The economy dominates Turkey's elections
The Turkish economy is in a perilous situation, largely due to the lack of orthodoxy that has dominated its monetary policy in recent times. According to the latest report released by Crédito y Caución, the current path of prioritising high public spending, with increased public investment and social spending measures to support private consumption, is unsustainable. The Turkish economy survived the pandemic relatively well, with GDP growth exceeding 11% in 2021. However, this peak was short-lived. Growth fell to 5.6% in 2022, and is forecast to stand at 1%, this year despite an expansionary fiscal policy. "These measures have included an increase in the minimum wage, a major social housing project, credit subsidies and the abolition of income tax on the minimum wage," explains the company's economist Theo Smid.
High inflation and the weak Turkish lira are weighing on consumers' purchasing power. When the CPI reached 85% year-on-year, as it did in October and November, generous fiscal policy lost its ability to support expansion as consumers' purchasing power only reaches essential goods. Despite easing in recent months due to the base effect, Crédito y Caución expects average inflation to be close to 40% in 2023. While many central banks have tackled global inflation with interest rate hikes, Turkey has taken the opposite path: since 2021, the central bank's policy rate has been cut by 10.5 percentage points to 8.5%.
The Turkish lira has been one of the main victims of this stance, depreciating by 34% against the US dollar during this period. Crédito y Caución expects the currency to continue its gradual depreciation against other benchmark currencies in 2023 and 2024. Add to this the slowdown in exports, which are expected to contract by 0.8% this year. The already severe fragility of the economy was magnified in February by the devastating earthquake that struck the central and southern regions of the country. The human cost has been catastrophic. The economic cost will also be high as the affected region accounts for 9.3% of GDP.
Turkey has large external financing needs, to cover debt repayments and strengthen the current account balance. Crédito y Caución expects this need to reach 267 billion dollars in 2023 and 2024, which represents more than 30% of the country's GDP. In this context, Turkish companies may find it difficult to cope with their high foreign currency over-indebtedness. While some sectors remain robust, they face high inflation, rising raw material and operating costs, and limited access to finance. The pharmaceutical, food and retail sectors continue to perform well, and the export-oriented automotive sector is doing better than expected. In the consumer durables retail sector, sales volumes also increased in 2022. Credit risk is of particular concern in the construction sector, with heavily indebted companies facing rising financing costs. The sector may receive a boost from reconstruction in the earthquake region, but there will be strict rules on the number of contracts that can be awarded to any one company. The earthquake also disrupted much of Turkey's textile industry, which is highly concentrated in the affected regions.
The administration that is formed after the next elections, whoever wins at the polls, will have to follow a more conventional path to control inflation and reduce Turkey's external imbalances. This will involve reducing public spending and implementing a more orthodox monetary policy from the central bank aimed at stabilising the lira. "The scope of the economic challenges and the depth of external vulnerabilities ensure that any shift towards more conventional policies will be a difficult and gradual process. Raising interest rates would be the first step in bringing inflation under control, restoring investor confidence and rebuilding foreign exchange reserves. But this could also spur the first annual contraction in economic activity since 2009," Smid explains.