OECD Economic Outlook, Volume 2021 Issue 2

Turkey

In the absence of further shocks, GDP growth is projected to be 9% in 2021 before easing to 3.3% in 2022 and 3.9% in 2023. Vaccinations have progressed fast, but certain population groups are still reluctant and the number of COVID-19 cases has increased through the autumn with the spread of more contagious variants. Inflation is very high and sticky. Recent cuts in interest rates have put further pressures on inflation expectations, the exchange rate, real household incomes and external financing.

The macroeconomic policy stance and mix should be normalised. Monetary policy should provide credible forward guidance for a realistic convergence path to the official inflation target. This should be accompanied by targeted fiscal support to highly indebted firms and households who relied on subsidised loans during the pandemic and may face strains under rapidly increasing market interest rates and high inflation. Turkey could better seize the new opportunities stemming from global value chain restructuring by reducing labour tax wedges and employment rigidities in the formal sector, promoting level-playing competition between different types of firms and implementing more assertive green transition policies, drawing on its welcome recent ratification of the Paris agreement.

The surge in exports fuelled the recovery

The vaccination rate of the population above 18 attained 80% for two dose injections by mid‑November and third dose vaccinations have started. The number of fatalities has declined, supporting domestic activity and the recovery of international tourism. However, certain population groups and provinces remain reluctant and, with more contagious virus variants, daily COVID-19 cases were around 25 000 in mid‑November. Not all major tourism markets have recognised Turkey as a safe destination. The authorities are pushing for a broader vaccine uptake.

Turkey: Current account, exchange rate and rates indicators

1. Stripped spread in basis points of the JP Morgan Emerging Market Bond Index (EMBI). Global index for Turkey, Poland and Chile and Euro EMBI global diversified index for Emerging market Europe. The last data point refers to 17 November 2021.

Source: OECD Economic Outlook 110 database; and Factset.

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Turkey: Demand, output and prices

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Growth has been buoyant, pulled by very strong exports. Manufacturers have seized the opportunities arising in their traditional European and new overseas markets following disruptions in international value chains. Substantial real exchange rate depreciation has boosted net exports, but has severely destabilised relative prices, market expectations and risk perceptions. The competitiveness and profit margins of small‑size manufacturers, who generally rely on short-term commercial loans denominated in domestic currency, have benefitted. Large firms integrated in global value chains, who import their technological inputs and rely on long-term loans denominated in foreign currency, have been negatively affected. Employment has expanded more rapidly in export-oriented manufacturing than in services. Turkey’s aggregate employment rate, at 46% of the working age population, still remains well below the OECD average of 61%.

The policy mix is unbalanced

Inflation has drifted up further after the COVID-19 shock, approaching 20% in October against the official central bank target of 5%. The lack of credibility in monetary policy has fostered recurrent episodes of capital outflows, the dollarisation of domestic savings and foreign exchange reserve losses. Gross foreign reserves have nevertheless improved in recent months, with the help of special drawing rights from the IMF and swap agreements with certain foreign central banks. The policy interest rate is set below inflation, and was cut further in October and November. Risk premia have surged, 12 and 24-month ahead inflation expectations have increased further and medium-to-long term market interest rates have reached very high levels — 10-year government bond rates are above 21% and the currency has depreciated further. The credibility of inflation measurement should be improved, for instance by using independent expert advice, as previously envisaged. Fiscal policy remains tight, partly to offset the weak credibility of monetary policy and the uncertainties surrounding the contingent liabilities which have built up in the public financial sector. According to government plans, the primary fiscal deficit which had increased only slightly from 0.7% of GDP in 2019 to 1.2% in 2020 will tighten to 0.8% in 2021, 0.4% in 2022 and 0.1% of GDP in 2023.

Growth is projected to stay below potential

High inflation – which has a larger impact on low and middle-income households since energy and food account for a large share of their consumption basket – as well as higher rollover costs of subsidised pandemic loans will dent real incomes. Demand and employment in domestic services will be affected, while tourism and manufacturing exports are expected to remain dynamic as international mobility, trade and transportation conditions improve. Current account funding and foreign debt rollover needs are high, at above 20% of GDP for the next 12 months. The evolution of monetary policy and related exchange rate developments are difficult to predict in the current environment and inflation is projected to remain at a high level and is subject to potential further pressures from wages, import costs and producer prices. This outlook is subject to significant upward and downward risks. If monetary policy tightens and succeeds in lowering inflation, the normalisation of risk premia and market interest rates would support confidence and economic activity. If current policy weaknesses generate additional strains as global monetary conditions tighten, external and internal funding conditions may worsen, with adverse macroeconomic consequences.

Improving the policy mix and structural reforms will be key to support activity and job creation

The macroeconomic policy mix should be consolidated. The central bank should raise its policy interest rate above inflation and provide credible forward guidance for achieving the official inflation target. Meanwhile, the government should provide temporary and targeted support to the firms and households who may face severe strains under higher market interest rates and inflation. Turkey should also resume structural reforms, including by reducing tax wedges and promoting more flexible employment conditions in the formal sector, more level-playing competition between different types of firms, and more assertive climate transition policies. These reforms would help the many dynamic firms throughout the country to better seize the opportunities arising from the restructuring of international value chains and from the transition to a low-carbon economy, permitting the business sector to grow at full potential.