Monday, September 7, 2009

Weekly Hurriyet Column: The year of living dangerously

Below is the unedited version of my column for this week. You can read the final version at the Daily News website. First, I have to apologize for yet another cheesy movie reference, but this one is one of Peter Weir's underrated classics, as he is better known for Master and Commander or Dead Poets Society.

As for the column below, there have been important developments in the two weeks since I wrote this column. First, the government disclosed the Medium-Term Economic Program. As I discussed in the preface to last week's column, while the macro projections are realistic and consistent, the fiscal framework lacks bite. For one thing, almost all of the mediocre fiscal adjustment, which incidentally falls short of securing debt sustainability, is coming from robust revenue growth stemming mainly from the expected economic recovery. Moreover, this limited adjustment is not enough to ensure debt sustainability. As for the fiscal rule, I am devoting the last column of the month to that, so stay tuned.

Another theme of the column is the 2010 redemptions schedule. The Treasury got the burden off the heavy January and February with a couple of swap auctions just before the Bayram. This made sense, as market conditions were rather suitable, and unsurprisingly demand was strong.

After going over my growth and inflation forecasts last week, it is time to broaden my horizon to fiscal policy.

Fiscal policy has been off the markets’ radar for some time for a number of reasons: For one thing, the government has been able to put almost everyone in a “see no evil, hear no evil” mode with its inaction. Not only waiting for the Medium-Term Fiscal Framework (MTFF), which should have been out early summer, has started to look more and more like Samuel Beckett’s famous play, the Ministry of Finance has yet to release the July and August budget data.

There are in fact three distinctively different rationales for the unresponsiveness. One group, which I aptly term the wait-and-see guys, is just waiting for the MTFF and a concrete conclusion on the never-ending IMF saga. It is safe to assume that the government will be more punctual than Godot, but even if it isn’t, these guys will not be as patient as Vladimir and Estragon. In fact, the October IMF-World Bank annual meetings in Istanbul has emerged as a consensus deadline for both.

To give the ostriches some credit, some had been vocal with their criticism of fiscal policy for a long time. However, they too have been quiet as of late, after being burnt by their earlier calls. After all, despite the sharp budget deterioration and increase in the monthly domestic borrowing, the Treasury has been successful in rolling over debt. A case-in-point is August, where the Treasury breezed past record-level redemptions with a rollover ratio of over 100 percent and historically low benchmark rates, consequentially quieting the burnt-by-the-Treasury camp for a while.

In fact, there is a third group, which I coin the optimists, who see these easing conditions as permanent and hail them as signs of normalization of the Turkish economy. However, this argument is not supported by facts. In fact, the return of global risk appetite, full Central Bank (CBT) support and the country’s large output gap explain much of the recent fall in rates. Therefore, just as I do not see benchmark rates going below 9 percent in a sustainable manner, I see no reason to believe that the ultra-low rates are the new normal. With the output gap closing and CBT hiking rates next year, market rates are likely to head north again.

As for the high debt rollovers, with ample liquidity, not much other use for their money and a high capacity for debt absorption, banks were behind the Treasury success story. Moreover, as foreigners got out, they have been able increase their share of the bond market significantly for the past year, a process that has left the big players with a lot of market power. To top all of this, contrary to the consensus view, the crowding out has not been as large as real sector representatives claim, mainly because of a lack of demand for credit.

Without a credible fiscal framework, this fairytale will not last much longer. With the deficit set to hit 66.6 billion liras at year-end, gross central government debt will make nearly one half of GDP. As a result of the short maturity of the debt, 2010 will be tougher, as my projected 170 billion liras of redemptions are evenly distributed after a heavy first couple of months, increasing the chance of an accident somewhere down the road. In all likelihood, debt sustainability will enter markets’ radar sooner or later. Moreover, as the economy begins to stir, crowding out will start to bite.

Barring a positive surprise, I will remain convinced that 2010 will be the year of living dangerously for Turkey. Then, 2011 could be the year where things fall apart, with the government unwilling to undertake a much-needed expenditures adjustment before the elections.

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