April 2015 98249  Growth slowed to 2.9 percent in 2014 and short-term prospects The pace of disinflation has markedly slowed, leading us to revise remain subdued. upward our end-year projection to 7 percent. The strong price rise before August 2014 kept twelve-month headline inflation well above  The fall in energy prices and weak domestic demand are helping bring the current account deficit down, but in the face of further the CBRT`s target rate of 5 percent throughout 2014. Headline inflation exchange rate depreciation, the impact on inflation is less than started to decline in December and slowed to 7.2 percent in January expected. 2015. However, since then, inflationary pressures have been building again. Monthly energy inflation (SA) accelerated in February and  Uncertainty related to the upcoming parliamentary elections March, due to another considerable depreciation of the Lira and a small continues to weigh on investor sentiment; rapid implementation of key structural reforms is critical to restore confidence. recovery in global energy prices, feeding through to rising transport prices (SA) as well. Moreover, monthly food inflation (SA) along with the prices of catering services (SA) rose in February and March, Subdued aggregate demand in the second half of 2014 kept growth bringing the annualized 3-month food inflation (SA) to 12.9 percent in at 2.9 percent in 2014. While the pace of expansion accelerated to 0.7 March, up from 4.5 percent in December. While a better 2015 harvest percent q-o-q in Q4, the full year print remains below potential. should help bring food prices down as the year progresses, the broad Externally, net exports subtracted 2.9 pps from growth in Q4, as a dip in range of price increases in the past two months indicates that the pace of the global economy translated into negative export growth while import disinflation is slower than we had forecast in December. demand recovered. Private consumption added 1 pps to sequential growth in Q4, but with private investment falling, and government External adjustment continues, driven by an increase in gold spending overall remaining flat, this was hardly enough to compensate exports and a lower energy bill. The 12-month rolling current account for weak external demand. Inventories increased substantially, making deficit declined to $42.8 billion (5.4 percent of GDP) in February 2015, the largest contribution to growth with 2.5 pps in Q4. The unexpected from $46.9 billion (5.8 percent of GDP) in September 2014. Substantial inventory build-up and a series of poor leading indicators suggest the gold exports lowered the annual gold deficit by $2.1 billion while the current economic weakness is likely to be extended into the first half of annual energy deficit declined by $3.1 billion over the same period. 2015. We revise our end-year growth forecast down to 3 percent. However, the non-gold non-energy current account balance deteriorated by $1.1 billion, as export performance weakened markedly in the Weak industrial activity has slowed the pace of job creation. The second half of 2014. In addition to weak global conditions, the seasonally adjusted (SA) job creation in the non-agricultural sectors depreciation of Euro against USD also put pressure on the dollar value slowed to 215 thousand in the three months through February 2015, of total exports, given around 45 percent of exports are invoiced in from 354 thousand in the previous three months. Employment in the Euro. For some companies, reportedly falling export earnings and rising industrial sector declined by 4 thousand while employment in import bills due to changes in the Euro/USD parity have depressed construction and services increased by 34 thousand and 185 thousand, profitability, but for the economy as a whole the effect has not been respectively, over this period. At the same time, the increase in the non- large. On the financing side, inflows to Turkey accelerated in Q4, but agricultural labor force (SA) slowed to just 191 thousand, allowing weakened in the last three months through February, driven by slower unemployment (SA) to fall by 24 thousand. As a result, the non- portfolio and other investment inflows. Turkey attracted $4.1 billion agricultural unemployment rate (SA) declined to 12.4 percent, from worth of FDI inflows and another $1.6 billion worth of portfolio 12.6 percent, in the period December-February. inflows, and received $2.7 billion worth of other investment in this period. Figure 1. Contributions to Quarterly GDP growth – Q4 2014 Figure 2. Monthly Change in Non-Agricultural (NA) Unemployment Selected Economic Indicators 2013 2014 2015 2016 2017 Real GDP growth rate (percent) 4.2 2.9 3.0 3.9 3.7 Consumer price inflation (end period, in percent) 7.4 8.2 7.0 6.5 6.5 Central government primary balance (in percent of GDP) 2.0 1.6 0.8 1.2 1.3 General government debt (in percent of GDP) 36.1 33.5 32.0 31.0 30.0 Current account balance (in billions of US dollars) -64.7 -45.9 -34.6 -41.5 -44.8 Current account balance (in percent of GDP) -7.9 -5.7 -4.4 -4.9 -5.0 Gross external debt (in percent of GDP) 47.3 50.3 50.8 50.6 50.0 Foreign exchange reserves (in billions of US dollars) 110.9 106.9 104.0 106.6 107.3 Source: World Bank staff projections, TURKSTAT, CBRT, Undersecretariat of Treasury After two rate cuts in January and February, the CBRT has Risks to our forecast are evenly balanced; the key to faster growth is signaled a pause as inflation has remained above target levels and to restore confidence. Weak investment has lowered Turkey`s GDP the TL suffered from repeated downward pressures. At its January growth since 2012 and reduced its medium-term potential. Against this and February meetings, the Monetary Policy Committee (MPC) cut the background, a credit-driven consumption-based growth strategy is no 1-week repo rate by 75 bps, lowered the overnight lending rate by 50 longer a viable option for Turkey. Households and corporates are now bps, and reduced the overnight borrowing rate by 25 bps. The sharp rise more leveraged compared to the early 2000s, and with banking sector of the USD and domestic uncertainty put pressure on the currency, with profitability declining and the loan-to-deposit ratio rising to 115 percent, the TL depreciation among the strongest in emerging markets since the the ability of the banking sector to support rapid credit growth is more start of the year. In reaction, the CBRT increased the daily FX selling limited going forward. These factors may explain why domestic demand auction amount and maintained a tight liquidity stance by keeping the remains subdued despite considerable policy stimulus, as domestic interbank overnight lending rate at the upper end of its policy rate actors prepare to rebuild buffers against downside risks. Restoring corridor. In its March meeting, the MPC kept rates unchanged. On the confidence through strong reform signals is critical to boost investment fiscal side, Prime Minister Davutoglu announced a new set of measures and increase the economy’s medium-term potential. The key reform worth of TL7.5 billion (0.4 percent of GDP) to support growth and priorities are well known: improvements in the business climate, employment in April. Although the total cost of the new measures is investments in skills and education and reforms to the labor market to manageable, some introduce new long-term commitments, which could facilitate job creation, and a commitment to the rule of law and limit budget flexibility going forward. independent economic institutions. Implementation of Government`s announced 25 Transformation Programs would do much to put Turkey With economic confidence subdued, we adjust our forecast for 2015. back on a higher growth path and to lower risks to the economic Domestic uncertainty continues in the face of approaching parliamentary outlook. elections in June 2015. The PMI slipped to 48 in March 2015 while consumer confidence fell to 64.4 the lowest level since March 2009. With mixed impulses from the global economy, despite signals of a recovery in the Eurozone, it is likely that households and corporates will postpone key spending decisions until after the elections. Under the assumption that domestic demand recovers sharply after the elections, as uncertainty is resolved, growth will accelerate in the second half of the year, but the carry-over from a weak start will keep the yearly pace of expansion to 3 percent. Rising import demand and uncertain export prospects will dampen the pace of external adjustment, although lower oil prices should keep the current account deficit to 4.4 percent of GDP. Accordingly, the external financing requirement is expected to decline to about $200 billion in 2015, from $220 billion in 2014. Quarterly dynamics will push up 2016 growth to 3.9 percent, before regaining trend levels of 3.7 in 2017. Contacts: Ulrich Bartsch: ubartsch@worldbank.org Ayberk Yılmaz: ayilmaz@worldbank.org