Turkey: Choices and Consequences

One of the most important things I learned from my first economy professor Demir Demirgil was that economy was all about choices. Now let's look at the choices made by the current government and its intended but mostly unintended consequences.

In the run up to the elections the government decided to shine the IMF and decided to go through the toughest part of the downturn solo. I have always portrayed this crisis as a hitting the immune system the world economy. In the case of Turkey the softbelly was the current account deficit and inflation. IMF money was important to cushion the adjustment on the external financing side. Without the extra funding from the IMF most of the adjusment naturally happened on this front through sharp correction in growth -- contraction almost matching the troubled Baltic states. This has led to inflation plunging as output gap widened. On the negative front, however, unemployment went through the roof, reaching levels seen in the over extended countries in Europe like Spain.

Fast forward to today. The debate about whether to enter an IMF program should be viewed from the above perspective. That's why I refrain from using statements such as "failure to reach an agreement" and opt for "decided not to" type comments.

As the crisis progressed the adjustment in domestic savings happened mostly in the private sector whereas public sector savings deteriorated - as per most other countries -- on the back of falling tax revenues and fiscal stimilus. Consequently the roll over ratio increased threatening crowding out of the private sector further. This is where the IMF money is most needed at this juncture and not, as some suggest, on the external financing front. Agreement with the Fund will bring some credibility and increase chances of getting higher inflows of capital in a world unlikely to see the record amounts of flow registered before the crisis.

If we were to look at the national income equation (Y= C +I+G+(X-M)) it is hard to see any of the variables to contribute significantly to growth. Hence below potential economic growth will be the outcome of the choice made by the government (as it stands now). The unintended consequence of this scenario, however, is that current account will most likely cease to be an issue and growing output gap will ensure inflation to reamain depressed. This will perversely present a golden opportunity to nail inflation once and for all and put Turkey in the league of low inflation countries. History suggests countries at some stage face a trade of between growth and inflation. There is usually a period of foregoing growth for achieving permenantly low inflation and this could be the time for Turkey to make its bid. Turkey was fortunate to go through a disinflationary boom since its own crisis but persistently low inflation may come with a bit more effort than currently assumed. The rewards on the other hand will be incontroversible.

Overall if the government decides to go solo again for whatever reason Turkey will end up with below potential growth, relatively decent external balance and low inflation. This scenario, however, is unlikely to generate much -- if any -- employment. "It is the economy, stupid" is what I believe in as far as the election outcomes are concerned. In that sense the current government is perhaps underestimating the impact of the above and overestimating the feel-good factor from going solo.