Turkey’s temporary reprieve, EU budget proposals - Capital Economics
Emerging Europe Economics

Turkey’s temporary reprieve, EU budget proposals

Emerging Europe Economics Weekly
Written by Jason Tuvey

Financial support for Turkey unveiled by Qatar and Japan this week reduce the immediate threat of another currency crisis. But the funds being provided pale into comparison with Turkey’s external financing needs and ongoing efforts to defend the lira will simply store up a sharper and larger adjustment further down the line. Meanwhile, the €500bn EU joint fiscal package proposed by France and Germany earlier this week to finance a post-crisis recovery would benefit those countries hardest hit by the coronavirus crisis but the support for Central and Eastern Europe may be limited.

Financial support for Turkey a sticking plaster

Financing provided by Qatar and Japan has reduced the immediate threat of another currency crisis in Turkey, but ongoing efforts to defend the lira will ultimately lead to a sharp adjustment.

Earlier this week, Turkey reached an agreement with Qatar to triple the size of a currency swap line from $5bn to $15bn. And on Thursday, Japan’s prime minister, Shinzo Abe, announced that the country will also provide financial support for Turkey (although details have yet to be unveiled). Turkey is also reportedly in talks with the Bank of England and the People’s Bank of China over currency swap lines.

The external financing secured so far will help to alleviate immediate strains in Turkey’s balance of payments and provide the central bank with more firepower to defend the lira. Rumours that support was on its way had helped the lira to rally over the past couple of weeks and the risk of a repeat of the 2018 currency crisis has, in the very near term at least, diminished. Against this backdrop, we think that the central bank (CBRT) is likely to follow up this week’s interest rate cut with further easing in June.

That said, the funds being provided pale in comparison with Turkey’s external financing needs over the next twelve months, which amount to close to $170bn. And it’s worth noting that the CBRT’s net FX reserves fell by $12bn in March and April, suggesting that the financing provided by Qatar and Japan could quickly be expended.

The past week has seen further steps taken to try to ease pressure on the balance of payments position and the lira, with Finance Minister Berat Albayrak confirming that import compression is now a key component of the government’s policy agenda. Further tariffs hikes were announced this week, along with more soft capital controls in the form of delaying settlement on gold transactions.

But we’ve argued before that, in the absence of concerted efforts to tackle high inflation, propping up the currency will ultimately prove futile. The real exchange will appreciate and erode Turkey’s external competitiveness, weighing on exports and encouraging imports over domestically-produced goods. This would simply store up a sharper and larger adjustment in the lira further down the line.

EU budget proposals and the implications for CEE

The €500bn EU joint fiscal package suggested by France and Germany earlier this week to finance a post-crisis recovery would benefit those countries hardest hit by the coronavirus crisis but the support for Central and Eastern Europe may be limited.

Details are scarce at the moment, including how the extra borrowing would be paid back in the future and the allocation for distributing funds. (See here.) Full details will be released by the European Commission next week. If the funds are distributed according to each country’s share of EU budget revenue, Poland, the Czech Republic and Hungary could expect a generous allocation worth 2.5% of GDP each.

However, it seems almost certain that funds will be directed towards countries worst affected by the health crisis. This could result in Poland, the Czech Republic and Hungary – where virus outbreaks were brought under control early due to the quick implementation of lockdown measures – receiving a much lower share of the funding. Even so, the details will probably be watered down to ensure that all 27 EU member agree to the proposal, particularly as the package will form part of the EU’s 2021-27 budget framework that has been so heavily resisted by Poland and Hungary. (See here.)

The week ahead

We expect interest rates to be left on hold in Hungary and Poland. Meanwhile, GDP data are likely to show that Turkey’s economy contracted in Q1.


Data Previews

Hungary Interest Rate Announcement (May) Tue. 26th May

Time (BST)

Previous

Consensus

Capital Economics

Base Rate (%)

13.00

0.90

0.90

0.90

MNB to maintain its focus on QE

We expect Hungary’s central bank to leave its key interest rates unchanged next week.

Hungary’s central bank (MNB) has overhauled its policy framework, launched targeted financing measures for businesses and announced a fully-fledged quantitiatve easing programme over the past few months. The net result is that policymakers are trying to control both the short-and long-end of the interest rate curve to stabilise the forint and loosen monetary conditions.

The early evidence is that policymakers have been successful; the currency has stabilised at around 350/€ and the yield curve has flattened – the 10-year local currency bond yield has fallen by around 50bp since the end of April. (See Chart 1.)

With the MNB’s renewed focus on the shape of the yield curve, Tuesday’s meeting is likely to be rather uneventful. We don’t expect any policy changes but we will be keeping an eye on whether the central bank is still too sanguine on the risks to the economy.

Chart 1: Hungary Yield Curve (%)

Sources: Refinitiv, Capital Economics

Poland Interest Rate Announcement (May) Thu. 28th May

Time (BST)

Previous

Consensus

Capital Economics

Policy Rate (%)

0.50%

0.50%

0.50%

Rates on hold, bond purchases will be the central bank’s main tool

We think that the Polish central bank will leave interest rates unchanged at 0.50% next week and

Poland’s central bank has lowered interest rates by 100bp since the middle of March but the divisions between the hawks and the doves on the MPC have never been clearer. The hawkish members have suggested that the central bank will raise interest rates once the economy returns to normal due to the inflationary pressures caused by pent-up demand and policy stimulus. The dovish members have called for more unconventional policy easing.

