This week, second quarter GDP numbers were released for Turkey. The economy contracted by 9.9 per cent over the same quarter in the previous year. Whilst the contraction is large in historical terms, it is in line with contractions seen in other developing economies that imposed COVID-19 lockdowns.
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Although COVID-19 has not hit Turkey harder than other developing economies, its currency has seen an 8.4 per cent depreciation against the US dollar since the beginning of July. This is despite the central bank expending significant foreign exchange reserves to try to stop the decline in the lira.
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Some of the weakness of the lira may stem from the consistently high level of Turkish inflation. Between 2012 and 2019 CPI inflation in Turkey averaged 10.4 per cent. Meanwhile, PCE inflation in the US over the same period averaged just 1.4 per cent.
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With an inflation target of 5 per cent since 2012, and an uncertainty band of 2 per cent either side, the Turkish central bank has appeared willing to tolerate above-target inflation. Whilst the central bank had managed to maintain some credibility with moderately above-target inflation, since the removal of Governor Murat Cetinkaya in July 2019 and the rate-cutting cycle that followed, the credibility of its inflation target has been called into question. Since the sacking of the governor in July 2019, bank lending has grown by an average of 17 per cent on an annualised basis compared to 6 per cent in the previous 12 months.
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The credibility of the Turkish central bank will be crucial for the long-run outlook for the economy. This will largely depend upon how much independence President Recep Tayyip Erdogan is willing to give it. Recent evidence would suggest that his preference for low rates will override the need for credibility.
Over the medium term, the outlook for Turkey will depend upon its ability to open its borders to foreign tourists. The economy is heavily dependent upon the income tourism brings and in the wake of the coronavirus pandemic it effectively ground to a halt. Tourists have begun to return but the medium-term outlook will largely be determined by whether Turkey can avoid a second wave and the problems that would bring, both in terms of domestic lockdowns and appearing on international quarantine lists.
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