THE SITUATION IS AWKWARD, even by the Turkish standards. Clearly neither inflation is under control nor is the exchange rate. And yet there is talk about rate cuts. This could only lead to a ‘chaotic’ trajectory – in the technical sense. This means non-linearity, complex dynamics and eventually chaos. Because the exchange rate is by and large determined by the ‘own’ (exchange rate) expectations and the rate of interest (possibly as a control variable only) the equilibrium exchange rate may well be indeterminate. The link between investments, i.e. the rate of change in fixed capital formation, is broken also. Policy tools are broken. Political tools are alive, if not well. There are high hopes for exports this year, and that may be vindicated in the coming months. This is a plus. Exchange rate volatility, if it endures, could curtail imports. That is also a plus. Tourism revenues may go up compared to last year, but this outcome is still uncertain given the spread of the outbreak lately. Other than that, the recovery in question risks being a figment of statistics; incoming data will necessarily post high rates of increase due to favorable base effects. Inflation is soaring, and that is also a minus. So?
RATE OF FIXED CAPITAL FORMATION AND THE INTEREST RATE
In fact it isn’t even clear whether there has ever been such a causal connection. The rate of interest doesn’t Granger-cause, i.e. predict, the rate of change in the demand for physical depreciable capital. For instance, the capital goods imports wave of 2010-11 wasn’t caused by low TRY rates but by cheap dollars and euros that were readily available. TRY rates were by and large inconsequential at that time. Rather, a window of opportunity opened up as foreign capital flowed in and, coupled with regained confidence – regained after the 2008-09 hit – caused an investment wave. It was also determined by the fact that the extant machinery & equipment park was old and needed either renovation or a complete remake. Since after Lehman such machinery was supplied by European countries at low prices – because capacity utilization had fallen in a Europe that was struggling to revitalize domestic demand, the private sector here didn’t miss the opportunity. It didn’t have to do anything with TRY rates per se but with the availability of foreign currency funding at low cost. In 2010-11, prudent measures taken previously had renewed, and in fact strengthened, the ability of Turkish banks to lend and on-lend. That too reinforced the feeling of confidence.
NOT ONE CONDITION FOR A GENUINE REBOUND IS PRESENT
The situation couldn’t be further away from the realities of a decade ago. Back then there was little FX liability the Central Bank had incurred, and net reserves were in the order of USD 65bn. Now the opposite is true. Back then neither Turkish banks nor corporates were that heavily indebted. In fact, banks had barely begun to tap debt capital markets. Households weren’t that indebted either. Furthermore, earnings hadn’t fallen that much. The current account deficit hadn’t yet hit the sky, and the delicate balance between construction – a non-tradeable, non-efficiency enhancing sector – and machinery & equipment wasn’t that twisted. Hundreds of billions of dollars hadn’t been used up yet – at what gain? I am not talking about reserves here, but the foreign currency corporate debt and other funds that were secured over a decade. At some point back in 2015 EM corporate debt was such a lucrative business that even for small syndications and security issuances big plays in London were ready to jump in. Political concerns and international problems didn’t abound back then. From both an economic and demographic standpoint, a whole decade has been lost. It is possible, of course, to try to stimulate domestic consumption once again via credit boom at low rates, but the cost would be even more severe, and the duration of that kind of policy can only be shorter, much shorter than the late 2019 and early 2020 episode. Besides, there is a bigger difference. There wasn’t a pandemic back then. Now that the outbreak is yet to be contained, and vaccination –I f completed – offers no guarantees against mutant viruses everything hangs in a balance. Yes, there will be growth because of the way we measure and report GDP, but this would neither be inclusive nor significant enough to get to where we have already been. We observe the clear loss of prosperity in per capita GDP comparisons.
It is wise to think there can be snap elections any moment. One has to be ready for everything. Possibly they could have been held earlier – or so I think, but the outbreak prevented this from happening. I impute 50% probability to the occurrence of early elections come autumn. This isn’t trivial because there are other options as well. Otherwise anyone can tell there is 50% for x to happen and 50% for x not to happen. It isn’t about tossing coins though. Why? A ‘keep it that way until it isn’t’ route can be imagined also. This would entail a ‘no early elections clause’, but also no decision not to call any elections before the normal time in 2023. To this ‘suspense’ scenario I attach 30%. There is also the normal time decision –no early elections, period – but it definitely requires greater and more transparent normalization with the U.S. and a clearcut bargain and a truce with the EU, which is both easier to achieve and a derivative of the former. Yet it still means two fronts, and a return to ‘classical’ foreign policy. That would carry 15% weight. Because I don’t think that kind of clear-cut repositioning is doable given domestic political costs, I impute less weight to a full normalization course. Also, the U.S. seems no longer to be strong enough to determine any bargaining outcome with certainty; they are, or should be, open to middle of the road solutions also. Well, the remaining 5% probability goes into the box of outright indeterminacy, which can’t be specified because it is extrinsically uncertain.
The first and foremost scenario is easy to figure out. It involves an all-ideological front line propaganda drive against any kind of opposition and an accompanying rate cut-cum-credit boom phase. Basically it would be a repetition of yesteryears with the same or even worse unwarranted aftertaste conclusions. Yet it can be tried for a limited time span, maybe for just a couple of months ahead of elections. This is especially so given that polls point to a delicate balance. If the yet undecided types are normally distributed according to relative past party votes, the two electoral blocks are very close to each other. Any policy that could potentially tip the balance off can be resorted to. Some could respond by saying that this would be reminiscent of a classical political business cycle. Isn’t this always so, they might ask? Yes, perhaps it is, but it will come in with a high-intensity mark on it this time around because that kind of loose fiscal and monetary policy mix was used last year already.
The second option is laden with roller- coaster type dynamics, the economy being translated from one coordinate to the other with completely discretionary monetary and fiscal policies for at least a year. The third would induce a determinate path. Good, but determinacy is an elusive concept right now. Is this option likely? I am not saying that there will be insurmountable obstacles ahead in terms of international politics, but I think adopting an openly pro-U.S. stance is less probable than any middle solution. In international politics, in particular vis-à-vis Europe and the U.S., nobody should expect a ‘corner solution’. In the coming months, there is a high probability that, both politically and economically, a kind of ‘muddling through’ will be attempted in order to see if it is possible to get away with – possibly already incurred – co sts that visible risks entail without choosing a clear position.