Turkey Business Forecast Report Q1 2008

Watch For An Economic Upswing In 2008 Positive macroeconomic and political risk trends are expected to converge in Turkey in 2008, lifting real GNP growth to a forecast 6.2%. The economy will benefit from a combination of steadily declining real interest rates, alongside measured cuts to the Central Bank of Turkey (CBT)'s overnight borrowing rate, and a renewed reform drive from the re-elected Justice and Development Party (AKP) government, which will help to underpin foreign investor confidence. In the Q108 Turkey Business Forecast Report we explore the dynamics and direction of core macroeconomic and political risk indicators in Turkey, including balance of payments, monetary policy, exchange rate, domestic politics and foreign policy. Overall, our long-term positive view for the country remains unchanged and we hold to the belief that Turkey will continue steadily along the path to EU convergence. Indeed, in 2008, we are forecasting the current account deficit to decline to below 5.0% of GNP, the lira to appreciate to TRY1.1000/US$ and inflation to fall to within 1.0 percentage points (pps) of the CBT's 4.0% year-on-year (y-o-y) target.

The improvement in Turkey's political risk environment after the re-election of the AKP will pay dividends in 2008 as the government moves to accelerate the reform agenda after a slowdown due to the election cycle in 2007. Not only do we expect to see the continuation of major privatisations, but also the harmonisation of regulations to EU standards and further liberalisation of Turkey's capital markets. That said, while domestic political risks have been mitigated substantially by the election, foreign policy affairs are likely to remain a key risk to Turkish stability. Tensions along the border with Iraq over Kurdish separatist guerrillas are likely to remain over the medium term and while we believe a full-scale invasion of Iraq by Turkish forces is still unlikely, we do not rule it out as a possibility.

Going forward, there are signals that economic growth will remain lacklustre through H207. Pressure on private consumption from high interest rates is expected to remain, with the overnight borrowing rate forecast to come in at a still high 16.25% at end-year. Moreover, in H2, public sector consumption growth is likely to fall considerably, as the newly elected AKP government slashes spending in line with its renewed reform drive. That said, our core view is that there is only a limited likelihood of a combined weak public, private and external sector through the medium term. Indeed, while the Turkish economy is likely to remain uninspiring in the second half of 2007, we are expecting renewed robust growth in 2008.

Real interest rates are set to fall significantly beginning in 2008, helping to increase economic activity, improve local currency liquidity and lower the cost of doing business. We are forecasting the CBT to continue its monetary policy loosening through 2008 and beyond, with the benchmark overnight borrowing rate expected to fall to 13.75% by end-2008 and further to 10.75% a year later. Continued steady rate cuts will follow the monetary policy committee's dovish moves in September and October of 2007, where the CBT surprised financial markets by cutting the policy rate unexpectedly by 25 basis points (bps) in September, followed by a large 50bps cut a month later.