After the severe financial shock in August 2018, which triggered a recession in the second half of the year, strong fiscal and quasi-fiscal stimulus have moderated the contraction in early 2019. However, investor uncertainty remains high after the recent municipal elections. Business and household sentiment are affected by increased uncertainty. Absent any new shocks to international and domestic confidence, a measured recovery is projected from the second half of 2019 onwards, although the level of GDP in 2019 and 2020 is projected to remain below the 2018 level. Substantial risks remain around the projected recovery of growth.

Regaining the confidence of households, businesses, and domestic and international investors in the quality and predictability of economic policies and the credibility of market institutions is crucial. The central bank should aim to enhance its credibility and to re-build its net international reserve position. Fiscal policy should be made much more transparent. Countercyclical measures would be more effective if implemented in a transparent and predictable way. Structural reforms would boost growth, notably the enforcement of a level playing field in product and labour markets.

Domestic demand has contracted sharply and trade adjustment is underway

Household consumption, the central driver of the macroeconomic cycle, stayed weak in the first quarter of 2019 despite very strong fiscal stimulus, due to increased unemployment and low household confidence. Households have also faced real income losses due to high inflation, despite a significant increase in the official minimum wage at the beginning of the year. In particular, low-income households suffer from higher food costs. Private investment remained very weak, but public infrastructure investment, including by state-owned companies in the commercial sector, appears to have strengthened. On the back of strong labour force growth despite the recession, the rate of unemployment soared to 14.7% in the December-February period and the youth unemployment rate has reached almost 27%.

Economic activity and bond spreads: Turkey
Economic activity and bond spreads: Turkey

1. Three-quarter moving average.

Source: OECD Economic Outlook 105 database; and Refinitiv.

 StatLink https://doi.org/10.1787/888933934983

Turkey: Demand, production and prices
Turkey: Demand, production and prices

 StatLink https://doi.org/10.1787/888933935876

Manufacturing and service exports, including tourism exports, are being boosted by the substantial real exchange rate depreciation which followed the August financial shock and further depreciation episodes in March and May. With the sharp contraction of imports, reflecting the decline of domestic demand and real depreciation, external adjustment has accelerated and the current account balance has significantly improved. However, the slowdown of demand from Turkey’s main export markets in Europe, notably from Germany-centered value chains, has moderated this positive support in the first half of 2019.

The policy framework should be made more predictable

The authorities introduced a large number of fiscal and quasi-fiscal stimulus measures in late 2018 and early 2019. These included major consumption tax cuts, administrative price reductions, subsidised foodstuff sales, loan restructuring for firms and households by public banks, and generous job subsidies. However, the relatively unpredictable implementation of these measures, and uncertainty about their sustainability may have reduced their impact. Publishing a regular fiscal policy report based on standard government accounts according to international norms would help implement countercyclical policies in a transparent way, provided that all quasi-fiscal activities are also covered.

Monetary conditions were tightened in 2018, and policy interest rates have been kept high to support the Turkish Lira and to contain the increased dollarisation of the economy. The central bank should restore credibility by putting inflation on a convergence path to its 5% target. The transparency of its policy instruments and accounts should be improved and tightening measures, when needed, should be implemented more directly. Explicit rather than indirect tightening measures would be more effective. Financial conditions for long-term business and household borrowers are very restrictive, due to Turkey’s high sovereign risk premia and banks’ and blue-chip firms’ very high international borrowing costs. The loan restructuring vehicles envisaged for the highly strained energy and real estate sectors (that the Turkish Banking Association is expected to put in place with domestic and foreign private investors, without direct government participation), if implemented successfully, would reduce pressures on creditor banks, offset financial contagion risks, and help improve confidence.

A slow recovery is projected, but risks are substantial

Turkey’s post-shock recovery experiences suggest that under an adequate policy framework household consumption and business investment tend to rebound relatively rapidly. However, the high debt stock, high debt roll-over costs (with 25% of GDP of foreign debt maturing in the next 12 months), which will be particularly challenging for non-financial firms carrying high foreign and foreign-currency domestic debt, and substantial uncertainties in political conditions and economic policies weigh heavily on the recovery. A gradual upturn is foreseen from the second half of 2019, on the assumption that Turkey will face no further confidence shocks. If domestic and international confidence is restored more rapidly, risk premia and investment costs will likely start to normalise and the economy could recover faster. However, if current uncertainties continue to prevail and confidence remains fragile, Turkey would remain vulnerable to turbulences and headwinds, and GDP growth would be weaker. The phasing-in of the structural reforms needed to enhance the rule of law in, and the level-playing operation of, product and labour markets would improve confidence and help increase the potential growth rate.

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