Monday, July 6, 2009

Weekly Hurriyet Column: Asking the right questions on growth

Below is the unedited version of my column for this week. You can read the final version at Hurriyet's authors archive. As for the sources of growth, the graph below is what the second paragraph is describing- have a look at the picture for a couple of minutes and you'll notice some interesting "reversals" in the last three quarters.

It is not often that you get two medals with one performance: While first quarter growth easily brushed past the 1994 and the 2001 crises to secure the gold medal for the largest contraction, it also briefly held the bronze medal in the international competition.

While the -13.8% yearly growth figure was not that far off from expectations, the devil is in the details. Specifically, looking at the contribution to growth on the expenditure side reveals important facts. First, make no mistake, the private sector hit rock bottom in the first quarter: The contribution to growth of private consumption and investment were -6.6% and -8.4% respectively. Second, even though the government used fiscal measures to the full at the expense of risking a disruption to debt dynamics, while increasing the rollover rations and crowding out private credit in the process, the public sector's contribution to growth has been a limited 1.1%. Third, there were huge positive and negative contributions from net exports and inventories, which exactly cancelled out. Experience has told me not to make too much out of the stocks figures, but the sharp decline is in line with the large falls in industrial production. As for next exports, both exports and imports contracted, but imports by a much larger amount on the back of the large demand pullback and lower oil prices.

On the production side, financial intermediation stood out from the across the board declines, but given the Central Bank/Treasury policy of money for nothing and bonds for free, this should not have come as a surprise. Looking forward, while forecasting the first quarter was rather easy, as seen from the convergence of market economists on a 12-13% contraction, projecting the second quarter will be much more difficult, as there will be two affects more difficult to estimate: A natural bounce-back, amplified by the impact of the fiscal stimulus, especially the tax cuts. This week’s May industrial production and June capacity utilization releases should clear up the outlook a bit. But for one thing, while I would want to wait for Friday’s volume figures to say for sure, last week’s April trade data hint that the contribution of net exports will not be as large in the second quarter, as the gap between the contraction of exports and imports is narrowing.

In any case, the billion dollar question is not what happened, but what will happen: While the global and domestic economic skies are too hazy to have a clear look at the horizon, the latest data are not that encouraging. For one thing, even though the government's timely tax cuts have boosted consumption in the second quarter, it is questionable how much of this will carry on to the rest of the year. While latest real sector and purchasing managers indices hint to some restocking, a sustained recovery depends crucially on the consumer, with rising unemployment and falling real wages making a strong consumer comeback unlikely. As for investment, according to the same surveys, there is only a limited improvement in investment prospects, with the outlook continuing to look dire.

The trillion dollar question, on the other hand, is what will happen in 2010 and beyond. Here is where an economic policy framework, with fiscal sustainability as one of its main pillars, would be extremely useful, with or without the IMF. Otherwise, we may see a repeat of the lost decade of the 1990s.

The only good part of the growth figures is that the PM might have finally learned the difference between tangent and diameter. The perennial optimist in me is therefore telling me that these numbers will serve as a sharp wake-up call, but I’ve been fooled before.

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