Friday, October 2, 2009

Daily Hurriyet Column: Seven years in slump

Hurriyet Daily News asked me to write daily rather than weekly during the meetings, which I gladly obliged. The unedited version of my fist column is below; you can read the final version at the Daily News web site. As you can see, I managed yet another cheesy title; I wonder I'll be able to keep it up for a week:) Anyway, enjoy:

As an unofficial kickoff to the IMF-World Bank Annual Meetings in Istanbul, the IMF disclosed the main chapters of its Global Financial Stability Report (GFSR) and World Economic Outlook (WEO) on Wednesday and Thursday.

Main takes from the GFSR…

First, the Fund notes that credit supply has been retracting faster than demand, leading to credit constraints. While this mechanism is likely to play out somewhat differently in Turkey, with the credit demand expected to increase as the economy recovers, the result will be similar, as the private sector is likely to hit credit constraints in 2010.

In the Turkish context, with the private sector lending crowded out by banks' appetite for Treasuries, a consequence of the high rollover ratios, it remains to be seen if the Central Bank will start buying Treasuries to unclog credit markets directly, as rate cuts have had limited impact on market rates so far. While the Fund recommends continued support from Central Banks to alleviate credit constraints, I wonder how they would feel about quantitative easing a la Turca, as the risk that such policy will be perceived as fiscal accommodation or debt monetization hangs like a sword of Damocles.

Second, IMF analysis suggests that there is a risk that the high fiscal deficits could lead to a rise in long-term interest rates. As Turkish Treasuries are more responsive than usually believed to core market long-term rates, such a bear steepener would create upward pressure on Turkish rates, forcing the Central Bank to abandon its on-hold policy earlier than expected, in effect changing the lead-lag relationship between the benchmark and the policy rate.

Third, the report notes that Turkey's largest risk is in external debt refinancing needs, with the bulk coming from corporate rollovers. The Fund’s analysis of contributions to changes in emerging market (EM) sovereign external spreads is also worth a look: Increased risk appetite accounts for most of the decline in spreads in the second quarter. I doubt the picture has changed much since then, and it is safe to claim that a retraction in risk appetite is probably the single largest risk to EM assets at the moment.

And the WEO…

IMF Chief Economist Olivier Blanchard’s take on the so-called recovery was one of the most sound sum-ups of the current situation I have heard. While he did not say it in exactly this manner, Blanchard highlighted the difference between rates and levels, whether it be debt or GDP: While consumers are deleveraging and banks getting rids of toxic assets, levels are still too high to support a quick recovery.

And a very slow recovery it will be, if history could be any guide. According to the Fund’s estimates in the analytical chapters of the WEO, GDP/capita declines by about 10 percent of its pre-crisis trend after a crisis, failing to rebound seven years after the crisis.

As is the norm with such meetings, where carefully-prepared texts are read without changing a single punctuation mark, the most interesting insights came in the Q&A session that followed. For example, Blanchard remarked that a fiscal rule, without the necessary structural reforms to accompany, would not amount to much. His comments should ring bells in those introducing black-box fiscal rules, while at the same time fiercely resisting much-needed reforms.

As for the Turkey forecasts, the Fund’s projection of 6.5 percent contraction this year and a recovery of 3.7 percent in the next are almost identical to my own estimates. More interesting is the Fund’s take on the Great Turkish Contraction: Jörg Decressin, chief of the World Economic Studies Division, surprised me by attributing the large decline in Turkish growth in the first half of the year to the larger cyclicality of the economy, due to the greater share of manufacturing in GDP.

While this is a valid point, I doubt it would be enough to explain the large contraction. I maintain my view that with its healthy & unleveraged financial sector and growth not led by exports, Turkey was in a position to be one of the countries that the crisis could really pass tangent to, but ended up as one of the worst effected, mainly due to bad policy management.

Perhaps most interestingly, the Central Bank’s credibility problem has now spread to the IMF: While the Fund’s average inflation projection of 6.2 percent is line with the Bank’s end-year forecast, the Fund sees inflation heading north next year, in contrast to the Bank’s expectation of lower inflation.

No comments: