Summary: While the slowdown in the global economy and in Turkey expected for the second half of the year remained limited in Q3, there seems to be a revival in Q4. This should keep pushing up the consensus growth forecast for 2010. However, the growth estimates for 2011 is at reasonable levels. That limits the room for surprises from either side and inflation appears to be a more important theme for markets next year, as it is more exposed to surprises. The inflation forecasts for next year are quite high, preparing an appropriate ground for positive surprises.
We will see the third quarter growth performance in Turkey when the GDP figures are released on next Friday. After the data, the consensus for the overall year is likely to keep being upgraded from 7.0% print of the last survey. I believe this is quite important, considering the fact that the uninterrupted increase in the growth forecasts this year has become the key driver of the markets. The tight relation between the forward-looking expectations and the market performance would most likely be valid in the upcoming years, as well. The average GDP estimate has come all the way up to 7.0% in the last Central Bank expectation survey from the initial 3.3% in the beginning of the year, exploring the big potential for a positive surprise when the expectations are set irrationally low. In essence, there is still upside potential for the consensus. However, it is time to focus on 2011 expectations as we approach the new year.
Regarding the next year’s growth prospects, two important aspects would determine the outcome. Starting with the favorable one, the leading indicators suggest that the economic activity has picked up in the last quarter of the year and this momentum is highly likely to be preserved in the next year. Technically speaking, the seasonally adjusted industrial output that has recovered to pre-crisis levels would sustain quite strong year-on-year growth rates. Moreover, as suggested by the PMIs, the economic activity has been gaining steam globally which is an assuring factor for the sustainability of the revival at home. Nevertheless, this support from the global backdrop would be valid only if the heightened worries regarding the European debt crisis and the Fed’s launch of the second phase of the quantitative easing program, do not jeopardize the business and consumer confidence. Coming to the dismal aspect of growth dynamics for the year ahead, the GDP growth is set to reach 8% this year and this robust performance would form an unfavorable base year effect for 2011. In that context, the 4.8% average forecast for next year’s GDP is neither low nor high, limiting the surprise from either side.
Therefore, even though the GDP forecast continue playing an important role, the inflation forecasts are likely to replace as the more dominant market driver in 2011. Until then, the data disclosures regarding the growth outlook would continue to be attractive for markets. As we said before, all the leading indicators (capacity use, reel sector confidence index, Turkish PMI and consumer confidence) suggest acceleration of economic activity in the last quarter of this year. For a quick flash back, in the first half of the year both the leading indicators and the hard data for output had implied a strong growth performance, which was then replaced by a slower performance due to the European debt problems. Rather than suffering a contraction, output remained flat during May-September period. The other country groups also displayed a similar performance, with their seasonally adjusted industrial production lacking any visible improvement in that period. However, this standstill position shall change from October onwards. As is known, the hard data is two-month backward-looking and we expect to see the activity gaining ground in October. This remains to be confirmed when the October industrial output figure is disclosed on December 8th. On year-on-year comparisons, the industrial output is to enjoy 10% growth in the first month of the last quarter, after expanding by 10% in the third quarter and 13.5% in the first 9 months of the year. At first look, this seems to indicate a similar performance to the third quarter. However, in reality, my estimate implies a seasonally adjusted 2.4% m/m increase and suggests acceleration. The 6.1% consensus for the industrial output is below my forecast. The second important data of the week is the Q3 GDP due December 10th. My forecast is 6.2% y/y expansion. If our call turns out to be true, this would urge the markets to upgrade their 7% forecast for the overall 2010. Otherwise, Q4 GDP growth would need to come at a subdued 1.5% or lower in order to be consistent with 7% growth for the year. If industrial output expands as rapidly as we expect in October, the odds of such a weak performance would get even lower.
If the data disclosures mentioned here come in line with our forecasts, the Central Bank would narrow the output gap forecast when they release the Inflation Report in January. By itself, this outlook would normally urge for earlier rate hikes. At that point, the inflation pattern would play an important role to prevent the markets revising their rate hike forecasts to an earlier date than the last quarter of the year, as the recent polls suggest.
In that context, the key market theme to follow next year is whether the annual CPI would recede to the 5-6% interval from the first months onwards, in line with the Central Bank’s presumptions. It seems that the upward pressure on inflation has been building up, given the industrial output that is poised to return to pre-crisis levels, along with the recovery of the capacity use to long term averages and the ongoing improvement in labor market. This outlook makes the pricing behavior more important than ever. The underlying inflation trend that is best gauged by the core indices and the service sector prices suggest that there is no visible deterioration yet and the benign pattern is still on track. However, after displaying a sluggish performance when coming out of the recession, Turkish economy has now been pulled into an unbalanced growth structure on the back of robust domestic demand and weak external demand. While this outlook warns against threats to financial stability on one hand, it at the same time raises the question marks regarding the policy reaction of the Central Bank. It is true that the inflation is hovering above the official target and is set to overshoot the year-end target. However, acknowledging that the food component contributes some 4.7 pp to the headline CPI and the annual inflation in the unprocessed food component is at a record high 31.3% as of October, there is a large potential of decline in their contributions going forward and that in turn makes any policy reaction unnecessary. Unless the inflationary pressures become widespread and the inflation in non-food and non-energy segments deteriorates, a wait-and-see approach, accompanied with measures to prevent excess credit expansion, is worth to try, despite all the ambiguities regarding its effectiveness.
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