publication January 10, 2019

Turkey Economic Monitor: Steadying the Ship

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Taking Stock

Over the past six months, Emerging Markets and Developing Economies (EMDEs) have faced headwinds from declining capital flows, slowing global trade, and commodity price volatility. In Turkey, these factors have combined with macro imbalances, perceived policy weaknesses, and international tensions to trigger a Lira sell-off and capital outflows.

Market volatility has subsided since August and the Lira has rebounded and external imbalances have narrowed. But Turkey’s external financial situation remains fragile and market perceptions of risks are high. Market volatility has also affected the real sector through high inflation, falling demand, and a big supply side correction.

Supply side adjustments, combined with elevated corporate debt - including FX exposure - has raised corporate solvency and liquidity concerns. Impacts vary across sectors; non-tradable sectors are the worst affected, while outward-oriented manufacturing sectors remain buoyant. Rising corporate stress has exacerbated banking sector vulnerabilities.

Timely policy actions - including liquidity management, a tightening of monetary policy, and addressing corporate debt vulnerabilities - have helped prevent a sharper correction.


Looking Ahead

The economic outlook is subject to higher levels of uncertainty than usual, given domestic and external vulnerabilities. Growth is projected to slow to a 10-year low of 1.6 percent in 2019, followed by a gradual medium-term recovery. Private domestic demand is projected to drop sharply in 2019, offset in part by public consumption and external demand.

Monetary tightening and commitments in the New Economic Program (NEP) signal important policy adjustments, though any uncertainty or inaction could tip the economy into a more difficult situation. The lack of progress on an orderly deleveraging in the private sector could precipitate this tipping point.

The projected economic slowdown poses multiple challenges for households, with the impact of inflation on household purchasing power likely to be the most acute. The authorities’ New Economic Program provides a solid foundation to tackle Turkey’s economic challenges, though a bigger role for counter-cyclical fiscal policy will be needed than what is currently envisaged under the NEP.

This should be complemented by tight monetary policy and a financial sector response that both supports gradual deleveraging of the private sector and enhances financial risk monitoring and management in the banking sector.

A strong corporate debt restructuring framework is critical to supporting the deleveraging process - the absence of which could mean the difference between an orderly adjustment for the economy and a hard landing.