taken to rein-in the current account deficit, and to attract more in the way of job-creating FDI, 6% growth could well remain a realistic target for 2011, even if there is a deterioration in the external environment and a weakening in the level of external demand.

One factor which makes Turkey stand out from many of its regional peers is that it is not overly export-dependent and has a dynamic domestic economy which complements the export sector. This means that the Turkish economy basically stands upright, and on both feet, and that, despite the recent loss of export competitiveness the impetus behind GDP growth is much more broadly-based than in the other, heavily-indebted countries which can be found in the surrounding region. In addition, the underlying strength of domestic demand means the Turkish government has a far broader, and ever-growing, potential tax base. This makes it much easier to attain longer term fiscal stability, and means that the country does not have to continually stagger forward on the basis of a series of “one off” measures to keep the deficit under control.

To some extent the slackening in Turkey's growth performance is only to be expected, since, in terms of external demand (and as in many other economies) all the "low lying" fruit has now been picked as exports have steadily attained their previous level. Reaching out for the rest will now become more and more difficult, especially with so much "deleveraging" going on in the neighbourhood, and so many export dependent economies in the region, which is why the export competitiveness issue needs to be so strongly stressed.

Thus, while Turkey turned in an 11.7% annual growth rate in the first three months of the year, and then followed up with an impressive 10.3% in the second three – a rate only equaled by China among the major economies – the calendar adjusted 6.4% rate registered between July and March is better read as a return to normality rather than the commencement of a serious slowdown. Quarter on quarter the economy grew by a seasonally adjusted 1.1%, and output was still up by 8.2% in the first nine months of the year over the equivalent period in 2009.

On top of this, the economy is now reaping the long run fruits of major macro economic restructuring in the early years of this century, while in addition the country faces a very favourable demographic evolution. The result of this very fortunate combination is that the dollar denominated value of Turkish GDP is now very substantially above where it was ten years ago, and now that the recession is behind us it should continue to rise rapidly.

Current Account Woes

Throughout this year the negative balance on Turkey’s current account has steadily worsened, and the trailing 12 month deficit total in October was around $40 billion, or 5% of GDP. This underlying deterioration in parts reflects the country’s energy dependence and the impact of rising fuel costs, but it also gives a measure of the strength of the domestic consumer rebound coupled with the impact of the inflation-driven real exchange rate appreciation.

Turkey has had a long history of persistent current account deficits, and as might have been expected while the problem eased during the recession, the arrival of the recovery slammed issue straight back onto the table. During last year’s sharp contraction, Turkey’s current account deficit fell back to 2.3% of GDP, and the topic moved quietly off everyone's radar. But last year's reduction was due to very exceptional circumstances (the sharp contraction in domestic demand during the global financial crisis), so this years widening of the deficit to a level which could eventually be as high as 6% of GDP (or even slightly over) is essentially a reversion back to type. Which does not make it any the less problematic.

When thinking about competitiveness, as well as simple exchange rate movements it is also important to take inflation differential's into account. Indeed the Turkish currency has been weakening recently on the back of the European Sovereign Debt Crisis, and the lira fell to a five-month low against the dollar following the central bank announcement of the latest measures. But even prior to the rate reduction the lira had been falling, and is now down around 7.5% against the US dollar since November 4 as concern has grown about potential economic spillovers to Europe's trading partners from the growing problems in countries like Ireland, Spain and Portugal. Weakening European demand is not good news for Turkey, since Europe is Turkey's main trading partner.

Thus while the lira rose by something like 9% against the euro last year the net 2010 gain against the dollar (before the post-November 4 slide) was only about 4 percent. However, given the much closer trade ties that Turkey has with the EU, it was the Euro rate which mattered for the export performance.

Although Turkey's exports were up sharply in October (to $11 million), after several months stuck around the $9 million mark, the improved performance was not sustained, and in November they fell back again to around $9.4 billion.

But of course, in the complete picture we would have to note that imports (and with them the trade deficit) have also continued to rise steadily, although at $17.1 billion in November, they were still some considerable way below the July 2008 high of $20.5 billion.

The seasonally adjusted trade deficit has continued to deteriorate steadily since the recovery started in late 2009.

Domestic Activity Also Rises

The recent recovery in manufacturing activity continued at full pace in October, with industrial output posting an annual increase of 9.8%, well above the 6.1% market consensus expectation. Following a tame performance in September, where seasonally adjusted output stayed flat at the August level, production surged again in October, and by an eye-catching 3.1% on the month. It is worth noting that industrial production has now returned to pre-crisis levels, implying that (even though overheating is not an issue at this point) the output gap may be narrowing faster than central bank projections anticipate.

The better-than-expected increase is largely due to a strong performance in both capital and consumer-durable goods. Capital goods were up by an annual 25.6%, and consumer durables by 21.7%. While the numbers for consumer durables reflect the expansion in consumer credit, the ongoing strong performance in capital goods suggests that the investment activity also continues apace.

