Monday, January 5, 2009

Weekly Hurriyet Daily News Column: Behind Titanic in uncharted waters

Below is the unedited version of my column for this week. You can read the final version at Hurriyet's authors archive. You can read more of my thoughts on trade and specifically on exports in recent posts. Two issues I mention in the article and plan to look in more detail in future blogs are the exchange rate pass-through mechanism and degree of crowding out (from Treasury borrowing to private lending). There has been some work on the former, but just anecdotal evidence (to the best of my knowledge) on the latter. My gut feeling is that crowding out has been limited so far (unlike what are claiming), but is quite possible this year.

I start the year by painting the Turkish economic outlook, using the global backdrop as the canvas, in the Impressionist style- with short, thick strokes to quickly capture the essence of the subject rather than gory details.

The Turkish economy in 2009

To avoid Cassandra’s fate, I have chosen to support my outlook with last week’s data, which illustrate some of the main economic themes of 2009 as well as offer hints on what is to come.

First, the Central Bank of Turkey (CBT) had taken what I deemed excessive risk when it cut its policy rate a surprising 1.25%. December inflation has proved the Bank right for now, and the CBT has won the first round at the poker table. However, further volatility in the lira could pass on to inflation, and despite the downward trend in core indices, prices still exhibit a considerable amount of inertia. While the December inflation outturn has almost secured another large rate cut from the CBT in January, it will be interesting to see the Bank play its hand down the road.

Second, November trade data showed that trade is plunging. While falling oil prices and indicators of a sharp slowdown in the last quarter make the contraction in imports hardly a surprise, the fall in exports is more than what economic models can account for and is in line with the rest of the world. In fact, there is increasing evidence that financing constraints account for a considerable part of the decline in trade across the globe. If this is indeed the case for Turkey as well, the recently reported export credit package would be a welcome development. In any case, if exports fall sharply, the contribution to growth from external demand is likely to be smaller than the 0.5-1.0% expected by most economists, pulling down growth further. In this respect, trade volume indices, devoid of price effects, will be important for tracking the impact of trade on growth.

Finally, Treasury’s 2009 borrowing program was largely overlooked, but the fiscal/debt outlook is likely to be increasingly important for the dynamics of the economy. While the recent fiscal adjustments have led some to fear that fiscal tightening is on the agenda with the IMF, the budget has just gained more realistic footing, as it was based on unrealistic assumptions such as a 4% 2009 growth rate. In fact, while limited fiscal easing is likely to be the case this year, more important will be the other side of the fiscal coin, i.e. debt. For one thing, the deficit is likely to have a limited negative impact as long as public debt ratios do not deteriorate. In a similar vein, with a high debt-rollover ratio, credit crowding out, one of the ghosts of Christmas past, looms ahead.

Sailing in uncharted waters

The global backdrop will nevertheless have important implications on how these three main themes and the rest of the economy will play out: The trajectory of oil prices would affect both inflation and the external balance. There is serious uncertainty regarding the effectiveness of Fed’s monetary policy and the fiscal stimuli many countries are undertaking. It is up for grabs whether emerging market (EM) outflows will continue, when the US will start showing signs of recovery, or how the expected sovereign bond glut will impact EM borrowing.

These questions, and many more, are left unanswered because we have never been here before. Truth be told, the world is sailing in uncharted waters, with Turkey towed behind. Just cross your fingers that we are not headed for an iceberg.

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