Enthusiastic Plans Aims to Find Solutions to Macroeconomic Issues

Inflation continues to be the core problem for the country, as we expect it to soar to 69% by the end of 2023, while the recently announced MTP is projecting it to decreasing from 65% in 2023 sharply to 8.5% in 2026. (Note: Inflation continued to gallop along and increased to 58.9% y/y in August from 47.8% y/y in July). We think the road to glory looks bumpy, taking into account that upside risks emanating from increasing food and energy prices remain high for the country, in addition to the weakening currency, and expected hike in public spending before the 2024 local elections. Our 2026 inflation forecast is now 30%.

Another significant matter worth pondering is the current account deficit (CAD). According to the figures announced by Central Bank of Turkiye (CBRT) on September 11, the current account balance registered a $42.3 billion deficit in January-July, nearly matching the government’s year-end forecast of $42.5 billion that was outlined in the new medium-term program, which puts more pressure on TRY. (Note: The MTP projected current account deficit is expected to be $42.5 billion in 2023, and $34.7 billion in 2024.) 

Treasury and Finance Minister Simsek has said on September 11 that the shortfall is expected to decrease to around $40 billion in December due to a slowdown in consumer loan growth and a sharp rise in tourism revenues, demonstrating the economic management’s high set of goals of reversing the situation and acknowledging that it will take time. 

According to the September 6 MTP announcement, the major aim of the program is to develop new economic targets for the country and maintain domestic and external budget balance allocating resources in line with public policies. Speaking at the launch ceremony, Erdogan said “With the basket of policies we adopt in the MTP, we will remove the inflation problem off our country's agenda by ensuring coordination in our monetary, fiscal and incomes policies. There will be no concession from economic growth in the period covered by the program.”

MTP expects Turkiye's GDP to grow 4.4 percent this year, 4 percent by 2024, 4.5 percent by 2025, and 5 percent by 2026. (Note: It appears MTP trimmed GDP growth forecasts to 4.4% this year and 4% next year, from 5% and 5.5% previously). Moreover, per capita income is predicted to surpass $12,400 in 2023, reaching $12,875 in 2024, $13,717 in 2025, and $14,855 in 2026. 

According to MTP, the increasing trend in employment and labor force participation in 2022, continued partly in the first half of 2023. In the first six months of the year, a net employment increase of 220 thousand was achieved despite the regulations regarding retirement eligibility conditions and the negative effects of the earthquake. MTP notes that the annual increase in employment is expected to be 909 thousand people on average throughout the 3-year program, which is a cornerstone to long-term growth projections. This comes both from an increase in the working age population and a higher participation rate (Turkey current rate is 54%).

Driving a turnaround toward more orthodox policies since June, we interpret the new program intends to help the country to improve the current account balance (CAB) by triggering exports (and cutting imports), cutting the budget deficit, cool off inflation and support strategic investments in the long-term, to help sustain high GDP growth. Turkey is helped by its population dividend, with the labor force also set to grow at in the next few years. The shift back towards more orthodoxy policies should also help productivity. However, Turkiye also requires structural reforms to enhance productivity to achieve 5% growth by 2026, such as encouraging job creation and investments improving productivity, reallocating workers across productive sectors, labor training focused on catching the latest manufacturing and technological developments and redesigning investments support scheme. (Note: In his recent study, Prof. Suicmez created an index for the change in labor productivity in European countries and Turkey between 2005 and 2015. Accordingly, he revealed that the labor productivity index increased by an average of 3.2% in selected European countries in the mentioned period while it increased only by 1.64% in Turkiye, showing labor productivity growth falling behind the EU.)

We think this MTP program is significant as it serves a guide for the midterm framework for upcoming monetary and financial policies, given forward guidance by the CBRT with disinflation beginning in 2024, and macroeconomic stability forecast beginning in 2025. We believe MTP may help increase economic confidence among economic actors in the near term if CBRT continue to focus on using its tool set effectively until inflation is under control and TRY pace of decline slows, taking budget and current account deficits into account in addition to surging inflation. Slowing the pace of TRY decline is important in cooling down inflation given FX pass-through from a weak TRY as currency fluctuations continue to prevail. However, the forecast of 5.0% GDP growth in 2026 is likely too high, as too much improvement is required in macroeconomic imbalances and also structural policy. Our 2026 GDP forecast is 4%.

MTP seems determined, but we are of the view that a strong determination in monetary tightening supported by accurate fiscal policies is required until the expected inflation outlook is achieved and twin deficits are fully controlled.