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Turkey Economic Monitor - August 2020: Adjusting the Sails

Core Content Overview

The Turkey Economic Monitor (TEM) for August 2020 provides a comprehensive analysis of Turkey's economic response to the COVID-19 pandemic, focusing on the health and economic impacts, policy measures, and future outlook. The report highlights both the effectiveness of early containment strategies and the challenges posed by the pandemic's economic fallout.

I. Taking Stock

A. Health Crisis and Containment

• Rapid spread of the virus was observed in Turkey, with Istanbul as the epicenter.
• Despite initial challenges, Turkey contained the spread and health effects relatively quickly, aided by early and targeted measures.
• The health response included social distancing, mobility restrictions, and increased testing, which helped flatten the curve and reduce the decline in economic activity.
• However, continued vigilance is needed to sustain this trend and prevent a second wave of infections.

B. Economic Impact

• The health crisis triggered the biggest economic shock in Turkey's modern history.
• Current account imbalances reemerged in Q2 2020 due to declines in trade and tourism.
• Global demand collapse severely impacted merchandise trade, especially GVC-intensive sectors.
• Portfolio outflows from emerging and developing economies (EMDEs) were more pronounced than during the 2008 GFC.
• Foreign exchange reserves dropped by 25% between February and May 2020, raising external financing pressures and currency volatility.
• Manufacturing and services sectors experienced significant contractions in April-May 2020, with services being the most affected.

C. Labor Market Effects

• Employment declined by 2 million compared to February 2020, and labor participation dropped by 1.9 million.
• Services sector saw the largest job losses, while labor force participation rates helped keep unemployment rates stable at 12-13%.
• Discouraged workers, especially among youth, increased due to the decline in labor demand.
• Wages and working hours declined, and many firms put employees on leave.

D. Policy Response

• Fiscal policy provided critical support to households and businesses, with automatic stabilizers and discretionary measures.
• Monetary expansion helped finance the deficit, but reached its limits, contributing to inflation and macroeconomic pressures.
• Credit expansion was a key tool, with public banks providing over 49% of credit to SMEs in Q2 2020, compared to 22% for private banks.
• Government support included cash transfers, reduced work hours, and wage cuts, which helped keep firms afloat.

II. Looking Ahead

A. Economic Outlook

• Turkey is projected to contract by 3.8% in 2020, with high uncertainty surrounding the rebound in 2021.
• Private consumption and services, which typically rebound quickly, face recovery headwinds due to containment measures and debt overhang.
• Potential growth fell below 4% in 2019, the lowest in 15 years, due to productivity stagnation and muted investment.
• Female labor participation increased, supporting potential employment growth, but overall labor force participation remains low.

B. Policy Priorities

• Transition from relief to recovery and resilience is essential.
• Monetary discipline is a key priority to anchor economic expectations, restore investor confidence, and avoid a vicious cycle of capital outflows, currency pressures, and price instability.
• Fiscal flexibility is needed to support the recovery, while ensuring fiscal sustainability.
• Financial stability must be protected, with caution in extending forbearance measures and maintaining capital buffers.
• Structural reforms and productivity improvements are necessary to enhance long-term growth prospects.
• Access to long-term finance and developing alternative finance mechanisms should be prioritized to prevent credit glut.

C. Social and Economic Vulnerabilities

• Poverty is expected to rise from 10.4% to 14.4% due to income shocks, but government support could bring it down to 11.8%.
• New poor households are more likely to have low education levels, high dependency ratios, and larger household sizes.
• Three-quarters of the new poor are covered by social protection systems, but one-quarter are outside and require targeted outreach.

Key Information Summary

• Containment measures were early and targeted, helping limit the spread and economic impact.
• Current account deficits and declining foreign exchange reserves highlight external vulnerabilities.
• Fiscal and monetary support helped absorb the shock, but intensified macroeconomic pressures.
• Services sector was most affected by the economic downturn, with large job losses and declining confidence.
• Private enterprises adapted through policy support and firm-level adjustments, but small and young firms were most vulnerable.
• Poverty and labor market disruptions are major concerns, especially for low-income and vulnerable groups.
• Monetary and fiscal policies need to balance short-term support with long-term stability and resilience.

Main Findings

• The pandemic had a profound impact on Turkey’s economy, exacerbating existing vulnerabilities.
• Early and targeted containment was effective in reducing health and economic impacts.
• Fiscal support was swift and comprehensive, but monetary expansion reached its limits.
• External imbalances and currency pressures remain key risks for the Turkish economy.
• Structural reforms and productivity improvements are critical for long-term recovery.
• Social protection systems have covered most new poor households, but targeted efforts are needed to reach the remaining.

Conclusion

The Turkey Economic Monitor underscores the complexity of the pandemic’s impact, highlighting both successes in containment and challenges in economic recovery. The report recommends a balanced approach to monetary and fiscal policies, financial sector stability, and structural reforms to build resilience and promote sustainable growth.