Global Real-ISM…

The Purchasing Managers Index (PMI) that is disclosed in the first day of every month and is followed as the most important leading indicator for economic activity showed that the World economy remained in a weakening trend in August. The Global PMI that is the average of the country PMIs across the World took the value of 53.8 and held above the 50 threshold that demarcates the expansion and contraction periods. Nevertheless, this was the lowest print over the last 1 year. Contrary to the surprising jump in the U.S., the index in China (51.7) and Japan (50.1), which are the engines of global growth, dropped below this average. No doubt, the growth implication of a PMI that is slightly above the threshold would not be the same for developing countries, with high potential growth rate like China, and developed countries. However, what is certain is that in both country groups the PMI levels imply a near potential at best and most probably a weaker growth rate. In due course, the downtrend in the leading indicators also suggests that the most robust phase of the post-recession recovery has been over. Obviously, the extent that the countries could benefit from this fast rebound period differed depending on the initial shape of the economy prior to the recession. The countries which performed poorly in that respect would also be most vulnerable to a new slowdown cycle. Glancing at home, the leading indicators (Real Sector Confidence Index (RCSI), Turkish PMI and Central Bank Composite Leading Indicator) indicate that Turkey stands at a similar point in terms of the economic cycle. Tracking the global trends, the PMI and RSCI started to fall after peaking in April-May period, hinting that the robust growth performance in H1 would not be extended into H2. Meanwhile, the Central Bank’s Composite Leading Indicator signaled for the turning point of the industrial production two-three months ahead, as usual and the annual expansion of the industrial output eased to around 3% from around 10% after that point. This is a very weak recovery pace and let alone narrowing, the output gap would widen further in these circumstances.

Now, the question is whether this is an irreversible trend? How does the Central Bank perceive these developments and what are the measures they plan? We will be seeking answers to these questions in this weekly.
In order to have a better view of the picture above, the economy needs to be cleared from last year’s weak base effect. In essence it seems that the weak economic outlook that is described above may be undermined due to a number of reasons. For instance we expect 9.2% annual GDP growth in Q2 and 9.5% annual expansion in July industrial output both due to be released in the following weeks. Moreover, the domestic demand depicts a relatively better picture, thanks to the support from monetary policy. What then is going to be our benchmark? The rate of growth in the consecutive periods… A slowdown in GDP to 5-6% in Q3 and to 3-4% in Q4 would be acceptable, while growth rates below these intervals would be alarming.

The Central Banks are always concerned with the growth-inflation balance, while growth outlook outweighs in their monetary policy response function during crisis periods. The CBRT adopted countercyclical monetary policy strategy during and post recession period as much as the inflation outlook allowed them to do so. The Bank still sticks to this approach, as implied by the latest MPC meeting summary. Recall that in April the Bank had announced an exit strategy and pointed at Q4 this year as the start of the rate hikes, while coming to July, the risks associated with the global economy and the accompanying slowdown in the domestic economic activity urged the Bank to postpone rate hikes to an uncertain date next year, together with a delay in the exit strategy towards the end of this year. The Bank’s rhetoric seems to have changed a little bit since then as well. Among the alternative scenarios to the baseline described in the July Inflation Report, the Bank picked the one that we name as “economic contraction at home” and emphasized it in the latest MPC meeting summary. This has given the impression that they may be closer to this scenario than other alternatives (Pls. see below the Box for Central Bank Scenarios). In this scenario the Bank says should problems in the global economy further intensify, thereby increasing the possibility of a domestic recession, a new easing cycle may be considered. Even though in the meeting summary the Bank hints that they stick to the baseline scenario by saying that the outlook is in line with the July Inflation Report, the Bank only underlined the “economic contraction at home” scenario, without mentioning of “delayed recovery at home” scenario. This may be a sign that the alternative scenario that assumes first rate hike through the end of 2011 is now the Bank’s baseline scenario.
Against this backdrop, the Central Bank underlines that there is no change in the presumed timing of the steps in exit strategy (gradual increase in the TRY-FX reserve requirement rate and technical rate cut), which are planned to be introduced this year. Nevertheless, the Bank leaves the door open to different cases, mentioning of the risks that would either cause those steps to be brought forward or delayed. For instance, in the “economic contraction at home” scenario, the exit strategy was assumed to be delayed. Therefore, if this scenario is to be priced, that should consider both rate cuts and not implementing exit strategy. Needless to say, the above conclusions do depend on the domestic and foreign data disclosures more than ever.

In summary, the global economy remains in a slowdown trend, making it clearer that the strongest phase of recovery has been left behind. However, the uncertainties regarding the pace of recovery feed into double dip fears. Despite the support from monetary policy in Turkey, there is a significant deceleration in industrial output, while the leading indicators suggest deepening of this slowdown going forward. It is relieving to see that the Bank would keep the countercyclical monetary policy to combat this threat, which is not fully acknowledged by public opinion yet.

Central Bank Scenarios
Baseline: No important change in the recovery pace of economic activity is foreseen, with limited rate hikes starting sometime in 2011.
Delayed Recovery At Home: Should the global economy face a longer-than-anticipated period of anemic growth, which would consequently delay the domestic recovery significantly, the monetary tightening envisaged in 2011 under the baseline scenario may be postponed towards the end of 2011.
Economic Contraction At Home: An outcome whereby global economic problems intensify and contribute to a contraction of domestic economic activity may trigger a new easing cycle.
Faster Global Recovery: Monetary tightening may be implemented in an earlier period during 2011, should the recovery in economic activity turns out to be faster than expected.