That said, there appears to be a general view on the MPC that interest rates should not be lowered further due to the adverse affects of ultra-low interest rates on the financial system and the amount of stimulus provided so far (recall that Poland’s direct fiscal support package is one of the largest in Europe).

We expect interest rates to remain on hold at 0.50%. (see Chart 2) and the central bank to increase the size of its bond purchases over the coming months.

Chart 2: Poland Policy Rate (%)

Sources: Refinitiv, Capital Economics

Turkey GDP (Q1 2020) Fri. 29th May

Time (BST)

Previous

Consensus

Capital Economics

GDP %q/q(% y/y)

08.00

+1.9(+6.0)

+1.6(+5.1)

-1.0(+3.0)

Contraction in Q1 to be followed by collapse in Q2

We estimate that Turkey’s economy contracted by around 1.0% q/q in Q1 but this is likely to overshadowed by an even bigger slump in Q2.

The economy had performed well in the first two months of 2020 but the coronavirus outbreak caused activity to plummet in March. Industrial production and retail sales slumped. (See Chart 3.) Overall, we think the Turkish economy contracted by around 1.0% q/q, which would consistent with year-on-year growth in the region of 3.0%.

Q2 is shaping up to be much worse. April’s manufacturing PMI is consistent, on past form, with manufacturing output falling by 40% y/y. Capacity utilisation has also dropped back sharply. And the tourism sector has ground to a halt – foreign tourist arrivals were down by 99% last month.

The upshot is that the contraction in GDP in Q1 is likely to be followed by an even larger decline in activity in Q2. For the year as a whole, we forecast the Turkish economy to contract by more than 8%.

Chart 3: Turkey Industrial Production & Retail Sales (% 3m/3m)

Sources: Refinitiv, Capital Economics


Economic Diary & Forecasts

Upcoming Events and Data Releases

Date

Country

Release/Indicator/Event

Time (BST)

Previous*

Median*

CE Forecasts*

26th May

Pol

Unemployment Rate (Apr)

(09.00)

5.4%

5.7%

Hun

Interest Rate Announcement (Base Rate)

(13.00)

0.90%

0.90%

0.90%

Hun

Interest Rate Announcement (O/N Deposit Rate)

(13.00)

-0.05%

-0.05%

-0.05%

Slk

Current Account Balance (Mar)

(13.30)

-266m

Rus

Retail Sales (Apr)

(14.00)

(+5.6%)

(-16.0%)

(-13.0%)

Rus

Unemployment Rate (Apr)

(14.00)

4.7%

5.4%

Rus

Wage Growth (Mar)

(14.00)

(+5.7%)

(+3.1%)

27th May

Hun

Unemployment Rate (Apr)

(08.00)

+3.7%

4.6%

Cro

GDP (Q1, Prov.)

(10.00)

(+2.5%)

28th May

Pol

Interest Rate Announcement

0.50%

0.50%

0.50%

Hun

Wage Growth (Mar)

(08.00)

(+9.1%)

Tur

Economic Confidence Index (May)

(08.00)

51.3

EZ

Economic Sentiment Indicator

(10.00)

67

29th May

Est

GDP (Q1, q/q(y/y))

(06.00)

+0.9%(+3.9%)

-2.0%(+0.9%)

Hun

GDP (Q1, Fin., q/q(y/y))

(08.00)

-0.4%(+2.2%)

(+2.2%)

-0.4%(+2.2%)

Tur

Trade Balance (Apr)

(08.00)

-5.4bn

Tur

GDP (Q1, q/q(y/y))

(08.00)

+1.9%(+6.0%)

+1.6%(+5.1%)

-1.0%(+3.0%)

Pol

GDP (Q1, Fin., q/q(y/y))

(09.00)

-0.5%(+1.9%)

-0.5%(+1.9%)

Pol

CPI (May)

(09.00)

-0.1%(+3.4%)

(+2.8%)

(+2.6%)

Cro

Retail Sales (Apr)

(10.00)

(-7.0%)

Cro

Industrial Production (Apr)

(10.00)

(-4.9%)

Also expected during this period:

22nd – 29th

Pol

Budget Balance Apr, PLN, YTD)

-9,355m

29th – 31st

Slk

Unemployment Rate (Apr)

5.2%

Selected future data releases and events

1st Jun

Tur

CBRT Monetary Policy Committee Minutes

Rus

Markit Manufacturing PMI (May)

(07.00)

31.3

Tur

Manufacturing PMI (May)

(08.00)

33.4

2nd Jun

Cze

GDP (Q1, Prov., q/q(y/y))

(08.00)

-3.6%(-2.2%)

3rd Jun

Pol

Interest Rate Announcement

Rus

Markit Services PMI (May)

(07.00)

12.2

Tur

CPI (May)

(08.00)

+0.9%(+10.9%)

4th Jun

Bul

GDP (Q1. Final., q/q(y/y))

(09.00)

+0.3%(+2.4%)

EZ

Interest Rate Announcement

(12.45)

-0.50%

-0.50%

5th Jun

Slk

GDP (Q1, Final.)

