Q2 Recap: Economy Regaining Momentum

Turkish economy has appeared to be regaining momentum and followed the path of recovery after a dismal record in the second half of last year. After 1Q17 when Turkey posted a growth rate that exceeded expectations, economic indicator overall suggested the continuation of the economic upswing and we now estimate that Turkey will post another 5% growth rate for second quarter.

Before leading in, we see it fit to add some comments about Turkey’s GDP revision. We believe that the harsh criticism over the reliance of the this new methodology on current prices is justified, as well as huge back dated revisions make rationalizing the data even harder. To date we have seen some examples of some poor countries turning into middle class ones overnight (Ghana in 2013, Nigeria 2014). Being skeptical of accuracy of economic data in developing economies is likely to be a rising phenomenon across the board where not just the future but also the past starts to become uncertain.

Turning back to the subject at hand, yesterday’s industrial production data suggested an average increase of 1.2% in the 3-month period ended in May, but more importantly, capital goods, that performed a 3.6% growth in the same regard gave us the color we needed to draw a rosy picture. The overall trend in both indicators showed an uptick that could be a sign of a better shape in the economy in months to come.

On another positive note, we still see export to be contribution to output growth in Turkey as our bullish scenario for auto production (exports) is still intact due to depreciated lira and the recovery in Europe.

After such optimistic comments, this is where we should note that there are plenty of reasons to feel unsettled about this economic growth since we see the government sponsored lending growth as the main driver of it. Turkey’s banks experienced one of the fastest lending booms in country’s financial history in February-April period. While this increases chance of major asset quality deterioration in case of an economic downturn, it sets the bar high for growth due to the base effect. Turkey may find itself in a scuzzy situation after this impermanent business cycle.

Why Inflation May Not Fell to Single-Digit Figures This Year

The following is an update about April inflation print in Turkey (source: Hurriyet Daily News):

Turkey’s annual inflation rate increased in April, reaching its highest level in around nine years, as a result of a weak Turkish Lira in several sectors, according to official data released on May 3.

Consumer prices in Turkey rose 11.87 percent year-on-year in April from 11.29 percent in March, data from the Turkish Statistics Institute (TÜİK) showed. Annual consumer price inflation was also at the highest level since October 2008.

The volatility in food prices again had its impact on the headline inflation registering an April reading of 16.09% y/y while the 12-month moving average stood at 7.2%. As being one of the biggest importers of Turkish agriculture products, Russia’s ban/unban policy has had influenced the pricing behaviors in the local unprocessed food markets. That being said, Turkey has not managed to reduce the dependence on intermediaries in logistics operations that has enabled oil prices and some other factors to heavily impact the food prices in Turkey. We believe that negative low-base effect will be here to stay until early 2018 that would potential lead Turkey’s annual inflation figures to stay higher than targeted range for longer than expected.

Turkey’s producer prices also hit a nine-year high in April at 16.37% on the back of the depreciating lira. This, not surprisingly, is being and will be reflected at price tags for the products, which builds a supportive case a double-digit inflation figure for the rest of the year. We also see the strong short-term momentum as we newly started to detect signals of the beginning of a malign cycle in PPI, as evidenced by the chart below.

Finally, Turkey’s inflation history also tells us a lot about the possible trajectory of the macroeconomic indicator. For this, we calculate median and adjusted average (average when maximum and minimum values excluded) of the monthly changes in monthly CPI growth over the past twelve years, and imply it to the figures reported as of April 2017. Admittedly, it is hard to forecast inflation via some simulation process, but we aim to make a modest contribution.

Our analysis shows that inflation may peak on November this year and finish the year at double-digit figures. We also see core indicators being close to the threshold of 10% this year. With pointing that this research is solely based on the historical pricing behaviors of economic agents, we fear that Turkey may perform even worse this time given the imminent further deterioration in expectations with inflation becoming hardened at the current levels.

A close look at the other factors affecting CPI such as negative low-base effect, the strong increase in lending growth, also suggests that April reading is a cause for alarm and may whip up a tsunami of opinion that an abnormal cycle is about to emerge.