Fatih Özatay: Economic Growth in 2022 as the Winds of War Blow?

At the beginning of the week, we learned that we grew by 11 percent in 2021. It’s too high. So, is it sustainable? What is the 2022 growth rate? What kind of risks does our economy face that will affect our growth rate?

Potential growth

It is useful to pay attention to two different concepts related to growth. The first is the growth rate in any period. The second is the potential growth rate of a country.

The potential growth rate is briefly as follows: Your workforce and the skill level of your workforce, your physical capital stock and quality, and your technology level determine your potential growth rate in a certain period. It is not possible to change this ratio from today to tomorrow. We can accept the average of the growth rates realized over many years as the potential growth rate. In this case, the potential growth rate for Turkey is somewhere around 4.7 percent. Unless, of course, it fell due to the great erosion of the institutional structure in recent years.

Problems of exceeding potential

It is clear that it would be undesirable for the growth rate to remain significantly below the potential growth rate in any given period. Because it causes important problems, especially unemployment.

A growth rate that significantly exceeds its potential is also a problem. It increases inflation, increases the current account deficit due to imports of more exploration and investment goods. This means more foreign debt.

In addition, the economic policy behind the growth rate exceeding its potential sows the seeds of other problems. For example, if growth has jumped due to a large amount of credit pumping at low interest rates, it means that there will be problems for the financial system in the future: an increase in non-performing loans, a meltdown in capital. Because no economy can stay above its potential for a long time. When growth declines significantly, investments made as if growth far above the potential will continue, and the money spent becomes a problem.

How to increase potential growth?

I said that it is not possible to increase the potential growth rate of a country all at once.

Take, for example, the skill level of the workforce. How will you upgrade? It’s all about education. It’s not just high school and college education. On-the-job training, master-journeyman training and the like. The quality of teachers. Deep topics…

Or consider capital stock and quality. It is directly related to physical investments. No one invests in a hurry just because you lowered the interest rate. First of all, it needs to be an investment-friendly environment. Such as a properly functioning legal system, the rules of the game not changing every second, a wide planning horizon (little uncertainties).

It is clear that a growth of 11 percent is well above our potential. It is equally clear that we have not done anything to increase our potential in recent years, on the contrary, we have worsened the investment environment. So the answer to the first question in the introduction is obvious: No, this growth is unsustainable.

Inconsistent figures

It is obvious that the Russia-Ukraine war will create significant risks for our economy. But even without this war, we had big problems in 2022. Our most important problem is this: The situation we are in is not sustainable. Our risk premium (CDS) is 590 basis points (510 pre-war).

These are very high values. For example, the Treasury recently borrowed in international markets with a five-year maturity of 7 percent in dollar terms. However, the US bond yield for the same maturity is 1.9 percent. The difference is very high.

January inflation is 49 percent; will rise even higher. On the other hand, the CBRT policy rate is 14 percent. The deposit rate is around 17 percent. The exchange rate increase since January has been at the level of 3.7 percent. It corresponds to 24.7 percent annually. Neither the interest rate nor the exchange rate increase is compatible with inflation. Moreover, the exchange rate increase before the start of the war was much lower.

if the rate jumps

The mere inconsistency of these figures shows that there is quite a problem. In my previous article, I discussed this issue in terms of inflation. Unsustainability is also an important problem in terms of growth. Will the exchange rate increase converge to the inflation or will the inflation increase with the exchange rate increase? A major source of uncertainty. It is a big problem in terms of making long-term plans.

On the other hand, consider the purchasing power of the flat rate. High inflation in January took away a significant part of the minimum wage and civil servant salary increase. The convergence of the exchange rate increase to inflation means that after a while, the inflation will increase further, that is, the purchasing power of the fixed income will decrease further. It is clear that it will not be a pleasant development in terms of domestic demand and therefore growth. Despite the interest rate below inflation.

Consider the possibility of currency fluctuations in terms of companies that borrow in foreign currency. Their balance sheet will deteriorate. This disruption will push them to operate less – less production and less employment.

We don’t want the rate to jump

This means that the jump in the exchange rate will negatively affect the 2022 growth.

Well, on what conditions does the rate jump? Of course, possible developments in foreign exchange supply and demand.

Three main factors need to be considered. Firstly, in an environment of tension, there are very few foreign financial investors left to convert their lira-denominated financial assets into foreign currency and go to their countries. Let’s assume that there will be no development that will increase the demand for foreign currency. Secondly, we have a foreign debt repayment of 172 billion dollars in one year. If we find less debt than due debt, the demand for foreign currency will increase. Third, of course, the current account deficit. The more it is, the more the demand for foreign currency will increase.

This is where the war comes into play. First of all, less tourism income and higher energy import bill. To some extent, less export to these two countries. If the war is prolonged, it is possible that exports to other countries will also be adversely affected. All of them will be developments that will increase the current account deficit, that is, the demand for foreign exchange. Not to mention the increase in our risk premium. This means increased difficulties in borrowing and borrowing at higher costs. That is, the probability of problems in the supply of foreign currency.

There is also the fact that the central banks of large developed countries -especially the FED- will enter the process of increasing interest rates. This means less foreign exchange supply risk. If the war does not delay this process or reduce the severity of interest rate hikes, countries like ours will be dealt a blow from here.

growth in 2022

If I sum up:

  1. After 11 percent growth, it is expected that the growth will decrease towards its potential.
  2. Interest-risk-currency-inflation: Not consistent with each other.
  3. High inflation drags down purchasing power: It is negative for growth.
  4. If the exchange rate jumps, it will lower our growth rate by both increasing inflation and distorting the balance sheets.
  5. There are developments that can spatter dry.

The whole article is here.

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