Outlook On the heels of the worst economic downturn in over a decade in Q2 owing to the Covid-19 fallout, recent data hints at a fragile rec...

Economic Update: Turkish Outlook Deteriorates

On the heels of the worst economic downturn in over a decade in Q2 owing to the Covid-19 fallout, recent data hints at a fragile recovery in Q3. After two months of robust gains as the economy reopened, industrial production cooled markedly in July in monthly terms as output in the mining and manufacturing sectors lost stride. Additionally, despite a strong rebound in June, merchandise exports contracted again in both July and August amid still-subdued foreign demand. Leading data also shows a slight retreat in sentiment, with business confidence edging lower in September as views over the general business situation deteriorated. Similarly, the manufacturing PMI slipped in the same month on signs of demand losing strength. Complicating matters, Moody’s cut the country’s credit rating deeper into junk from B1 to B2 on 14 September, citing increasing risks of a balance of payments crisis. 

GDP is seen tumbling at the sharpest pace since the 2009 global financial crisis this year as the pandemic and associated restrictions take their toll. Fiscal stimulus should help to cushion the contraction somewhat, however, and the economy should recover strongly next year. Elevated inflation, a depreciating currency and a fragile external position all cloud the outlook. FocusEconomics Consensus Forecast panelists project the economy to contract 3.3% in 2020. In 2021, GDP growth is seen at 4.4%, which is down 0.5 percentage points from last month. 

Price pressures remained high in August, with inflation coming in at July’s 11.8%, in part stoked by continued lira weakness. Inflation should subside gradually ahead, weighed on by tepid aggregate demand and subdued energy prices. Potential further depreciation of the lira poses an upward risk, however. FocusEconomics Consensus Forecast panelists see inflation ending 2020 at 11.8% and 2021 at 10.5%, which is up 0.4 percentage points from last month. • At its 24 September meeting, the Central Bank raised the one-week repo rate by 200 basis points to 10.25%, taking market analysts by surprise and tightening policy for the first time since the 2018 currency crisis. The move was aimed at quelling elevated inflation and propping up a sliding lira. Most of our panelists expect the Bank to tighten policy further by year-end. FocusEconomics Consensus Forecast panelists see the one- week repo rate ending 2020 at 11.52% and 2021 at 11.02%. 

On 2 October, the lira traded at TRY 7.77 per USD, depreciating 5.0% month-on-month. Although the Central Bank’s unexpected rate hike sent the lira rallying, concerns that Turkey could get more involved in the Azerbaijan-Armenia conflict erased those gains. Depleted FX reserves and low real interest rates weighed further. The lira is seen remaining under pressure ahead. FocusEconomics Consensus Forecast panelists project the lira to end 2020 at TRY 7.63 per USD and 2021 at TRY 8.04 per USD.

Central Bank unexpectedly raises interest rate in September
At its 24 September meeting, the Central Bank’s Monetary Policy Committee (MPC) took market analysts by surprise and raised the one-week repo rate by 200 basis points to 10.25% from 8.25%. Market analysts had largely expected the Central Bank to stand pat, but the MPC instead delivered the first rate hike since the country’s currency crisis in 2018.

In deliberating the decision, the Bank took into account the higher-thanexpected inflation readings and as such opted to tighten financial conditions in the market to cool price pressures. The MPC noted that it had expected “demand-driven disinflationary effects” as domestic demand has been weakened by the pandemic; however, the strong credit impulse and the fiscal and monetary policy action taken so far have fueled a robust economic recovery in the third quarter. This, in conjunction with continued lira weakness, put upside pressure on prices. The move to aggressively hike the interest rate was likely also aimed at stemming the lira’s slide and appeasing international financial markets to an extent. On 23 September, the currency was down 4.7% month-on-month and 22.8% year-to-date against the U.S. dollar amid renewed geopolitical tensions with Greece in the Mediterranean. Moreover, in mid-September, Moody’s downgraded Turkey’s credit rating to B2 and maintained the negative outlook in part due to deteriorating government finances and the fact that the country’s institutions “appear to be unwilling […] to effectively address” increasing credit profile risks. 

In the press release, the Bank struck a largely unchanged tone, reaffirming its belief that “a cautious monetary stance” is needed to sustain a disinflationary process. Commenting on the potential policy direction ahead, Gökçe Çelik, senior CEE economist at Unicredit, noted: “The CBRT’s outright rate hike might support the TRY against further depreciation in the short term. However, the re-acceleration of COVID-19 infection rates and uncertainty surrounding the upcoming US presidential election could deteriorate sentiment in financial markets, hurting risky assets in 4Q20. Meanwhile, annual inflation is likely to trend upward from 11.8% in August, and towards 13% by the end of 2020, driven primarily by the exchange-rate pass through. […] We see inflation ending next year at 10.8%. These factors call for the central bank to carry on with monetary tightening strongly.” The next monetary policy meeting is scheduled for 22 October.

FocusEconomics Consensus Forecast South-Eastern Europe

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