Summary: The latest data disclosures support our long-held view for a high growth rate for this year, while we also realize that the divergence between domestic and external demand has turned more visible. This outlook would unlikely change the monetary stance of the Central Bank, but ease the downside risks on the policy rates. The Bank is more likely to respond via instruments other than interest rate in case this divergence continues. Separately, the fresh budget figures seem to be relieving for the Bank, who emphasized that they would be monitoring the implementation at the absence of fiscal rule.
The data disclosures over the recent term suggest that divergence between growth rates of domestic and external demand has turned more apparent in Turkey. The Consumption Index reached all time high in August, posting around 20% y/y gains in each of the last two months, while the annual expansion in the domestic loans climbed above 35%. Meanwhile, the unemployment rate remained on a steep decline pattern and more importantly the seasonally adjusted rate receded to its lowest level since October 2008. Also, after the limited drop in May, the economy continued to generate jobs in June, as was valid in the m/m increase of 161K in the total payrolls (the average increase in the first five months was 100K). The consumption and investment contribitued above-expected 4.5 pp and 5.9 pp to the overall GDP growth in Q2. Despite this healthy domestic demand outlook, the industrial output has lost pace over the last months due to the slowdown in exports. The seasonally adjusted industrial output could only recoup by 0.3% m/m in June atop of the sharp 2.2% slump in June. Note also that the net exports erased some 1.6 pp off the GDP in Q2. Nevertheless, Q2 GDP came better than expected; posting a seasonally adjusted quarterly growth rate of 3.7% and GDP level has reached mildly above its pre-crisis peak. The fresh data disclosures such as the increase in current account deficit, improvement in labor market and budget performance, suggest a slightly better economic outlook. On the contrary, the leading indicators of economic activity indicate that economy would enter to a somewhat slower pace in the third quarter and display a flattish trend. Separately, as we approach to a period where the weak base effect would fade off, the Turkish economy is likely to post more conservative single-digit growth rates in the following quarters (we expect around 6% growth in Q3, followed by 4% in the following quarters). In other words, we stick to our baseline scenario that includes below-potential growth rate and slow recovery.
While the growth outlook is a bit stronger than what the market expected, we stick to our above-consensus GDP growth forecast of 7.0% for 2010. Note that the risks now are upside on this forecast. However, we reckon the growth rate would decelerate to 4.0% vicinity in 2011, due to the weak global backdrop, unfavorable base effect linked to this year’s strong performance and likely deterioration in confidence in the election year. Thus, the fresh data would unlikely change the monetary stance of the Central Bank, but ease the downside risks on the policy rates. Recall that in the August MPC meeting summary, the Bank mentioned the ‘Economic Contraction At Home’ scenario whereby global economic problems intensify and contribute to a contraction of domestic economic activity, consequently triggering a new easing cycle. Back then, the Bank had also said “If this [exacerbating pattern of the divergence between the pace of recovery in the domestic demand and external demand] pattern of growth coexists with rapid credit expansion and a deterioration in the current account balance, consequently leading to financial stability concerns, it would be necessary to utilize other policy instruments such as reserve requirement ratios and liquidity tools more effectively.” In this context, the Bank introduced the technical rate cut in September MPC meeting, while also noting that it would be appropriate to proceed with the other measures outlined in the exit strategy. We expect soon there will be increase in F/X and TRY reserve requirements and anticipate the Bank resuming rate hikes by May next year reaching 200 bps in end-2011.
On the other hand, the Central Bank frequently signals that they keep a close eye on the fiscal policies while forming their monetary policy strategy. Recalling from the August meeting summary, the Bank had noted that “…the delay in the enactment of the fiscal rule has increased the importance of current fiscal policy implementation.” In that context, the July-August budget realizations that were disclosed a month later than normal timing due to fiscal holiday would probably give some relief to the Bank. The Bank’s assessment regarding the 1H performance was positive and the Bank had said “… the better-than-expected performance in budget revenues, due to stronger economic activity than envisaged in the Medium Term Program (MTP), is largely being used to reduce government debt,” signaling that they do not see any problem with the fiscal discipline. We think that July-August budget performance is likely to deserve a similar assessment.
Having a closer look at the fiscal outlook, the central government budget produced TRY8.8bn primary surplus in July-August period, much better than the TRY5.1bn surplus in the look-alike slice of last year. There is substantial improvement in revenues on the back of strong tax proceeds that is more than enough to counterbalance the increase in primary expenditures, while around TRY2.0bn transfers from unemployment insurance fund and privatization revenues also helped the revenue performance. Adding the visible decline in interest payments, the budget balance improved at an even greater pace as the two-month budget produced a surplus of TRY1.0bn vs. last year’s TRY8.1bn deficit. All in all, the 12-month central government budget deficit to GDP declined to 3.4% vs. the year-end target of 4.9% in the Medium Term Program (MTP). This improvement is in line with our estimates disclosed in the ‘Fiscal Outlook’ report published on Monday. This may indicate that there is an extra room for 1.5 pp more (TRY15.8bn) for expenditures boosting or revenue-damping policies. In other words, extra improvement in July-August budget implies that the fiscal area that can be turned into higher expenditures is enlarged and both Finance Minister Simsek’s words that “we will be loyal to our targets” and Economy Minister Babacan’s emphasis that the year-end budget deficit will be in line with MTP targets are consistent with deterioration vs. the current point. Along with the Central Bank, we will continue to monitor how this fiscal area will be used in the following period. However, even if budget performance deteriorates somewhat in the period ahead, we do not anticipate the Bank would react unless this deterioration yields upward pressure on inflation via for example indirect tax hikes.
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