The 5-5-5 plan finally within reach

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By Emre Akcakmak, portfolio manager and Marcus Svedberg, chief economist at East Capital.

Turkey has an economic plan that it has never been close to realise – until now. The plan is sometimes referred to as the 5-5-5 rule and stipulates that it would be ideal for Turkey to have 5% growth, inflation and current account deficit.

Growth has not really been a problem over the years, averaging 4.4% since 2000 and 5.6% since 2010, although it has been quite volatile and never being just 5% on an annual basis (although it came pretty close in 2003 and 2007).

The real problems have been that inflation and the current account deficits have been too high, especially during years of strong growth.

The reason for this is a combination of structural – Turkey is too dependent on imports in general and energy in particular – and cyclical factors since policies, especially interest rates, tend to be too pro-cyclical.

Turkish growth, inflation and current account balance

  2000 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15
GDP 6,8 -5,7 6,2 5,3 9,4 8,4 6,9 4,7 0,7 -4,8 9,2 8,8 2,1 4,1 3,0 3,0
CPI 55,0 54,2 45,1 25,3 8,6 8,2 9,6 8,8 10,4 6,3 8,6 6,5 8,9 7,5 9,0 7,0
CAB -3,7 1,9 -0,3 -2,5 -3,6 -4,4 -6,0 -5,8 -5,5 -2,0 -6,2 -9,7 -6,2 -7,9 -5,8 -6,0

Source: IMF, October 2014

 

We believe Turkey has a chance to achieve the 5-5-5 goal in 2015 thanks to lower oil prices and more prudent monetary policies. There is obviously a lot of uncertainty regarding the oil price but we believe the average price for Brent on average will be roughly USD 50 lower in 2015 than it was in 2014.

This means that Turkish growth will be 0.7pp higher while inflation and the current account deficit could be 2.5pp and 2pp lower respectively. In their autumn forecast, which was made before oil prices dropped dramatically (the oil price was only believed to be 3.3% lower), the IMF expected the Turkish economy to grow 3% while inflation and the current account deficit would be 7% and 6% respectively in 2015.

We believe the fund was too conservative on the growth recovery back then, which in turn made their inflation and current account numbers too optimistic.

The second part of the story relates to policies in general and interest rates in particular. The Turkish Central Bank (CBT) has a track record of cutting rates aggressively as soon as inflation starts to decelerate even though it is much above the 5% target.

More specifically, they have previously aimed to keep credit growth, which is an important growth engines, around 20%. These policies have often resulted in large swings, exacerbating the external monetary policy influences.

The situation is not completely different this time around but the CBT seems to have learned a few lessons and may turn out to be somewhat more moderate this year. That means a less aggressive rate cutting cycle and an ambition to keep credit growth at 15%.

The main risk is that the tailwinds of lower oil prices and incentives to boost the economy ahead of the June general election could tempt Turkish policymakers to return to their old pattern. That would not only jeopardize the 5-5-5 goal but also confirm that Turkey has not grown out of its boom-bust tendency. And that could prove dangerous at a time when the FED is preparing to make its first rate hike in nine years.

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