Turkey chartbook: all eyes on the elections as imbalances grow

- Despite challenging circumstances, like the recent earthquake, widespread uncertainty and a deceleration in 2H22, the latest high-frequency data for 1Q23 suggests that the economy remains strong, on the back of increased public expenditure, transfers, and also good exports and a resilient labour market. Looking ahead, growth sustainability and the current stability remain very uncertain due to the unorthodox macro policy increasing the external imbalances. The post-election policy normalisation will be critical to understand the direction Turkey is taking.
-- Last year, despite weak economic sentiment, the Turkish economy performed well, driven by household consumption and exports. Contributions from other domestic demand components were subdued, however, and inventories decreased significantly. In addition, the disrupted monetary policy framework, focused on keeping real interest rates deeply negative, contributed to an increase in inflation to multi-year highs.
-- The economic outlook after the elections is uncertain due to the growing imbalances and the current macro policy. While the growth outlook is holding, despite the earthquake, we expect inflation to remain high and decrease slowly due to unanchored inflation expectations and very loose monetary policy. On the bright side, however, the current account deficit is also expected to decrease with the normalisation of energy prices.
-- Given the country’s reliance on external financing and the current monetary policy framework, there are significant risks to this mixed outlook. Imports rebounded due to the rise in demand and relative appreciation of the real effective exchange rate (REER), which also damaged competitiveness at a time when exports, which have been a strong driver of economic growth in recent years, should slow over weaker external demand from Turkey’s major trading partners.
-- Even before the earthquake, we expected a deterioration in the public finances, as the costs of measures to mitigate inflation support the TRY, and “electioneering” became more significant (early pension schemes, wage increases, energy-related subsidies, lending, a new government investment scheme in subsidised housing). We have downgraded our deficit estimates further but, on this front, and also thanks to the low debt-to-GDP ratio, we see limited funding risks. Only in a scenario where Turkey decides to frontload post-earthquake spending (a deficit of close to 10% of GDP), do we see some funding risks.
-- In terms of earthquake impact, the UNDP has estimated the cost of the disaster at around USD 103.6 bn, or about 9% of the country's GDP forecast for 2023. In response, there has been significant international support, including pledges of EUR 7bn from donors at a conference led by the European Union on 20 March. The World Bank has also announced an initial contribution of USD 1.78bn towards Turkey's recovery and reconstruction efforts.