Turkey avoids recession, but not lira volatility and high inflation

Despite the impact of the pandemic on tourism and exports, Turkey's GDP grew by 1.8% in 2020 thanks to the intense stimulation of credit, which increased by 35% year-on-year, to boost private consumption and fixed investment. In 2021, Crédito y Caución expects Turkey to grow by close to 5%, supported by the global recovery, growth in industrial production (9%), exports (11%) and a possible recovery in tourism from the second half of the year. Private consumption will only increase by 2%, affected by inflation, which could reach 14% in 2021.

The sharp depreciation of the Turkish lira due to capital outflows in the first quarter of 2020 was sustained in the following months by the provision of cheap and large loans to stimulate the economy. In the fourth quarter of 2020, the central bank tightened the interest rate by a total of 875 basis points to 17% to curb inflation and currency depreciation. Recently, the benchmark interest rate was raised again by 200 basis points to 19 per cent. However, the governor of the Central Bank was dismissed immediately afterwards, which has shaken the credibility of Turkish economic policies and investor confidence, leading to a further depreciation of the exchange rate. 

The lira's exchange rate against the dollar is still 20 per cent lower than a year ago, adding to the burden of the corporate sector's large exposure to foreign currency debt. In the past, Turkish companies, especially in the energy, building materials, steel, transport and chemicals sectors, borrowed extensively in foreign currency from local banks. Despite continued private sector deleveraging since the previous currency crisis in 2018, liabilities remain high and sensitive to interest rate, rollover and exchange rate risks. Many firms pay high interest on loans and struggle with the impact of the weaker value of the local currency on external debt repayments. 

The direct fiscal response to the pandemic has been modest. Budgetary measures accounted for only 2.5% of GDP, focused on employment support and tax deferrals. The budget deficit of 3.7% in 2020 was low compared to neighbouring markets. Fiscal consolidation is expected to resume this year. Turkey's public debt is just 36% of GDP. However, it is vulnerable to exchange rate risk, as more than half is denominated in foreign currency. The current account deficit widened to 5.8% in 2020 and, although tourism is expected to pick up in 2021, it is not expected to narrow rapidly. 

The administration is likely to return to its policy of credit-led economic growth in the run-up to the 2023 elections. Without a revival of long-neglected major structural reforms, the Turkish economy will remain constrained by macroeconomic imbalances related to credit growth, high inflation, large external deficits, low savings, competitiveness weaknesses and an inflexible labour market. In the absence of comprehensive reforms to address these problems, Turkey's long-term potential growth rate will decline to the range of 3 to 3.5 per cent, insufficient to absorb the increase in the working age population of one million people per year.