(08.00)

(-3.9%)

Rus

CPI (May)

(14.00)

+0.8%(+3.1%)

*m/m(y/y) unless otherwise stated

Sources: Bloomberg, Capital Economics

Main Economic and Market Forecasts

Table 1: GDP & Consumer Prices (% y/y)

Share of

2008-17

GDP

Consumer Prices

World 1

Ave.

2019

2020f

2021f

2022f

2019

2020f

2021f

2022f

Russia

3.1

1.3

1.3

-6.0

4.5

1.5

4.5

3.5

3.8

3.5

Turkey

1.7

5.1

0.9

-8.3

8.0

3.0

15.2

10.5

14.0

12.5

Poland

0.9

3.4

4.1

-5.3

5.0

3.5

2.3

3.0

3.5

2.8

Romania

0.4

2.7

4.1

-7.5

5.8

3.8

3.8

3.0

3.3

3.0

Ukraine

0.3

-1.4

3.2

-6.8

4.0

2.3

7.9

5.5

6.5

7.0

Czech Rep

0.3

1.5

2.4

-6.0

5.5

2.3

2.8

3.5

2.5

2.3

Hungary

0.2

1.1

4.9

-6.8

5.0

3.5

3.4

4.0

4.0

3.5

Slovakia

0.1

2.4

2.3

-6.3

4.8

2.8

2.7

2.0

2.3

2.3

Bulgaria

0.1

1.9

3.4

-8.0

5.3

3.0

3.1

2.5

3.0

3.0

Croatia

0.1

-0.1

3.0

-9.8

6.3

3.5

0.8

0.5

2.0

1.5

Lithuania

0.1

1.5

3.9

-7.3

5.3

3.0

2.3

2.0

2.3

2.0

Latvia

0.04

0.2

2.2

-7.5

5.3

2.5

2.8

2.3

3.0

2.8

Estonia

0.03

0.9

4.4

-7.3

5.3

3.0

2.3

2.3

2.8

2.5

Emerging Europe

7.3

2.6

2.0

-6.7

5.5

2.4

6.5

5.0

6.0

5.4

Sources: Refinitiv, Capital Economics. 1) % of GDP, 2019, PPP terms (IMF estimates).

Table 2: Central Bank Policy Rates

Policy Rate

Latest

(22nd May)

Last Change

Next Change

Forecasts

End

2020

End

2021

End

2022

CIS

Russia

1W Repo Rate

5.50

Down 50bp (Apr. 20)

Down 50bp (Jun. 20)

4.50

4.50

4.50

Ukraine

Policy Rate

8.00

Down 200bp (Apr. 20)

Down 75bp (Jun. 20)

6.75

6.25

6.25

Central Europe

Poland

Reference Rate

0.50

Down 50bp (Apr. 20)

Up 25bp (2022)

0.50

0.50

1.00

Czech Rep

2W Repo Rate

0.25

Down 75bp (May 20)

Up 25bp (2022)

0.25

0.25

1.25

Hungary

O/N Deposit Rate

-0.05

Up 10bp (Mar 19)

None on horizon

-0.05

-0.05

-0.05

3M BUBOR

1.05

0.90

0.80

0.80

South-East Europe

Turkey

1W Repo Rate

8.25

Down 50bp (May 20)

Down 50bp (Jun. 20)

7.25

10.25

12.75

Romania

Reference Rate

2.00

Down 50bp (Mar. 20)

Down 25bp (May 20)

1.75

1.75

2.00

Sources: Refinitiv, Capital Economics

Table 3: Exchange Rates & Equity Markets

Forecasts

Forecasts

Currency

Latest

(22nd May)

End
2020

End
2021

End
2022

Equity
Market

Latest

(22nd May)

End
2020

End
2021

End
2022

CIS

Russia/$

RUB

71.5

70.0

67.0

63.0

MOEX

2,717

2,850

3,300

Russia/EUR

RUB

77.9

75.0

72.0

68.0

Ukraine/$

UAH

26.8

27.0

28.0

28.0

PFTS

500

520

550

Central Europe

Poland/EUR

PLN

4.52

4.40

4.35

4.30

WIG

45,836

50,750

58,500

Czech Rep/EUR

CZK

27.3

26.0

25.8

25.3

PSE

876

960

1,130

Hungary/EUR

HUF

349

345

343

343

BUX

35,182

41,750

49,500

South-East Europe

Turkey/$

TRY

6.81

7.50

8.50

9.25

ISE 100

103,232

98,625

126,575

Romania/EUR

RON

4.84

5.00

5.10

5.10

BET

8,568

8,200

8,500

Sources: Bloomberg, Capital Economics


Jason Tuvey, Senior Emerging Markets Economist, jason.tuvey@capitaleconomics.com
Liam Peach, Emerging Europe Economist, liam.peach@capitaleconomics.com