Turkey: constructive economic outlook, not without risks - Wells Fargo

According to analysts from Wells Fargo, the exceptional growth rate in Turkey during the third quarter simply reflected base effects. They estimate that growth will likely slow in 2018 as favorable base effects begin to fade, but consider that a solid global backdrop should continue to support the economy. 

Key Quotes: 

"Economic growth in Turkey strengthened in 2017. Domestic demand bounced back from the couprelated weakness in 2016, and solid global growth and a weak currency boosted exports. The flip side of currency depreciation has been double-digit inflation. The Turkish central bank has kept policy tight in its efforts to rein in inflation and keep capital flowing into the country. Cyclical strength in the exports of goods and services has helped boost economic growth, but structurally, Turkey is an importer of capital. In tranquil economic times, this should cause few disruptions, but during periods of heightened uncertainty there is a risk that investors will seek safer places to park their money. Turkey’s growing reliance on portfolio investment to finance its capital account deficit increases this risk, as portfolio flows are often far easier to liquidate than foreign direct investment."

“Portfolio investment inflows can be easily reversed should investors adopt a “risk-off” mentality as the result of global or Turkey-specific events. Were this to occur, the lira would likely come under additional downward pressure, pushing inflation higher. The Turkish central bank would likely be forced to increase interest rates in an effort to choke off inflation and stem capital outflows, but tightening policy in a period of heightened uncertainty and/or slowing economic growth is an unenviable situation.”

“We are generally constructive on the economic outlook in Turkey. Economic growth will likely slow this year as favorable base effects begin to fade, but a solid global backdrop should continue to support GDP growth in Turkey. Taking a longer-run view, Turkey’s relatively young population is a positive for potential growth, but low saving rates and political uncertainty are possible headwinds to the investment that would spur faster labor productivity growth, the other key ingredient to potential GDP growth.”

“Turkey is not without its risks. The country incurs a gaping current account deficit due to its low national saving rate, and these deficits must be financed by capital inflows. These inflows have increasingly taken the form of portfolio investment, which can be easily reversed. If risk aversion should increase because of global or Turkey-specific events, the Turkish lira could come under even more downward pressure, which could push inflation even higher.”