Turkey is facing tough choices. Global conditions are gradually set to tighten and investors are becoming more selective when it comes to emerging markets.
The country’s large current-account deficit and its reliance on short-term financing leave it vulnerable to shifts in risk appetite. Market fears of the US tapering its quantitative easing has put pressure on the currency with the lira depreciating by around 13 per cent in less than a year.
The country’s large current-account deficit and its reliance on short-term financing leave it vulnerable to shifts in risk appetite
Turkey’s GDP growth averaged 3.7 per cent in the first half of 2013 but that strong performance was driven exclusively by domestic demand. Household spending grew by an annualised 4.2 per cent but private-sector fixed investment has been falling since 2011.
To compensate, government investment has been ramped up. Public-sector fixed-capital formation jumped 60.3 per cent year-on-year in the first half of 2013 compared with a 4.7 per cent fall in private-sector investment and government expenditure also picked up, averaging 7.5 per cent growth.
Domestic spending growth was decent for most of 2013 but is expected to slow in the final quarter. We see GDP growth reaching 3.3 per cent for 2013 but have reduced the following year’s forecast from 4.0 per cent to 3.1 per cent.
The lira’s depreciation during the summer of 2013 has impacted on inflation, which we expect to rise to 7.9 per cent by the year-end but fall to 6.5 per cent by the end of 2014.
To prevent further depreciation, there is room for additional monetary tightening. Higher interest rates would probably slow growth in 2014 but they should also curb inflation, restore real returns for Turkish assets, reduce lira volatility, improve the central bank’s credibility and boost market confidence.
This research was first published on 2 October 2013.