Turkey is facing its first recession since 2009: economic growth contracted in the last two quarter of 2018 by -1.6% and -2.4%, respectively. As a result, Turkey’s economy only grew 2.6 % in all of 2018, compared to 7.4% in 2017 and an average of 6.8% in the period between 2010 and 2017. According to the latest OECD estimates, this year Turkey’s GDP will decrease by 1.8%. The current downturn takes its roots in the policies that were  implemented following the 2016 coup attempt that have undermined the ability of the country to deal with cyclical and structural problems.

From the cyclical point of view, the expansionary policies with large fiscal stimulus and policy-driven credit impulse boosted consumption and investment in 2017 and in the first part of 2018, but they later overheated the economy. Excessive lending contributed to rising inflation (from 8% in 2016 to more than 20% in the second half of 2018) and a widening current-account deficit, leaving the country vulnerable to sudden shifts in feelings of investors. The central bank’s independence and its ability to restore order were hindered by the government, pushing the Turkish lira to all-time lows (it fell from 3.7 to 6.8 against the dollar in the first eight months of 2018).  Only in September 2018, the central bank decided to raise its main policy rate to 24%, from 17.75%. The move reassured international investors and stabilised the value of the currency (around a value of 5.5 Turkish lira against the dollar) but triggered a contraction in bank lending, as well as a drop in business confidence and consumer spending. As a result, in the last quarter of 2018 consumption shrank by almost 9% compared to the previous earlier. Banks have curbed lending as they deal with rising non-performing loans. In addition, the depreciation of the currency has increased the financial pressure of the foreign currency denominated corporate debt (about half of the loans made to non-financial companies are done in foreign currency). Given the balance sheet nature of this recession, Turkey will struggle to replicate the strong recovery that followed previous crises. 

From the structural point of view, the success of Turkey’s economy in the past two decades (GDP per capita increased by more than 80% in the period between 2000-2018) has been rooted in pro-growth approach to economic policy, solid public finances, a well-capitalised banking sector, and a dynamic and diversified private sector. After almost two decades of fast growth and rising prosperity, the Turkish economy is now facing very different challenges. After the coup attempt of 2016, the government’s focus on domestic power struggles and foreign policy challenges has blocked the economic reforms needed to improve the business and investment climate. Shortcomings such as the weak judicial system, cronyism and corruption are unlikely to be addressed in the next years, as the attempt to stabilise and prop up the economy — in order to avoid social unrest – will remain the priority.

Macroeconomic policy has become more unpredictable, as it is now concentrated in the hands of the president’s family (the finance minister is the president’s son-in-law). Investors will be watching closely to see whether the central bank keeps will keep rates on hold. Any attempt to prematurely cut rates or adopt other stimulus measures could weigh on the lira and undermine the stability of the exchange rate. Markets are also closely watching the tensions with the US over Turkey’s plan to buy an air defence system from Moscow.

Without comprehensive reform efforts to raise savings and improve competitiveness, the future growth of the Turkish economy remains constrained by macroeconomic imbalances related to high credit growth, high inflation and a large external deficit.