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Turkey: a more manageable balance of risks in 2015Turkey: a more manageable balance of risks in 2015

In the last few years Turkey has quite frequently been included among the so-called fragile emerging economies, a label for the different countries with macroeconomic imbalances. In Turkey's case the most worrying are inflation and its current account deficit. The figures suggest that progress was made last year in adjusting the second of these imbalances although this is not so much the case with inflation. The current account imbalance went from  7.9% of GDP at the end of 2013 to 5.9% in 2014 Q3, a notable improvement which was mainly due to two factors. The first: falling oil prices. Turkey's oil imports represent 6% of its GDP, so cheaper crude oil has had a  considerable impact. A second element has been the adjustment in domestic demand resulting largely from more restrictive financial conditions (the reference rate was raised from 4.5% to 10.0% in January 2014).

However, inflation remained high during most of last year, specifically 8.9% on average and reaching an annual  peak of 9.5% in August. To a large extent this was due to larger margins for the distributors of agricultural products, pushing up the end price.1 Although the dip in the energy component helped to temporarily reduce inflation towards the end of 2014, both the current figure (7.2% in January) and inflation expectations are still far from the 5% target set by Turkey's central bank. Given this situation, the institution's decision to lower its reference interest rate by 250 bps over the last few months has been controversial.

Nonetheless, growth and inflation forecasts help to ease this controversy to some extent. Growth is expected to speed up slightly in 2015. The most important factor behind this recovery is the full impact of beneficial effects for the country provided by the current phase of lower oil prices. Cheaper crude means higher growth, lower inflation and further reductions in the current account deficit, all at the same time. Activity will also be supported by the effect of easier monetary conditions in 2014 and the beginning of 2015. In this scenario, in 2015 Turkey would see average inflation of 6.3% and a current account deficit of 4.3% of GDP. It should also be noted that, even though 2015 is an electoral year, the expected trend for public finances is notably favourable, partly thanks to higher fiscal revenue resulting from planned privatisations.

Nevertheless, although the recovery is expected to consolidate gradually in 2016, Turkey will continue to move within a scenario containing considerable downside risks. Firstly because the macroeconomic improvements it will experience in the short term are not structural in nature: the recovery in oil prices will push up both inflation and the current account deficit again. Nevertheless, the recovery of the country's main trading partners, the euro area and Russia, should also support Turkey's external balance.

Two additional risks threaten the Turkish economy. The first is the reaction by international investors once the Federal Reserve starts to raise its reference rate. Although Turkey is clearly less reliant on external financing than in previous years, once this happens we cannot rule out a weak period for the lira and a resulting hike in the reference rate in an attempt to defend it. A second risk is geostrategic in nature, given that conflict in Turkey's region has become markedly worse over the last few years.

1. In fact, the gap between Turkey's actual and potential GDP increased in 2014, according to OECD estimates, which should have reduced inflationary pressures.

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