Turkish economy predictions laid bare

A friend told me on Friday that most of the 2015 Turkish economy predictions he had seen on TV were rosy, prompting me to go through all the analyst reports I could get my hands on over the weekend. Here is the story they all seem to be telling:

Political risks will decrease, especially after the 2015 general elections, giving the country an advantage over other emerging markets (EMs). The improvement in economic balances will continue: Inflation will fall to near the Central Bank’s target, and the current account deficit will decrease to 4 percent of GDP, thanks to lower oil prices.

Even if the Federal Reserve (Fed) starts raising rates, quantitative easing from the European Central Bank (ECB) will ensure capital flows to Turkey. These conditions, along with a tight fiscal stance, will allow the Central Bank to decrease policy rates. Credit rating agencies could raise Turkey’s rating or outlook after they see the results of the government’s reform agenda.

I have several problems with this story. For starters, President Recep Tayyip Erdoğan did not keep the lid on spending before last year’s local and presidential elections. I don’t see why he would this time. Yes, inflation will fall early in the year, mainly thanks to base-year effects, but it will not come near the Central Bank’s 5 percent target.

I have been arguing for a long time that the effect of oil prices on the current account deficit, and more generally the economy, will be lower than expected. Yes, the energy deficit will contract, but so will exports to oil exporters and tourism revenues. According to preliminary statistics from the
Turkish Exporters’ Assembly, exports rose a meager 1.1 percent annually in December.

Besides, a lower current account deficit will not significantly reduce the country’s external vulnerabilities. Turkish companies will still be exposed to lira depreciation because of their foreign currency debt, and growth will still be dependent on external financing. And if you think that the government will enact its reform strategy, dream on!

Could the ECB buy Turkey some more time? Maybe a few months, but you can’t expect them to replace the Fed. Even if they do, there are other global risks: According to Işık Ökte, the roller-coaster ride in Turkey’s credit default swaps and rise in exchange rate volatility in December “sent a clear message that the only major 2015 risk factor for Turkish assets is not Fed lift-off.”

The TEB Investment strategist’s “number-one risk factor” for Turkish assets is “1997-type EM contagion risk,” and I tend to agree with him. If we are right, even if the domestic political scene is calm, as the consensus expects, geopolitical risks in the region could seal the fate of the Turkish economy.

I do agree with the consensus that the Central Bank will lower rates during the first half of the year, bowing to pressure from Erdoğan. In fact, I see Saturday’s surprise change in foreign currency reserve requirement ratios and reserve option coefficients as yet another preparatory step toward a rate cut. They will have acted prematurely again, and will probably end up with another significant hike, as in 2011 and more recently at the end of last January.

So if you decide to join the Turkish assets bandwagon, perhaps during a rally in government bonds driven by falling inflation and expectations of a rate cut by the Central Bank, make sure you jump off before it falls off the cliff. This could be that year!