FIRST, industrial production is still strong but has been losing steam since of February – already. Calendar- and seasonally-adjusted production is flat. Second, unemployment is very high and, according to the broad definition, almost up to 30%. More accurately, it stands at 28.9%. Third, inflation is high and even rampant in the short run. It might reach 18-19% in May-June. Fourth, the current account deficit is approaching USD 40bn per annum. This, coupled with portfolio outflows, enhances the importance of tourism revenues. In fact, tourism is now more critical than ever but the outbreak is spreading fast. Fifth, according to purchasing power parity comparisons Turkey is a middle income country per capita, but if we proceed to actual dollar comparisons, it has been declining fast. Most Turks feel that way given that even if they don’t travel abroad, a good part of their consumption is made up of imported goods. What could happen next? What does a panoramic view tell us?

MISERY INDEX

The misery index displayed here considers the total effect of unemployment and inflation on the citizenry. Turkey is fourth worst, but according to how one measures the index, it could well in fact be a distant third. Notice that the index measures the worst as the first. That is if either unemployment or inflation is understated, the misery index worsens. The worst is Iran – probably due mostly to sanctions – and the runner-up is Argentina, two failed economies. No wonder opinion polls do show that the approval rate of the government is dropping. It is falling, however, at a very slow rate. Given the pandemic, the economic crisis, unemployment, inflation and all that, the rate of decay in the voting base is remarkably low. In fact, I think the AKP vote may become sticky at around 32-33% even in the worst case. The “core” constituency, as recent polls show, may have contracted to 25%. However, the “core” constituencies of opposition parties aren’t high either. So, the incumbent party is still the most popular party by a wide margin. Nevertheless, the second party of the ruling bloc, the MHP, is losing steam and may be well below 10%. The two combined seldom rise above 45% in the polls.

UNEMPLOYMENT AND INFLATION

At 29% broad unemployment, and at very high D-PPI levels, which signal accumulated CPI inflation on the waiting list, no matter what industrial production figures post (given also that a new credit boom is unlikely and earnings are quite low), I don’t see how growth will be high. Yes, I also think unadjusted GDP growth will be quite high, but this is mostly on account of base effects. Furthermore, even this is uncertain, and possibly all growth estimates will be revised downwards as time goes by. In other words, this is a very tricky year. It depends on many factors: the pandemic, vaccination, tourism, political developments, and even the possibility of an early election. And there is another major risk that is going unnoticed.

DOLLARS, DEFICITS, AND BANKS

Which is what? Well, now it is high time to face the consequences of past deeds. For instance: the Credit Guarantee fund of 2017 will now take its toll in the form of NPLs. Yes, at that time it helped SMEs to roll over their debt, and it also helped them to secure working capital loans. It may even have led to loan hoarding because credit was cheap, an opportunity firms couldn’t miss even if they didn’t particularly need the credit. However, it invited moral hazard, obviously, and could have even led to ‘zombie protectionism’ of some sort. The Credit Guarantee Fund’s supply-side ‘hysteresis effect’ will definitely be measured properly in the coming years, but the more urgent non-performing loan cost is at the gates.

This is how fund-guaranteed credit works. The credit surface depends on at least two factors: the level of the collateral and the risk/credit score of the borrowers. However, it also takes into account the market risk, the impatience of the borrowers, lenders’ fears of default, expectations and so on. In the end, the lending interest rate involves an extra risk premium above the riskless rate. If collateral and the credit score are sufficiently high, the loan interest rate will converge to the riskless rate, represented by the sovereign bond rate at the roughly corresponding maturity. Nevertheless, the two-dimensional credit surface spanned by the collateral and the credit worthiness of the borrower – and the rate of interest, of course – doesn’t exhaust the characteristics of the loan market. First, there may be a fixed point, i.e. equilibrium, to which sufficiently high collateral and strong credit worthiness converge, and it need not be exactly the same as the riskless rate: it will be in general above it. Second, even if we could configure such a credit surface and extrapolate it at least quarterly, or even monthly, or as general risks and funding costs of banks unfold, the rate of convergence or divergence from the said equilibrium might change. There may be many functions that map the credit landscape. Some can cause the loan interest rate to head north swiftly as collaterals lose value or as credit worthiness crumbles. Others could work less rapidly, and render the surface smoother.

The gist of the matter is that after many delays the price to be paid is an enormous hidden NPL stock. It may wipe out part of profits, and pull banks back to the capital adequacy threshold. It is very difficult to initiate yet another wave of cheap ad abundant credit unless banks are recapitalized again – as public banks were in the past. Also note that as the exchange rate jumps, capital adequacy falls.

A POLITICAL CONUNDRUM

The received wisdom says that 1/3 of voters are either religiously motivated – at least pious, right-wing (whatever that means) and nationalist people. This automatically implies that if it comes to ideology, and not to purely economic voting, the right, center-right, or incumbent parties always win. This also says that unless opposition parties renounce their hard stance about secularism, women’s rights, intellectual freedoms and even a too openly harsh criticism of extant foreign policy, they can’t attract additional voters and are bound to lose ad infinitum. Sociologists of a rather peculiarly depraved type have been busy advocating a turn to “Volk” values, meaning ‘don’t be you’. In turn, this means don’t be an opposition party. After all, if everybody will tend to the same political views, why have opposition parties, or even why have different parties?

Add to this the following observations. As long as inflation doesn’t exceed a certain threshold, voters prefer growth over inflation, and so do governments. There is inertia in voting, but voters need not be fully sequentially faithful: the inertia coefficient is always less than unity, indicating strategic voting of some sort at the (20% maximal) margin. Voters swing to parties in the ideological/ cultural neighborhood though. Therefore, their loyalty is to the general path alone, not to the specific party that represents – and obviously modifies – their preferences. An incumbent party risks losing up to 5% of its support per annum in the run-up to elections if the economic factor disfavors it. In other words, voters cast their votes in a back-casting framework, their ‘rationality’ being a bit short-sighted and narrow, given ideological/cultural lenses that impute “meaning” to their choices. Probably, these stylized facts of the Turkish electoral cycle explain why there is very high likelihood that elections are (almost always) held ahead of their schedule.

Be this as it may, this largely accepted view – so-called sociological – is now under scrutiny, and it will be put to test anew, possibly soon. Will voters behave in a basically neoclassical fashion, i.e. consider their economic woes first and foremost and vote economically, or would they tend to mix these considerations with ideological matters? If the first option obtains, then the opposition stands a good chance of winning unless the outbreak is contained and the economy is back on track. Notice this: two consecutive years of economic woes takes approximately 4-5% of votes away from the incumbent, which is probably why the ruling party is constantly losing steam, at least in the polls. Furthermore, there is always a “core” that is irreducible, then there is a “belt” around it that is mostly loyal; and finally, the outer ring is composed of “swing voters”. Currently, the swing voters seem to have swung already, and new voting losses eat into the “protective belt” that surrounds the “inner core” constituency. We shall see shortly which is which.