Turkey: Government slashes growth forecasts and announces austerity measures in New Economic Program
September 26, 2018
Treasury and Finance Minister Berat Albayrak presented the New Economic Program (NEP) (formerly the Medium-Term Program, MTP) on 20 September. The plan provided more credible macroeconomic forecasts—including for reduced growth and markedly higher inflation—and set out a more cautious fiscal stance. As a result, the program should go some way to restoring investors’ faith in the government’s macroeconomic policymaking, reduce economic imbalances and support the lira. However, full implementation of the announced measures will be key to rebuilding investors’ trust, while concrete proposals for the banking sector were limited.
The program established TRY 60 billion of cost savings and TRY 16 billion of extra revenue for 2019 (around USD 12 billion in total). The vast majority of cost savings are expected to come from investment programs, incentives and the social security system, while extra revenue will be raised by broadening the tax base through a reduction in exemptions. The government also announced changes to public-private partnership (PPP) initiatives to boost affordability. This comes after the IMF warned the country earlier this year about the fiscal risks associated with such schemes, which have played a key role in infrastructure development under President Erdogan and were recently valued by the Fund at around USD 61 billion. Thanks to this fiscal austerity, the NEP forecasts a rising primary surplus and a central budget deficit contained below 2% of GDP going forward.
Moreover, the plan sees the economy growing just 2.3% next year and 3.5% in 2020, in contrast to a target of 5.5% growth in both those years in last year’s MTP. This seems to indicate that—at least in the near-term—President Erdogan appears willing to temper his growth-at-all-costs approach and marks a return to a more stable economic trajectory following the government stimulus drive which turbocharged the economy last year. Regarding inflation, the plan sees it ending next year at around 16%, and only returning to single digits in 2020.
Looking at the external sector, the government aims to sharply reduce the current account deficit going forward. As well as the weaker lira aiding competitiveness, the program also aims to achieve this by boosting domestic production in areas such as pharmaceuticals, energy and machinery, where Turkey is currently extremely dependent on imports. This will take time, however, and FocusEconomics panelists predict a more modest narrowing of the current account deficit over the coming years.
Regarding the banking sector, the NEP stated that the government will conduct a review of banks’ financial soundness. However, there were no concrete steps to address concerns over non-performing loans—which could rise as firms struggle with a hefty external debt burden—or banks’ access to international financing.
According to ING analysts, the “programme is a step in the right direction with rebalancing on growth and reviving a commitment to fiscal prudence, though the inflation path is to remain elevated longer.”
Economists at Nomura also agree that the NEP—together with the Central Bank’s recent rate hike—is a sign that “the authorities are gradually adjusting to reality.” However, they go on to state: “We do not believe they [the NEP and rate hike] are enough to reverse the long-running trend of erosion of policy making credibility in Turkey. Even if these are credible policy changes, it is probably too late to reverse the economic downturn because of the negative effects of currency depreciation on private sector balance sheets.”
The more conservative fiscal stance should provide support to the beleaguered lira going forward. However, ING and Nomura highlight that the Plan’s implicit 2019 exchange rate assumption—calculated by both firms at around TRY 5.60 per USD—could be slightly optimistic. FocusEconomics panelists concur, and see the currency ending 2018 at TRY 6.10 per USD and 2019 at TRY 6.35 per USD.
Despite tighter fiscal and monetary policy, a sustained improvement in the exchange rate outlook will likely be dependent on a reduction in geopolitical tensions, particularly a normalization of relations with the United States.
As economists at Nomura comment: “We also need a de-escalation on the foreign policy front. […] If there is no resolution […] and if this is followed by further US sanctions on Turkey (and a possible fine on state-owned Halkbank), then the pressure on Turkish assets will resume forcefully.”
Author: Oliver Reynolds, Economist