Turkey: Q2 2016 Recap

Turkey’s real GDP grew by 3.1% y/y in Q2, below the market consensus of 3.7% and our estimation of 3.4%. Of that growth number, 3.4% and 1.7% came from household and public consumption, respectively, which were partly offset by weak foreign demand that a negative impact of 2.2 pps on growth. Aside from being lower than expectations, the GDP report has some worrisome points including a public demand taking on a progressively larger role in driving economy.

turkey-q2-gdp-components-performanceIn seasonally adjusted terms, output rose by 0.3% q/q, down from 0.7% in Q1, its worst reading in two years. Household consumption contracted by 0.5%, whereas investment expenditures and government spending posted positive growth figures of 5.4% and 3.8%, respectively.

Another worrisome point is the composition of investment expenditures which has been increasingly reliant on construction. To be more precise, in real gross capital formation for both private and public, construction expenditures grew by 6.9% and 6.8% y/y while machinery & equipment investments declined by 5.2% and 5.8% y/y, respectively. Considering the characteristic of an emerging market, one would realize how huge risks are posed when construction is boosted in that way.

turkey-q2-gdp-investment-expendituresBelow we conduct two analyses in order to show changes in Turkey’s GDP composition from a sectoral point of view. Clearly, financial services have been the winner in the recent economic environment as agriculture seemed to be set for losing ground. Meanwhile, manufacturing still lags behind in output growth.

turkey-q2-gdp-sectoral-breakdownGoing forward, the government and the central bank will be under increasing pressure to support economic activity as growth slowed down sharply than expected. We believe that the current pace of the decline in average cost of funding which has circa 15 bps per month in the recent months, will not be enough to stop the slowdown, therefore pressure on fiscal policies are very likely to rise. Concerns around policy responses to this pressure are, in our view, justified at this stage.

Note that Q2 data predates the July 15 coup attempt which caused a serious confidence loss as evidenced by 7% y/y decline in industrial production. We expect downtrend economic activity to be more pronounced in 3Q.

Q1 2016 GDP Growth: Stronger but Iffy

Turkish economy grew by 4.8% in Q1 2015, above the consensus and our expectations of 4.4%. In seasonally adjusted terms, the economy expanded by 3% q/q. Household consumption expenditures, which generates two thirds of the GDP, continued to improve and posted a growth rate of 6.9% y/y. By this, the contribution of the biggest component of growth to the economy became 4.8%, in other words, it was all about domestic demand again. 120 bps of contribution to the economy by the government was offset by higher exports. With those being said, evidenced by the pre-indicators in Q2, we are very likely to see weaker GDP growth in Turkey going forward as downside risks are getting more visible. One also should highlight that 30% hike in minimum wage might have helped.

We noted the weakness in private sector capital formation time and time again. Despite 8.2% higher capital formation in construction, we saw investment expenditures declining for the private sector owing to the lower machinery and equipment investments.

Turkey - Components of Real GDP

Turning back to adjusted data, the annualized growth in Q1 2016 was 3%, way lower when compared the linked quarter when the economy expanded 4.8%. The same symptom of an underlying problem appeared there which was insufficient investment demand. Despite the intense criticism over high interest rates by politicians, we believe that the current rates are particularly low and investment-friendly given the inflation outlook. Our concern is the weak investment appetite evidenced by stagnant business confidence data. Interestingly, for the trailing four quarters, government expenditures were 8.5% higher y/y, suggesting that the government has recently devoted to itself to back the economy.

Turkey - SA GDP Growth and Domestic Demand

Meanwhile, some argued that the Q1 GDP data added to skepticism about Turkey’s true growth rate with more concerns about data reliability against this backdrop. According to the sub-lines of the household consumption, healthcare, entertainment and “other” items increased by 22.1%, 10.3% and 6.5%, respectively, adding a remarkable 200 bps to annual real GDP growth. However, this did not appear to be supported by the sectoral breakdown data as healthcare and TMT particularly remained weak.

Despite the better than expected data in Q1, we remain cautious on the sustainability of the current growth rates as we believe that consumption will be less buoyant, and more uncertainties on horizon for the economy including deterioration in tourism performance, recovery in energy prices and ongoing geopolitical problems. On the other hand, the high growth will create a better environment for the central bank in policy making.