Monday, June 15, 2009

Weekly Hurriyet Column: 2010: An Economics Odyssey

Below is the unedited version of my column for this week. You can read the final version at Hurriyet's authors archive. As usual, I have a few additional points:

For the recovery, I read today that the folks at BETAM expect a slow recovery as well.

As for consumers having the means to consume, that in itself would warrant a full column. Leaving aside technical issues like MPC and permanent income hypothesis, that argument, even if it were true in an aggregate sense totally ignores distributional issues: the PM should have a look the distribution of, say, deposits before making such bold claims in the first place. In fact, that is the one issue with the otherwise successful (so far) tax cuts, which were, by the way, extended today. The noted cuts, while they may have worked in an aggregate sense, would probably not have had the economy-wide participation that spending checks would have established. Such a policy would also have helped the real needy, but to give government some credit, with the unregistered workers out there, that would have been harder to implement as well.

As for the silly campaigns to get consumption rolling, as noble as they may sound, just as consumers will not rush to the market when you tell them to (unless, of course, Azize has their bonsevvis and can order them), let there be no unemployment won't work either- unless you are a higher being.

Coming to monetary policy, the lengthening of the repo auctions was exactly what I had in mind in terms of "keeping the dice rolling". With the liquidity tight, the Bank could opt for buying Treasuries (a really bad idea in the Turkish context) and decreasing reserve requirements before opting for the technical rate cut everyone is talking about these days.

Finally, I did not have a chance to mention this, but the net error & omissions in the BOP is not that mysterious after all. They are most probably flows of deposits of domestic residents back home, which can partially be tracked down from BIS statistics and CBT data on banks' foreign branches. Of course, there could be other factors: FX under the mattress getting into the system, swaps, or even overstatement of outflows because of valuation changes.

With mid-year around the corner, I would like to look further out and outline next year’s economy. However, don’t expect a full snapshot, just some brash strokes in the impressionist style.

Last week’s April Industrial Production and May Capacity Utilization, while showing that the freefall in production is finally over, have also led to premature jubilation. For one thing, the 2.5-3 percent (after adjusting for cyclicality and working days) monthly increase in production has been mainly domestic demand-driven, where the temporary tax cuts seem to have played a role. But Capacity Utilization hints that the monthly rise could have slowed down to 2 percent last month. For now, evidence hints that the April rise in production was an overshooting reaction to the rapid inventory depletion following the tax cuts, and a slow recovery lies ahead.

However, the real question is whether private consumption and investment will be able to follow production’s lead. In this regard, leading indicators such as consumption and confidence indices paint a bleak picture. First, the apparent rise in consumption is mainly driven by durables, reflecting the effect of tax cuts. As for investment, there are only scant signs of recovery in the real sector indices.

Looking ahead, given the close correlation between investment and external financing and the uncertain economic landscape, I would not bet on a sharp investment revival. As for consumption, despite repeated claims from the PM that consumers have the means to consume and silly campaigns to get consumption rolling, even those with the means will never mean to consume as long as the dwindling income prospects and the crowding out of private lending are in place. When you add the numbers up, following a 5 percent contraction this year, growth is unlikely to exceed 3 percent in 2010.

Coming to prices, I am projecting year-end inflation somewhat higher than the Central Bank’s forecast of 6 percent. In any case, while the inflation target of 7.5 percent is a piece of cake this year, I am much less upbeat for next year, as exchange rate pass-through will kick in, and temporary local (tax cuts, inventory depletion) & global (low oil prices, weak demand) disinflationary factors will start to wane. Add in the sticky inflation expectations, and I am rather confident that even if inflation does not reach my projection of 6.5-7 percent by year-end, it will soon after, forcing the Bank to a modest rate hike in 2010.

In a similar fashion, if you found the fiscal/debt scenario I have been outlining for the past few weeks gloomy, wait until next year, when redemptions are likely to increase by at least one third. While the Central Bank could keep the dice rolling for some time by funding banks through open market operations and technical rate cuts, debt rollover concerns are likely to stay with us for a long time. With the bond-friendly days almost certainly over, without capital flows back with a vengeance, the direction in Treasury yields is definitely upwards next year.

As for the external accounts, while the appropriately named Balance of Payments always balances out at the end, the billion dollar question is how: After a summer with current account surpluses, deficits are likely to surface starting the third quarter of this year and continue to widen into 2010. With the miraculous unidentified flows over, the financing picture is unlikely to improve, either. While Turkey could certainly make ends meet this year, an external gap in the order of 15-20 billion dollars is on the menu for 2010, which would imply reserve depletion and lira pressure.

If all this left a sour impression, please accept my most sincere apologies.

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