Turkish Delight – not so sweet!

There is no doubt that Turkey has grown considerably over the last decade – in 2011 the economy grew by 8.5%. However, like other countries, this growth does have its side effects when you delve deeper. The main concerns are as follows:

1. With this growth comes pressure on prices – inflation was 10.4% in March this year which is well above the target by the Central Bank
2. In order to create the demand in its economy Turkey has put a growing reliance on foreign capital and hot money which has not been generated in Turkey itself.
3. Furthermore the capital itself seems to be quite fickle and doesn’t lend itself to major industrial developments.
4. As with most growing economies the reliance on overseas goods becomes very pronounced. Turkey’s trade deficit in 2011 was 10% of GDP

As long as the global economy is bouyant there are significant funds (hot money) which find there way into emerging economies like Turkey. However, once the clouds appear on the horizon hot money tends to depart which forces the Turkish Lira down and domestic consumption to fall. Turkish interest rates (approx 6%) have attracted hot money but the real problem here is that there is a significant shortage of domestic saving. Furthermore businesses don’t want to grow in size as there are a myriad of regulations and therefore are less efficient than if they were larger and able to achieve economies of scale.

To be more stable over the next few years the Turkish economy needs to reduce its current account deficit (see graph below) and its reliance on capital inflows. Persistent deficits will mean serious problems when money flees the economy.

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