Turkey's economy recorded explosive growth in the last quarter, up over 11 percent year-on-year. The six-year high growth figure surprised markets, which had expected a much milder increase near 8 percent. The figure, while very positive, is tempered when considering the third quarter of last year was hit the hardest following the failed coup attempt of July 15. Especially hard-hit consumer confidence made a surprisingly robust showing in the third quarter. Non-government consumption was up 11.7 percent year-on-year. This is perhaps the most important figure in the growth numbers. It signals continued consumer consumption, which accounts for over two-thirds of gross domestic product (GDP). Any major growth story in Turkey will be accompanied by growth in consumer consumption, and that is precisely what happened.
Investments were also up sharply, 12.4 percent year-on-year, accounting for 3.4 percentage points of the 11.1 percent. Exports were also up over 17 percent while imports were up 14.5 percent, leading to a net increase in exports. Construction, one of the most crucial industries at increasing employment, was up 12 percent year-on-year and helped avoid an exodus from payrolls. The government implementing a multi-pronged strategy to counter the effects of the coup attempt and buoy struggling businesses was an important step. Cutting taxes on consumer goods put money directly into the pockets of households and lowering payroll taxes allowed firms to avoid massive layoffs.
The government's Credit Guarantee Fund guaranteed the majority of the debt a private lender made to firms and was widely utilized across industries. This allowed loan growth to increase, allowing banks to hedge their downside. All of these fiscal policies were critical to Turkey riding out the mother of all exogenous shocks, the failed coup attempt.
While much can be said for fiscal policy, the Central Bank of the Republic of Turkey (CBRT) will take the plate tomorrow to announce monetary policy decisions that will most likely increase interest rates. Turkey's interest rates are currently nominally very high. Firms are borrowing in the 15 percent to 20 percent range as it is, making financing by far the fastest growing expense they have. Continued growth in the cost of financing would be disastrous while unchecked inflation would force the cost of goods to also increase. As an energy importing country, Turkey is dependent on foreign energy denominated in dollars. Therefore, the strength of the Turkish lira is a key component in avoiding runaway inflation. How can one keep rates low while checking inflation and keeping the currency steady? All are intertwined components of an economy on which millions depend. It is a delicate balance that the CBRT will have to take up tomorrow.
While expected to raise rates anywhere from 50 basis points to 150 basis points, I believe the CBRT will raise rates at the lower end of the spectrum. While inflation is a problem, it can be attributed in large part to the highest energy prices in two years. Raising rates to appreciate the Turkish lira, which in turn will keep energy prices low and quell inflation, appears to be a fool's errand. That is a cycle that only ends in a halt to the economy, a massive decline in demand and ultimately thousands of firms that can no longer service their debts. The CBRT needs to be measured in its response in order to avoid just such a catastrophe.
Across the pond, the U.S. Federal Reserve's (Fed) Open Market Committee meets hours after the CBRT and will also announce its interest rate decision. While a quarter-point hike Thursday is universally accepted, the future of rate hikes is still in doubt. While many believe incoming Fed Chair Jerome Powell will push for a hastened pace of interest rate hikes, he was hardly the most hawkish choice President Donald Trump had to choose from. Continued uncertainty regarding fiscal policy, especially with the loss Tuesday of a Republican seat in the Senate coupled with a massive Fed balance sheet that is scheduled to be wound down, will make increasing rates difficult in 2018. Should the U.S. economy slow even a little bit, the Fed will have to jump in to decrease rates quickly. This is a risk Powell will try to avoid by not pushing for hastened rate hikes. Look for a quarter-point rate increase Thursday and no further hikes until the summer of 2018.
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