Turkey: Year in Review 2011

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In a sign that the country has performed well in the face of debt crisis affecting its neighbours in the EU, the Turkish government announced in January that the economy expanded 8% in 2011, with the construction, manufacturing, and retail sectors leading the way. Fears of a hard landing still remain, given Turkey’s chronic current account deficit and its recent struggles with inflation, but a burgeoning domestic economy, combined with political stability and a healthy fiscal position, have enabled the country to post decent macroeconomic data.

Stronger-than-expected third-quarter 2011 growth of 8.2% led JP Morgan to revise its yearly growth estimates to 8.2%, above its early predictions of 7%. However, the fallout from the eurozone crisis is expected to dramatically slow the economy. The IMF is the most pessimistic of forecasters, projecting 2% growth for 2012, while the government is anticipating that figure to top 4%. JP Morgan, hewing more closely to the IMF’s outlook, originally predicted 2.2% growth, before adjusting it to 2.5% on the strength of third-quarter 2011 figures.

Galloping inflation has replaced the current account deficit as the top concern for the Turkish economy. Inflation rose sharply in November to hit 9.5%, the highest Turkey has seen for over a year and a half. Major culprits included rising food prices, steeper taxes on goods like tobacco, automobiles and mobile phones, and higher import taxes.

But the weakening lira, which has lost 24% of its value since October 2010, dropping from TL1.44 to TL1.88 to the dollar in December, has been the largest contributor, causing the central bank governor, Erdem Basci, to name inflation the greatest problem for Turkey’s economy. In December Basci expressed hope that the bank’s increase of the overnight borrowing rate to 12.5% would slow the rise of prices.

The central bank itself has received a mixture of accolades and criticism for its unique monetary policy, which holds the “policy” repo rate at 5.75% while enforcing an overnight rate of 12.5%. Analysts have held this policy accountable for the unusually strong connection between lira depreciation and inflation, necessitating occasional central bank intervention into foreign exchange markets. The bank is expected to use $20bn in foreign exchange to hold the lira’s value below TL1.90 to the dollar, although this would significantly eat into Turkey’s forex reserves.

One outcome of the lira’s weakness has been a reduction in the current account deficit, which narrowed for the first time in two years recently due to a slowdown in output and an increase in exports spurred by a weaker currency. The current account deficit stood at $5.2bn in November, compared with $6bn in the same month of 2010. The deficit is expected to continue to decline into 2012.

Export growth was a robust 10.8%, no doubt aided by a weak currency that made Turkish goods cheaper. An analysis by JP Morgan, meanwhile, predicts that the annual current account deficit peaked at $78.6bn in October, and expects it to fall to US$61.4bn in 2012.

Sectoral highlights for 2011 included construction, which grew at 8.5%, driven by a 15.5% expansion of the residential subsector. Turkish construction companies suffered from the fallout of the Arab Spring, with some $23bn in contracts in Libya jeopardised by the civil war that began in March. Still, firms are looking hopefully at their prospects in the Middle East, and negotiations have begun with Libya for the resumption of work there.

On the domestic front, meanwhile, attention is shifting to Turkey’s ambitious infrastructural plans, which should drive growth in the sector for the next five years. Work is underway on the Gebze-Orhangazi-İzmir Highway Project, which will cut the driving time from Istanbul to Izmir from 8 to 3.5 hours, with the completion of a 1.7-km bridge across the Izmit Gulf. Other major projects include a third Bosphorus bridge for Istanbul, and a new canal project, which aims to build a second waterway from the Black Sea to the Marmara Sea to reduce congestion on the Bosphorus and allow greater throughput of oil and gas tankers from the Black Sea.

Turkey benefitted in 2011 from its status as an island of stability in a sea of economic and political turmoil. The uncertainty surrounding the Arab Spring drove tourists to visit stable Istanbul and its Aegean cousins, even as Turkey’s growing soft power drew in increasing numbers of Arabs themselves. Meanwhile, Europe’s stagnation has pushed investment towards more promising candidates, although these inflows to Turkey will be endangered if investors fear the Eurozone crisis will have strong effects.

Negotiating a soft landing will require Turkey’s monetary and fiscal policymakers to strike a careful balance — maintaining growth while containing inflation, and propping up the lira while working to avoid a balance of payments crisis. Indeed, if Turkey can meet these challenges, it looks to have a healthy future.

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