IMF warns about overheating in Turkey’s economy

IMF warns about overheating in Turkey’s economy

IMF warns about overheating in Turkey’s economy

The concluding statement of an International Monetary Fund (IMF) mission in Turkey has warned of the danger of overheating in the country’s economy following a rapid recent recovery, asking for further monetary and fiscal tightening. 

On Feb. 16, the IMF Staff Concluding Statement of the 2018 Article IV Mission noted that following a slowdown in activity in 2016, Turkey’s economic growth recovered sharply last year with the help of policy stimulus and favorable external conditions.

“Such has been the strength of the recovery that the economy now faces signs of overheating: A positive output gap, inflation well above target, and a wider current account deficit,” read the statement.

This increases Turkey’s potential exposure to changing global conditions and underscores the need to address vulnerabilities, it added.

To lower internal and external imbalances, the IMF staff recommended “a recalibrated policy mix - further monetary tightening is warranted, as is careful management of fiscal and quasi-fiscal policies, as well as associated contingent liabilities.”

“Macroprudential policies need to be squarely focused on maintaining financial stability and adequate buffers. Targeted structural reform implementation would underpin growth,” the statement added.

Growth is estimated at about 7 percent in 2017, well above potential, the statement also noted.

“As a result, the output gap now appears positive, with symptoms of associated imbalances. Under the staff’s baseline, growth is expected at 4 percent this year, reflecting in part a weaker policy-driven impulse,” it added.

Inflation is well above target and is expected to remain so without further policy adjustment, according to the IMF.

“Initially fueled by the large lira depreciation, inflation has since increased, in part due to higher demand, rising cost pressures, and rising inflation expectations. Although base effects are likely to see headline inflation fall during the early part of this year, in the staff’s view, without further interest rate increases, inflation is likely to end the year once again in double digits,” read the statement.

Warning on current account gap

The external current account deficit looks set to stay above 5 percent of GDP, the IMF predicted. 

“Despite strong partner growth and a recovering tourism sector, continued domestic demand strength and higher oil prices are expected to lead to a further widening of the current account deficit this year, with external financing needs remaining large. Reserves remain relatively low, covering only around half of Turkey’s gross external financing needs,” read the statement.

“Vulnerabilities include large external financing needs, limited foreign exchange reserves, increased reliance on short-term capital inflows, and high corporate exposure to foreign exchange risk. Signs of possible oversupply in the building and construction sector are also emerging. While risk triggers are, by their nature, difficult to project, they could stem from domestic developments or regional geopolitical developments or changes in investor sentiment towards emerging markets,” it added.

Turkey’s refugee policy

The IMF staff also noted that Turkey’s generosity in hosting refugees serves as a “global example.”

“The introduction of work permits for those under temporary protection is very welcome by the staff, recognizing that the informal sector has been one of the main modes of employment for refugees. To ensure further formal labor market integration of refugees, the application process for work permits and business creation could be simplified further,” the statement noted.

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