Turkey overview

The Turkish economy as a whole grew by 2.6 per cent in 2018, but this was driven by strong growth in the first half of the year, and the economy entered recession in the second half of 2018. Tighter monetary policy and deteriorating consumer and investor sentiment resulted in a cumulative contraction of 4 per cent in the second half of the year. While leading indicators suggest that the slowdown may have bottomed out in the first quarter of 2019, this may in part be driven by temporary counter-cyclical measures introduced in advance of the municipal elections in March 2019.

While the lira has stabilised following a period of high volatility in 2018, it remains highly vulnerable to fragile investor sentiment. Having depreciated by an average 29 per cent against the dollar in 2018, the lira has recovered part of its losses since the last quarter of the year. Nevertheless, it remains highly vulnerable to changing investor sentiment. The continuing dollarisation of bank deposits and volatility of the exchange rate in recent months indicate that confidence in the economy has not improved sufficiently to rule out another bout of currency depreciation. Meanwhile, the means employed to support the currency in the run-up to the municipal elections have done little to support investor confidence.

While the rapid rise in inflation has partly reversed since late 2018, inflation is likely to remain elevated throughout the first half of 2019. Having surged rapidly as a result of the lira’s depreciation and overheating of the economy, annual inflation hit a 15-year high of 25 per cent in October 2018. It has started to decline since November, as the economic slowdown has constrained consumer demand. At the same time, although several counter- inflationary measures introduced by the authorities have helped tame headline inflation, it remains elevated, at around 20 per cent. Inflation is likely to start to decline gradually in the second half of 2019 as the pass-through effect of last year’s lira depreciation recedes.

The sharp contraction in domestic demand has resulted in a significant reduction in the current account deficit. Depreciation of the lira and contracting domestic demand have resulted in a significant decline in imports in the second half of 2018, and it is likely that the current account balance will be close to zero by mid-2019, from 6.5 per cent of GDP a year earlier. Still, the short-term external financing requirement remains high, at around of 25 per cent of GDP.

The economic slowdown and weakness of the lira have led to concerns about bank asset quality and capitalization. Asset quality has been affected both by exposure to corporates with large foreign-currency-denominated liabilities, and by the effect of increased domestic interest rates on corporate and household balance sheets, particularly as the economy slows. This has reduced bank capital ratios, with some banks going to the market to raise capital. These challenges have resulted in a significant contraction in credit growth, albeit with a small reversal in the first quarter of 2019 driven by state banks.

Fiscal policies have been tightened, although there has been some slippage. While the 2018 budget deficit was realised as planned at 1.9 per cent of GDP, the target deficit of 1.8 per cent for 2019 will be difficult to meet, particularly in light of the counter-cyclical policies adopted in the period leading up to the municipal elections in March. Public finances are robust overall, with a low public debt of around 30 per cent of GDP. However, the long-term impact of growing contingent liabilities in the form of revenue guarantees to PPP projects and credit guarantees under the Credit Guarantee Fund (CGF) is unclear.

Recovery from the ongoing slowdown is likely to be gradual. The lira’s depreciation and high interest rates will continue to dampen consumption and investment, although net exports should make a positive contribution to growth. Deleveraging by the private sector means that the economic recovery will be slower than in past crises, when credit growth stimulated recovery. A contraction of around 1.0 per cent is expected in 2019, while 2020 will likely see a gradual recovery of growth to around 2.5 per cent.