October 2015 100235  Growth outlook remains subdued, despite investment led The hoped-for external adjustment fueled by a weaker lira surprise in the second quarter. and significantly lower oil prices has not materialized. The Turkish lira depreciated by 18.4 percent against the U.S. dollar  The current account deficit remains large, while financing (7.6 percent against the Euro) in the first seven months of 2015. becomes challenging. Despite a significantly lower energy deficit, Turkey`s current account deficit widened to $45 billion in the 12 months through  Economic activity is likely to decelerate in the second half July 2015 (gold adjusted), compared to $42.6 billion in 2014. The of the year as suggested by weakening early indicators. deterioration in the deficit is mainly due to weaknesses in trading partners, particularly slow growth in the EU, difficulties in MENA and Russia, and a fall in tourism revenues over the summer of A surprising surge in investment supported growth in the 2015. Depreciation of the lira has continued, with a year-to-date second quarter of 2015. Seasonally adjusted (SA) GDP grew loss of 29.8 percent against the U.S. dollar (20.1 percent against by 1.3 percent q-o-q in the second quarter, despite uncertainty the Euro) by end of September. before the June parliamentary election. Private and public consumption continued to lose momentum as expected. Net Domestic political concerns and global financial market exports, which contributed positively to GDP in the first quarter jitters dried up short-term inflows. Portfolio outflows because of gold exports and a slump in imports, became a drag accelerated in the three months through July, while long-term on growth with weak export demand in the second quarter. inflows strengthened due to the banking sector`s borrowing from Inventory de-stocking did not help either. However, private abroad and a large FDI influx in July. Although the quality of investment unexpectedly surged and became the main driver of finance improved thanks to lengthening maturity, net inflows fell growth in the second quarter, an indication that the private sector short of financing the current account deficit in the first seven carried out previously postponed investment spending, months of the year. A drawdown of foreign reserves by $2.5 anticipating elimination of uncertainties after June election. billion financed some of the current account deficit, with the unrecorded transactions amounting to a positive $9.1 billion in Inflation is likely to remain above target in 2015. After peaking this period. in May, 12-month inflation eased by 1.3 pps to 6.8 percent in July, mainly owing to a drop in food prices in May and June. The Central Bank remained on hold with policy decisions, Energy inflation, which escalated until May because of the while announcing a road map for its handling of possible depreciation of the lira and increase in global oil prices, eased rate increases by the US Federal Reserve. The Central Bank through September with global oil prices sliding towards $45 per left the key interest rates unchanged at their current levels for the barrel. However, food prices started to rise rapidly again, pushing third quarter. However, the Central Bank`s injection of funds has food inflation momentum up to 14.7 percent in September. risen to above TL90 billion in late September, from around TL65 Renewed currency depreciation brought core inflation above 8 billion in May, amid a growing liquidity need in the banking percent and its momentum above 10.5 percent. Particularly, a system. The Central Bank provided most of the excess funding sharp increase in automobile prices due to depreciation added through its overnight lending facility, increasing the share of significantly to inflation in September. As a result, 12-month overnight funding to 45 percent, up from 25 percent in May. As a inflation climbed to 7.9 percent in September. Also, energy result, the average cost of Central Bank funding reached 9 inflation tends to increase when depreciation feeds into local percent, compared to a 1-week repo rate of 7.5 percent. In energy prices. Thus, we are revising up our inflation forecast to addition, the Central Bank announced a road map, in which it 7.5 percent for 2015. promised to simplify the monetary policy framework by narrowing the width of the corridor. Figure 1. Contributions to Growth - Q2 2015 (SA, q-o-q) Figure 2. 12-Month Rolling Current Account Deficit and Its Finance Selected Economic Indicators 2013 2014 2015 2016 2017 Real GDP growth rate (percent) 4.2 2.9 3.2 3.5 3.5 Consumer price inflation (end period, in percent) 7.4 8.2 7.5 6.8 6.5 Central government primary balance (in percent of GDP) 2.0 1.6 0.3 0.8 0.9 General Government Debt (in percent of GDP) 36.1 33.5 31.1 29.4 27.8 Current account balance (in billions of US dollars) -64.7 -46.5 -40.5 -44.6 -48.8 Current account balance (in percent of GDP) -7.9 -5.8 -5.5 -5.7 -5.8 Source: World Bank staff projections, TURKSTAT, CBRT, Undersecretariat of Treasury Better-than-expected revenue performance thanks to Despite the expected slowdown in the second half of the stronger growth leads to a budget surplus. The central year, we are revising up our growth forecast to 3.2 percent government budget recorded a surplus of TL0.6 billion, with the for 2015. The faster GDP growth in the second quarter leads us primary surplus increasing to TL39 billion in the first eight months to revise our 2015 forecast up from 3.0 percent in the last Turkey of the year, from TL30.9 billion a year ago. Fiscal policy remained Regular Economic Note in July. This builds on the expectation growth supportive with year-to-date goods and service purchases that growth will slow notably in the second half of the year. rising by 17 percent by August. However, smaller increases in Considering the deterioration in the gold and energy adjusted other accounts restricted the increase in total expenses to 11.8 current account balance, the positive impact of lower oil prices on percent. Also, stronger tax revenues brought total revenues up by the current account will be very limited. Moreover, nominal GDP 13.1 percent, improving the budget balance. is shrinking because of a weaker lira, reducing the denominator of the ratio. In light of this we are correcting our current account The economy quickened its pace of job creation, but a rapid deficit projection to 5.5 percent of GDP for 2015, from 4.6 rise in the labor force led to an increase in unemployment. percent. The 3-month job creation (SA) in the non-agricultural sector reached 177 thousand in July, up from 150 thousand in April. At Political stability and continued progress with structural the same time, the labor force rose by 312 thousand, increasing reforms are key to faster and sustainable growth over the non-agricultural unemployment by 135 thousand in the three medium-term. Weak investment, together with sluggish global months through July. As a result, the non-agricultural growth and geopolitical tensions in the region, lowered GDP unemployment rate (SA) climbed to 12.6 percent in July, from growth notably since 2012, but with only limited improvements in 12.2 percent April. external vulnerabilities. Turkey`s current account deficit remains high and unlikely to fall below 5.5 percent without significant Economic activity is expected to decelerate in the second structural reforms, given the current external environment. half of 2015 against the backdrop of continued political Meanwhile, net financial inflows to Turkey dropped since May uncertainty. Consumer confidence hit the lowest level since 2013, and normalization of global monetary policies will make the January 2009, and business confidence dropped notably in competition for foreign funds fiercer among developing countries August and September. Moreover, credit growth momentum fell with higher costs. There is an urgent need for political stability below the Central Bank`s reference rate of 15 percent by mid- and to return to implementing the structural reform agenda to September. The renewed currency depreciation and high single restore investor confidence, address vulnerabilities and lift digit inflation are likely to decrease the purchasing power of growth. households. Hence, we expect private consumption to slow in the remainder of the year. In addition, continuing political uncertainty and tensions in Turkey’s south-east make it difficult for the private sector to sustain the investment spending witnessed in the second quarter. Businesses are likely to cut investment spending from the second quarter and postpone investment decisions until a new stable political equilibrium is reached. On the external side, although the nascent recovery in the EU is expected to support exports, the economic difficulties in MENA and Russia are likely to restrain export growth in 2015. External adjustment should continue, as lower oil prices will likely bring the current account deficit down by another $5 billion in the remainder of the year. Contacts: Ulrich Bartsch: ubartsch@worldbank.org Ayberk Yılmaz: ayilmaz@worldbank.org