Friday, April 9, 2010

Roubini Post: The Turkish Rainbow Tour

This post already appeared in the Hurriyet Daily News on Monday; Europe Economonitor is just republishing it, but I just wanted to cross link for the readers who might have missed it the first time around...

But while I am at it, I wanted to address a comment to a recent addendum to Monday's column. A reader wrote in the comments section of that post:
what is the underlying economic weakness in Turkey at the moment?
Luckily, this isn't a question I've been trying to avoid. Let me list them, in no particular order of importance.

First, it is fiscal. On that front, we are getting mixed signals. On the one hand, fiscal figures have been coming in quite strong as of late, despite the disclaimers I have highlighted at a recent column. It is also a positive development that as Econ. tsar Babacan disclosed in a recent interview, municipalities will be a part of the fiscal rule, but since he stopped short of saying that the magic formula will be on the consolidated (rather than central) government balance, I am not sure how this will work. In fact, I see a poorly-executed fiscal rule a big danger for the economy. Also, I am not sure that with elections looming, the government will be able to maintain a tight fiscal policy. Then, there would be spillover effects to the private sector, as Treasury borrowing would crowd out private lending. By the way, the Treasury has done a very good job in keeping the rollover ratio down so far, but there is only so much it can do if government spending goes out of control.

Then, there is the speed of recovery. While the latest Industrial Production data (February) was stronger than expected, there are still conflicting signs on the speed of the recovery. And even if Turkey did indeed recover speedily, it is unlikely that growth will be enough to bring unemployment down significantly.

Last but not the least, there is inflation: Turkey is one of the few countries, and the only one in EEMEA to my knowledge, where there are significant upwards pressures on inflation, meaning that the Central Bank will have to do something about it soon, as I have been arguing for a long time. While the exact details will be divulged at next week's MPC meeting and the CBT exit strategy document to be released right after, Turkey economists finally got wind of this challenging outlook and revised their policy rate projections upwards significantly. These developments are positive for the lira's prospects, but not quite so for stocks and bonds.

By the way, the inflation outlook, the speed of recovery and Central Bank policy rate outlook are not perfectly correlated, as I often read in market research reports. Let me elaborate a bit: Most economists base their policy rate projections on their inflation outlook, which is in turn tied to their growth forecasts for this year. While this makes sense in principle, the relationship is far more complicated than this Econ. 101 framework, as inflation could have many faces (demand, supply, money, expectations, FX, global). Similarly, liquidity and rate tightening are often confused: It is assumed that if the Central Bank decides to fight inflation, it will drain liquidity and raise rates at the same time because it is assumed that inflation is a monetary phenomenon. It is possible to get tight liquidity, inflation and moderate recovery at the same time, which would guarantee interesting actions by the Central Bank. But I am digressing too much; this will have to turn into a proper column in the next few weeks.

By the way, unlike some, I don't see external financing a big issue for this year, although the current account deficit will rise significantly with economic recovery. The reason is that as the name suggests, the balance of payments always balances. The question is at what price for the lira, but the Central Bank tightening all but ensures that the lira is unlikely to face significant depreciation pressures.

The reader just asked about economic risks, but the main risks in Turkey are political at the moment, in my humble opinion. In that respect, the Princip or 2001 crisis examples in the previous post do not really fit perfectly. But all I was trying to argue is that these ignored economic risks could suddenly come to the investors' radar as political risk rises.

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