Note that the government's own projections in the Medium-Term Economic Program (MTEP), which were released two weeks after I wrote this column, are more or less in line with mine, with the important exception of inflation, which I outline below in great detail. In fact, with the government projecting a budget deficit of 6.6% of GDP, it has taken my "number of the devil" pun further, so now noone can accuse me of non-PC behavior...
Unfortunately, despite the sound forecasts, the MTEP is far from quelling the devil, mainly from the weakness of its fiscal framework. I will detail what I mean in the preface to next week's column, which deals with the fiscal framework.
While updating his key economic forecasts in June, your friendly neighborhood economist stumbled upon an interesting observation.
Turkey’s holy trinity of economic forecasts was yielding the number of the beast, with my 2009 growth and budget deficit forecasts coming at -6.66 percent and 66.6 billion liras and end-year inflation expectation at 6.66 percent. After more than two months and a plethora of new data releases, it is time to go over these projections again. I take on growth and inflation today, leaving fiscal policy to next week.
The dismal first quarter GDP figures and the more recent data have, if anything, confirmed my dismal growth outlook. While it is true that private consumption and investment have bottomed out, media and economists alike seem to have been misled by the fiscal stimuli in the second quarter. With the consumption, real sector and confidence indices all having fallen recently, all we can hope for at this point is a tame W, with a small inflection point.
In the perennial optimist’s Turkish economy story, much ado is being made about nothing, i.e. Turkey’s much-hyped-about non-leveraged consumers and well-capitalized banks. However, the former will not splurge and the latter not lend unless a coherent economic framework is in place, as the latest data attest to. Even then, tighter external financing and a permanently-higher unemployment plateau will slow the speed of the recovery. I see yearly growth contraction at around 8 percent in the second quarter, hopefully with some positive surprises from housing and agriculture, and somewhat less in the third. Then, a modest positive growth in the last quarter will take us to a yearly figure of around 6.5 percent.
Unlike my growth outlook, my inflation projections need some updating, as it now seems that the country’s large output gap is here to stay for a while. Moreover, the effects of the considerable slackness in the economy, lower oil prices and the tax cuts have been larger than I had envisaged. As a result, I now see end-year inflation at 6-6.5 percent, which is still above market expectations of just below 6 percent. However, I believe I have only miscalculated the speed of the wagon, not its direction. I still see inflation heading uphill from here- in contrast to the Central Bank’s (CBT) downhill projection.
For one thing, the fiscal disarray, which I will outline in next week’s column, is bound to lead to a sharp pass-through from the higher oil prices in the coming months. Moreover, I believe that the recent weakening of the link between inflation and exchange rates is, contrary to what many economists claim, only temporary. Another misconception is attributing the recent taming of durable goods inflation solely to the output gap without acknowledging the contribution from tax cuts and inventory drawdowns, which are already over.
Once producers get some pricing power, probably during the last quarter of the year, exchange rate pass-through will return with a vengeance. Further complicating this gloomy picture are inflation expectations, which have proved to be quite sticky. The devastating effect expectations could have on services inflation over the medium-run is overlooked by many economists, partly owing to the CBT’s downplaying of this mechanism. As a result, I see inflation heading north rather than south in 2010. All this means that despite CBT’s assurances in its latest Inflation Report, policy rates will probably have to be moderately hiked next year.
My number of the beast forecasts have not changed by much. But at least we have just the right government to quell the devil; hopefully, it will be with the much-awaited economic framework.