And the continuing strong performance registered in December's manufacturing PMI suggests the short term outlook for the Turkish industrial sector remains positive.

Commenting on the Turkey Manufacturing PMI survey, Dr. Murat Ulgen, Chief Economist for Turkey at HSBC said:

The Turkish manufacturing sector maintained November’s impressive performance in December, expanding at its fastest rate since May. The pace of output and new order growth moderated slightly from the previous month, though still remained impressive. New export orders, on the other hand, showed the fastest improvement since October 2009. More encouragingly, this bright picture supported employment creation with conditions reaching their best level ever in the survey history. Backlogs of work increased marginally in December, while manufacturers continued to slash their finished goods inventories to meet order demand. In the meantime, this stellar performance also led to some price and margin pressures. Input prices soared at a very high rate, reminiscent of 2008 Q1 with rampant global commodity prices, whilst suppliers’ delivery times lengthened at a close to record rate. As such, manufacturers continued to reflect this in output prices that rose at the fastest pace in eight months.

Surprisingly, while retail sales continue to grow steadily, up to now they have not been one of the leading drivers of the current expansion, as indicated by the fact that the third quarter increase was only 7.5% over a year earlier. Not bad by developed economy standards, but well short of the level of construction investment increase, for example.

Unemployment Falls Even As The Labour Force Grows and Grows

Still, the outlook on domestic sales continues to improve, and one of the principal reasons for this is the continuing fall in the seasonally adjusted unemployment rate, which was down to 11.8% in September. In fact unemployment peaked (on a seasonally adjusted basis) at 14.8% in April 2009, and has since been falling steadily, while the seasonally adjusted level of employment continues to rise. Such strongly positive co-movements in employment and unemployment evidently lead households to have an increased sense of job security and purchasing capacity.

The country has been creating and continues to create jobs in large numbers. When compared with September 2009 the number of those employed rose by nearly a million (to around 23 million), with the share of those occupied in the industrial sector (around 20%) rising significantly.

Under the impact of the global financial crisis, Turkey’s unemployment hit a record high of 16.1% in February 2009. A year and a half later, and in sharp contrast with most of its regional peers, the country has achieved an impressive drop in its jobless rate. Even more significantly, Turkey has achieved this improvement at a time when the size of the labour force has been rising sharply, from 51.3 million to 52.7 million. This is yet another example of how Turkey is in a very different position to its regional peers, most of whom face ageing and declining labour forces due to their negative demographic trends.

In its bid to achieve ultra-fast "catch-up" economic and employment growth without generating excessively high inflation Turkey is able to benefit from the phenomenon known as the “demographic dividend.” Cutting aside the rigmarole, what this idea basically implies is that as fertility falls ever higher proportions of the population are to be found in the working age category, initially boosting employment and output, and then, in a second wave, fueling productivity, credit and consumption growth. This is what sets the Turkish case apart, for example, from the recent experiences in places like the Baltics and Bulgaria.

As the country's median age rises, Turkey is rapidly approaching that demographic “sweet spot” where sustainable rapid catch-up growth is totally realistic and achievable. However, it is important to bear in mind that this process is far from automatic, and depends for its effectiveness on continuing and deep structural reforms. The Turkish economy still fails to make satisfactory use of its existing labour resources, and the country’s employment rate, at just above 40%, remains the lowest in the OECD area. Deep-rooted socio-cultural factors, combined with the steady drift from rural to urban areas, mean that many Turkish women continue to withdraw from the labour force on marriage, which leaves the employment rate for women stuck around the 20% level, 40 percentage points lower than the equivalent rate for men.

Turkey's population has been growing rapidly, and will continue to grow quite rapidly for at least the next two decades. This will mean there will be an internal market with a strong growth dynamic, and that the country faces a more stable population pyramid in terms of pension and health care systems, and sovereign debt sustainability. This outlook also implies improving credit ratings and lower risk evaluation on the part of investors, with consequently lower interest rates for investment projects.

As I say, Turkey's median age is also rising, although the country is still very young, with a median age of just 28.5 and 30 per cent of the 74 million population under 18. The demographic "sweet spot" of median ages between 30 and 40 is thus set to last for some considerable period of time.

Rising median ages, and growing proportions of the population in the working age group are a product of two distinct forces, declining fertility and rising life expectancy. Turkey's fertility has been falling steadily for the last thirty years, and is now around the critical 2.1 replacement level. The key driving force behind the change is female emancipation and rising education levels. The difficult thing for the country now will be to arrest the fertility decline and maintain the birth rate around the replacement level. Unfortunately, absent a serious and sustained change in the policy approach it is far more likely that Turkey will follow the pattern already seen in Southern and Eastern Europe, and head towards very low (and therefore unsustainable in the long run) fertility levels.