Turkish economy poised to shrink after 7-year growth streak

The state of emergency rule introduced in Turkey after the July 15 coup attempt and the declining tourist income following a crisis with Russia has hampered economic growth.

Industrial production, one of the leading indicators of economic growth, dropped 3.1 percent in the third quarter and the consumer confidence index fell in November. If the economy shrinks in the third quarter this will be the first time since the third quarter of 2009.

Economists predict that the government will miss its 3.2 percent growth forecast this year while the 2017 growth forecast of 4.4 percent is also at risk.

"The coup attempt slowed down domestic demand by eroding consumer and real sector confidence in the third quarter," said Inan Demir, an emerging markets economist at Nomura in London, adding that the slowdown in the economy already started in the second quarter.

Demir also said that he expects the economy to narrow 1 percent in the third quarter and sees 2.7 percent year-end growth, but he warned that downside risks remained.

Slowdown in economic activity

Economic activity weakened due to slowing domestic demand following the implementation of the state of emergency and continuing political uncertainty after the July 15 coup attempt.

Russian sanctions following Turkey's downing of a Russian jet last year has also hampered tourism income. Investment economist Muammer Komurcuoglu said he expected 0.5 percent economic growth, but couldn't rule out a slip in the economy in the third quarter.

"In tourism income, there were losses in the high season - July, August, September- that impacted [the economy] a lot. Another factor is that the economic impact of the July 15 coup attempt was highest in the third quarter. These all pull economic growth downwards."

Turkish Prime Minister Binali Yildirim announced last month that the government would revise its year-end growth forecast to 3.2 percent, down from 4.5 percent. 

2017 growth at risk

Regional political tensions, attacks staged by the Kurdistan Workers Party (PKK) or the so-called "Islamic State" in Turkey, operations in Syria and Iraq on top of steps expected from the U.S. Federal Reserve and European Central Bank (ECB) all increase the downside risks to growth in the coming period. Economists said that even the 2017 growth forecast of 4.4 percent was also at risk.

QNB Finansbank economist Deniz Cicek is one of them. "For 2017 growth, it will be critical whether there will be a significant recovery in the last quarter of this year and the first of quarter of 2017.  In an environment where global bond yields are rising and external conditions are negative, we think political and geopolitical uncertainties will remain. Therefore, we think a 2017 growth forecast of 4,4 percent is optimistic. Our own forecast is 3 percent."

The government is working on measures, including tax breaks, to revive the economy. The central bank said in its monetary policy committee meeting decision on Thursday: "Recently released data indicate a deceleration in economic activity for the third quarter." Turkey's Statistics Institute is scheduled to announce third quarter growth data on December 12.

Surprise rate hike

The Turkish lira hit a record low against the dollar due to domestic security woes and the surge in the U.S. dollar after Donald Trump's election victory.

The central bank on Thursday raised interest rates in a surprise move to support the lira. The bank raised the policy rate to 8 percent from 7.5 percent. It also increased its overnight lending rate - the highest of the multiple rates it uses to set policy - to 8.5 percent from 8.25 percent.

"Exchange rate movements due to recently heightened global uncertainty and volatility pose upside risks on the inflation outlook. The Committee decided to implement monetary tightening to contain adverse impact of these developments on expectations and pricing behavior," the central bank said in a statement. A weaker lira could potentially slow already weak economy activity, economists said.

"For us today's meeting was mainly about sending a strong signal to markets that the central bank is ready to act to support the severely battered lira. Allowing the currency to weaken significantly would have negative implications in terms of inflation and growth, as a volatile lira may undermine the fragile confidence among households and corporations,” said Piotr Matys, a strategist at Rabobank in London, adding that contrary to market consensus of no change in rates, they expected a 25 basis point hike in the policy rate.

"Still, the measures implemented by the CBRT at today's meeting should provide the lira with much needed respite in the short term," Matys said.

The central bank also announced that it reduced foreign exchange reserve requirement ratios for all maturity brackets to provide dollar liquidity to the financial system. The lira bounced back from its historically low levels following the rate decision.