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.

2014 GDP Growth: Underwhelming

Turkey’s Gross Domestic Product expanded 2.6% in 4Q14, higher than the market consensus of 2.1%, bringing full year growth to 2.9%, compared with an upwardly revised 4.2% a year earlier. Stronger than projected stock drawdown was the key driver of the deviation from the consensus. The contribution of net exports and investments to GDP growth was negative. The data also suggested that the pace of economic activity slowed considerably in 2014, as the country has been facing quarters of sub-par growth.

Turkey - Real GDP Growth

Private sector investments continued to be the weakest part of the country’s GDP, as public sector investment expenditures had not been able to offset it. Investment spending decreased by 1% in 4Q14 (meaning a negative contribution of -0.3% to GDP growth). Private companies’ investment in machinery declined 3.7% in 2014, while the public sector’s purchases of equipment and spending on construction shrank 8.8%, according to the official data. On the other hand, household demand, which makes up two-thirds of GDP, grew 1.3% in 2014, compared with 5.1% in 2013. The drop was attributed to shocking rate hike in January 2014, and to the rising unemployment.

Turkey - GDP Components

The agricultural sector posted a 2% contraction in 2014. In contrary, financial services industry posted a robust 7% growth on annual basis. The industrial breakdown of Turkey’s GDP is as follows.

Turkey - Industrial Breakdown of GDP

There are questions to be considered mostly driven by slowing private investments, as the achievement of a sustainable growth rate appears doubtful in Turkey. Additionally, widespread loses among the leading indicators continue to point to a disappointing growth in the short-term. For instance, Purchasing Managers Index, or simply PMI, the manufacturing leading, is down to 48 in March showing a contraction. The reading has been on a declining trend since December 2014, and below 50 for the first three months of this year. The industrial production index was down to 112.26 from 130.3 in January. On the consumption side, the consumer confidence index drastically fell to 64.4 in March which was the worst print since the global financial crisis. In a nutshell, the 4Q14 GDP data did not provide encouraging signals, so did the leading indicators.

In a previous article about inflation, we noted no responsive policy implications by Turkish central bank after the worst March print since 2003. For this reason, we still expect the central bank to remain cautious, and more fiscal policy tools to be used for stimulating the economic growth.