Turkey: Weak Domestic Demand Hits Q2 Economic Growth

Turkish real GDP fell on a sequential basis in the second quarter while consensus expectations were for a modest increase. Weak domestic demand was the main culprit for the quarter-over-quarter decline. 

Elevated Interest Rates Applying Pressure on the Economy  

Real GDP in Turkey fell 0.5 percent (not annualized) on a sequential basis in Q2, which resulted in a disappointing increase of 2.1 percent on a year-over-year basis (top chart). The consensus forecast was calling for  2.8 percent growth. This is the slowest year-over-year growth since Q4 2012 and weakness was broad based. The biggest negative for economic growth this quarter was business fixed investment, which fell 3.5 percent. Weak investment spending is likely a result of the 550-bp rate hike the Turkish central bank implemented on its benchmark repurchase rate at the beginning of this year, in response to a large depreciation of the currency amongst political unrest. While the central bank has begun to cut interest rates from its peak of 10.00 percent—the benchmark rate is now down to 8.25 percent—this rate is still quite elevated from the 4.50 percent coming into 2014 and is clearly affecting investment spending. Growth in private consumption eased to 0.4 percent in Q2 from 3.5 percent in Q1 and growth in government consumption fell to 2.4 percent from 9.2 percent. The sharp slowing of growth in these two components coupled with the outright decline in business investment contributed to the contraction of 0.8 percent in overall domestic demand. This is particularly painful as domestic demand accounts for approximately two-thirds of the economy. 

The external sector was no more encouraging as export growth slowed to 5.5 percent and imports decreased 4.6 percent. Slowing export growth may likely be a result of the weakness we have seen in the Eurozone, as nearly 30 percent of Turkey’s exports are destined for the Eurozone. The decline in import growth further reflects weak domestic demand, while the drop in imports is one of the only reasons that overall GDP growth did not come in weaker in Q2. This weak reading will make it difficult for full-year growth to reach the 3.3 percent rate the consensus is currently anticipating. 

High Inflation, Weak Lira

Inflation has remained above the central bank’s 5 percent target rate for quite some time and CPI inflation has risen markedly following the depreciation of the currency at the beginning of this year. Today’s weak report puts pressure on the central bank to cut rates further in order to spur economic growth, even as the CPI stands at nearly double the target at 9.5 percent in August. 

While the lira initially bounced off the lows seen earlier this year, it has continued its decline more recently as weak growth in Europe seems to be weighing on the lira, and today’s anemic GDP report will likely further perpetuate this weakness. Continued geopolitical tension in the Middle East and Russia/Ukraine should weigh on emerging market currencies, and expectations that the Fed will hike interest rates in 2015 should buoy the dollar against most foreign currencies.