Turkey Short Insight – Fourth quarter preludes recession

by: Nora Neuteboom , Georgette Boele

  • The Turkish economy contracted by 3% yoy in the last quarter of 2018
  • Sentiment indicators point towards a continued period of contraction
  • We expect monetary policy to remain tight until July 2019
  • We expect some recovery in the USD/TRY to 5.2 end of year
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Q4 GDP came in at -3% yoy (below consensus)

GDP in Turkey contracted by 3% in the fourth quarter of 2018 (consensus: -2.5%). Both private consumption and investments contracted by 9% and 13% respectively, their lowest levels since 2009. Net export contributed positively to growth, by growing 8.4% in the fourth quarter, as imports fell by almost 25% due to low domestic demand and exports rose by 10.6% on the back of the low exchange rate and high tourism revenues. On average,  the Turkish economy grew by 2.6% in 2018, down from 7.4% in 2017. While the currency crisis (which erupted in August last year) has largely passed, slowing credit growth and high inflation are taking their toll on the Turkish economy. Leading indicators show little signs of recovery yet. Industrial production is still trending down, with no signs of bottoming out. The Markit Manufacturing PMI reached its lowest point in September last year and has slightly recovered since, but is still well below the neutral level of 50.

Fourth quarter results prelude a deep recession

Given that Turkey will have to redesign its growth model from being credit-oriented towards focussing on productivity gains, we expect that it will need some time to recover from the economic slowdown. We expect a further contraction of 2.5% in the first quarter of this year, 2% in Q2 and 1.5% in Q3 and around 0% in Q4. Turkey will face a prolonged period of negative and subdued growth due to structural issues in the economy and we think a V-shape recovery is very unlikely (see also:  Turkey outlook 2019: facing contraction).

We expect monetary policy to remain tight until July

On the 6th of March, the central bank held the one-week repo rate constant. The lira’s forward implied yield (2months) suggests that the market is pricing a rate decrease of around 50 to 100 basis points at the next meeting on April 25. We think the central bank will only start to ease monetary policy from July onwards as there is no clear indication yet that the inflation outlook will significantly improve in the coming months. Inflation still trends around 20%, far above the 4% target of the central bank. The central bank has worked hard in the last couple of months to re-establish their credibility. They will not want to throw their fragile reputation over board by easing prematurely. We expect inflation to come down substantially in the second half of 2019 due to the combination of base effects and economic slowdown. We expect  a first rate cut of 125 bp at the 25 July meeting and a total easing of 500bp throughout the second half of 2019, albeit this is largely dependent on the market reaction to the first rate cut and the future inflation data.

We see some lira appreciation later in the course of the year

In January, the lira recovered because of the overall improvement in investor sentiment towards emerging market currencies. The Fed rate hikes for 2019 were priced out, equity markets recovered and the US dollar was range-bound. Since then, sentiment towards the lira has deteriorated again and the lira has mostly given up earlier gains. Turkish economic fundamentals have weighed on the lira as well as less constructive investor sentiment and a stronger US dollar. In the near-term, the lira could weaken a bit further because of uncertainty on the Turkey-US relationship and local elections that take place end of March. However, we think that it is unlikely that there will be another sharp sell-off as we expect monetary policy to remain tight at least until July. In fact we expect some recovery towards 5.2 versus the US dollar towards the end of this year.