Europe winds threaten to shrink local economy

ISTANBUL - Hürriyet Daily News

A consumer looks at a dried fruits stall at a traditional market in historic Istanbul. A deeper economic crisis in the second half o the year may trigger an inflation hike, according to a recent report released by the Economic Policy Research Foundation of Turkey. DAILY NEWS photo, Hasan ALTINIŞIK

If the economic crisis in Europe deepens further, the Turkish economy may even face shrinkage, as the lira will fall and inflation will rise, according to a negative scenario in the Economic Policy Research Foundation of Turkey’s (TEPAV) debut Economic Outlook report. However, such a scenario would result in a drop in the current account deficit, the report on the second half of the year added.

Underlining the impact of European developments on the Turkish economy, the report said the moves by the Turkish Central Bank would also play an important role.

The report’s positive scenario was constructed under the forecast that the European crisis will not get worse, the probability of a Greek walkout from the 17-nation eurozone will not rise, the situation in Spain will be brought under control, and no more bad news will come from Italy or Portugal. This plan foresees an appetite for risk taking.

“Hardships between August 2011 and March 2012 in meeting the current account deficit with normal tools will fall. The upwards pressure on foreign exchange will ease or even disappear. If the oil prices stay at somewhere close to the current level, these developments will help inflation fall. The drop in the inflation rate will become more visible in the last quarter of the year.”

If Spain goes worse

TEPAV’s positive forecasts include a loosening in U.S. Federal Reserve’s policy. This would increase the short-term capital flows to Turkey and push the forex rate down, it said. But the second scenario, which discusses possible developments in an environment where discussions over a Spanish eurozone exit pile up, is rather more pessimistic.

Under deeper crisis conditions, the international appetite for risk-taking would weaken and fund flows into emerging economies would decrease, it said.

“The forex rate will be squeezed up. Investments and spending on consumer durables are also expected to be affected. This will decrease the loan demand and increase risks, and the shortage in loan-taking opportunities in external markets will decrease the loan supply. As a result, a slowdown in the acceleration of the loan growth is expected,” read the report.

The pressure on foreign exchange rates would increase inflation, the report said, and despite the fact that more uncertainty and a fall in the acceleration of loan growth would have a positive effect on inflation, the elements pushing the rate higher would overcome it, the report added.

“Accordingly, the growth rate will fall and even an economic shrinkage may take place as inflation goes slightly up. The current account deficit is expected to narrow under such conditions,” the report said.
In such a scenario, the Central Bank would face a hard task, TEPAV said. “The bank is initially expected to implement measures that will increase both lira and foreign exchange liquidity. The struggle against inflation will be pushed to the background for sure.”

The report also mentioned that of the two scenarios, the negative one was more likely to come true. “At this point, the crisis in Europe is gaining momentum. However, it is too early to make a certain judgment yet.”

TEPAV’s study will be repeated every two months.