Turkey—government sponsored credit boom boosts growth and risks

President Erdogan has called snap parliamentary and presidential elections originally scheduled for 2019, amid growing vulnerabilities in the economy. GDP expanded by 7% last year, owing to domestic stimulus including tax cuts and state loan guarantees for SMEs. But credit-fuelled domestic demand has seen inflation runaway, corporate debt swell (Chart) and the current account deficit more than double in the first two months of 2018 relative to the same period last year. The IMF warned of 'overheating' in February, and Moody’s downgraded its rating one notch further into ‘junk’ territory in March. Investor sentiment has plummeted—the lira fell to historic lows and bond yields rose sharply this month.

Markets rallied following the election announcement—presuming reduced political uncertainty. But with public debt relatively low (30% of GDP in 2017), there appears scope for new stimulus ahead of the vote. Populist pro-growth policies will exacerbate vulnerability to swings in global risk sentiment, and could see a more disruptive slowdown along the track, particularly given geopolitical risks associated with Turkey’s military operations in Syria. While portfolio investment has thus far held up, tighter global liquidity conditions could limit Turkey’s ability to maintain foreign capital inflows sufficient to finance large external financing needs. This imperils financial stability in a country that directly purchased A$1.5b of Australian goods last year.