Q3 2016: Growth Turned Negative

First, The Revision

Turkey’s official statistics office released major revisions to its national accounts data as the data was rebased such that the components are weighted to compile a real GDP statistics by chain-linking with 2009 as the base year. The office also introduced changes to the GDP calculation method are some items are now included within investment expenditures. Turkey’s macroeconomic variables seems to be healthier now as nominal GDP jumped about 10% solely based on revisions, taking CAD-to-GDP ratio down to 4% from the previous 4.5%. Meanwhile, fixed investments now account for roughly 30% of the economy (which was under 20% before revision).

On components basis investment expenditures seem to benefit most from the revision.

Then First Contraction Seen Since 2009

Turkey posted the first y/y decline in real GDP since the global financial crisis as expected. We noted that our prospect was for a 0.8% negative reading which, however, appears to be exceeded as the economy shrank by 1.8%. On a separate note, we saw government expenditures growing by 24% in real terms, adding almost 3.6 percentage points to growth, which means the growth would be remarkably weak if it weren’t the government supporting the economic activity. The economy took a huge hit in July when a failed coup attempt occurred in the country. That said, September data also suggest a gloomy outlook. Additionally, sectoral breakdown analysis suggests that all industries posted contractions with the exclusion of construction.

Finally, Q4 Outlook

Early sings demonstrate that the economy has started to recover from the slump in Q3 but it may even dodge a technical recession. Industrial production averaged -0.4% in 3-month period ending October (+0.5% in seasonally adjusted terms). That said, the elevated growth rates via the revision will bring a base effect that would make harden it further for Turkey to post a positive figure for Q4. We believe that FY 2016 growth is very likely to remain below 2.5%.

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.

Investment Expenditures by Businesses

In a previous post about Turkey’s GDP growth, we mentioned the investment expenditures of the private sector as the weakest part of the economy. Poor track record in the component has been undermining the growth for a dozen of quarters. Companies allocating less money to extend their businesses also have rising concerns around the sustainability. Because investment expenditures play a central role in macroeconomic activity affecting both short-run business cycles and long-run economic growth. These expenditures reflect the general act of investment involving foregoing current satisfaction to produce capital goods and are officially measured by gross private domestic investment.

The results of the survey of business posted by the Turkish Central Bank yesterday showed the real sector confidence index gaining momentum, hitting a 12-month. However, on the investment side, things still looked gloomy. Despite the rising confidence we saw a monthly drop of 1.6% in investment expenditures in October which was 6% lower compared to its January high.

Investment Expenditures and Business Confidence

Another important point is that the relationship between Turkey’s highly controversial monetary policy and risk appetite of the businesses while making investment decision. As seen from the chart below, Turkish businesses were more proned to invest despite the high funding costs and since then interest rates seem to have had a strong influence on investments. In other words, it is not only higher rates that erode investment confidence of Turkish companies as the investments evidently lost momentum followed by a nosedive in investor confidence.

Turkey - Interest Rates and Business Confidence

One thing Turkish politicians need to clearly understand is that the central bank is not able to provide a permanent solution for the weakness in investment expenditure by businesses.