Energy To Keep External Deficit Wide

BMI View: Despite a sharp slowdown in domestic demand, Turkey's current account deficit will remain uncomfortably high in 2014 at 6.0% of GDP due to relatively inelastic demand for imported energy. Turkey will continue to rely on short-term capital flows for external financing, implying that the financial account will remain susceptible to volatility in global investor risk sentiment.

We estimate Turkey's current account deficit to have widened from 6.2% of GDP in 2012 to 7.9% in 2013, the second highest shortfall on record. Although this pronounced deterioration was in part due to one-off factors including base effects from the now defunct "gas for gold" trade with Iran ( see 'Financing Risks Remain', August 16 2013), it was primarily a symptom of strong domestic demand growth, Turkey's dependence on imported energy, and robust financial account inflows through much of 2013. In 2014, Turkey is entering a period of slowing growth that will help to rein in imports and reduce its external financing requirement. However, we forecast the deficit to remain uncomfortably high, falling only slightly to 6.0% of GDP in 2014, as relatively inelastic demand for imported energy prevents a more rapid correction.

In 2013, Turkey's energy trade deficit totalled US$49.2bn, which represents approximately 75% of the total current account deficit. Although we expect a slowdown in domestic demand in 2014 ( see 'Turning More Bearish On Growth', January 31), our forecast for modest real GDP growth of 1.8% implies that the country's overall energy demand and import bill will remain relatively constant despite falling global energy prices. Our Oil & Gas team forecasts Turkey's hydrocarbon deficit to fall by just 0.7% in US dollar terms, and to total 6.5% of GDP in 2014, by our estimates.

Energy Demand Caps Potential Rebalancing
Turkey - Current Account Balance And Energy Trade Balance, 12mma

BMI View: Despite a sharp slowdown in domestic demand, Turkey's current account deficit will remain uncomfortably high in 2014 at 6.0% of GDP due to relatively inelastic demand for imported energy. Turkey will continue to rely on short-term capital flows for external financing, implying that the financial account will remain susceptible to volatility in global investor risk sentiment.

We estimate Turkey's current account deficit to have widened from 6.2% of GDP in 2012 to 7.9% in 2013, the second highest shortfall on record. Although this pronounced deterioration was in part due to one-off factors including base effects from the now defunct "gas for gold" trade with Iran ( see 'Financing Risks Remain', August 16 2013), it was primarily a symptom of strong domestic demand growth, Turkey's dependence on imported energy, and robust financial account inflows through much of 2013. In 2014, Turkey is entering a period of slowing growth that will help to rein in imports and reduce its external financing requirement. However, we forecast the deficit to remain uncomfortably high, falling only slightly to 6.0% of GDP in 2014, as relatively inelastic demand for imported energy prevents a more rapid correction.

Energy Demand Caps Potential Rebalancing
Turkey - Current Account Balance And Energy Trade Balance, 12mma

In 2013, Turkey's energy trade deficit totalled US$49.2bn, which represents approximately 75% of the total current account deficit. Although we expect a slowdown in domestic demand in 2014 ( see 'Turning More Bearish On Growth', January 31), our forecast for modest real GDP growth of 1.8% implies that the country's overall energy demand and import bill will remain relatively constant despite falling global energy prices. Our Oil & Gas team forecasts Turkey's hydrocarbon deficit to fall by just 0.7% in US dollar terms, and to total 6.5% of GDP in 2014, by our estimates.

However, we do expect non-energy import growth to decelerate substantially in 2014 in line with easing domestic demand. The Turkish lira has depreciated by 23.4% against the US dollar and 29.8% against the euro since May 2013, which will diminish household purchasing power and raise the cost of imported goods. Meanwhile, aggressive monetary tightening by the central bank will restrict credit growth, which soared in 2013 and has exhibited a tight historical correlation to import growth.

Export Growth To Outpace Imports
Turkey - Export And Import Growth, % chg y-o-y, 6mma

The lira's depreciation will boost the competitiveness of domestic manufacturing firms, which in conjunction with accelerating growth across the European Union, implies a fairly upbeat outlook for export growth in 2014. Overall, we expect export growth of 11.4% and import growth of just 2.0% in 2014, and a narrowing of the trade balance will be the main driver of current account deficit reduction. Furthermore, we expect Turkey's structural services account surplus, primarily a result of the country's robust tourism sector, to also benefit from a weak lira and an improving economic outlook for European households.

Over the medium to long-term, Turkey's energy needs will continue to prevent rapid current account rebalancing. Although progress is being made on energy diversification, our Oil & Gas team expects domestic production of hydrocarbons to remain stagnant as consumption steadily rises, with the net hydrocarbon deficit forecast to arrive at 5.4% of GDP in 2018. However, we expect Turkish export growth to outpace import growth over a multi-year time horizon, allowing for a gradual pace of current account deficit reduction, falling to 4.7% of GDP by 2018.

Large Energy Deficit Over The Long Term
Turkey - Current Account Balance, Hydrocarbon Trade Balance, US$bn and % of GDP

In our view, the Central Bank of Turkey (CBRT) brought the country precariously close to a balance of payments crisis in the early stages of 2014 through its reserve depletion and hesitancy to raise interest rates amidst a destabilising sell-off in the Turkish lira. This came on the back of tightening global liquidity conditions and a domestic political crisis that weighed heavily on demand for lira-denominated assets and raised concerns over Turkey's ability to finance its massive external deficit. However, on January 28 the CBRT more than doubled its main policy rate, supporting lira demand and stabilising the financial account.

Short-Term Capital Flows To Remain Subdued
Turkey - Financial Account Balance Components, 6mma

The volatility and rapid loss of confidence observed in the run up to the CBRT rate hike is not only a symptom of external imbalances, which in our view have reached unsustainable levels, but also of the composition of deficit financing. In 2013, long-term foreign direct investment accounted for just 18.2% of financial account inflows, compared to 37.3% in 2007. A reliance on short-term capital, in the form of portfolio or "other" investment inflows, implies that Turkey is susceptible to a rapid destabilisation of the financial account, as observed in early 2014. This can occur either via outflows, a sudden stop of foreign capital, or in Turkey's case, even a pronounced slowdown in portfolio and other investment inflows is sufficient to pressure the currency and central bank reserve levels.

Wrong Direction For FDI
Turkey - International Investment Position Liabilities, % chg from Q42007-Q42013

As domestic growth slows and political risk and policy uncertainty remain elevated in the run up to general elections in 2015 ( see 'Major Implications Of AKP Rift', December 19), we do not expect the make-up of Turkey's current account deficit financing to significantly change, implying that financial account volatility and a higher risk premium for lira-denominated assets will continue for some time. Given that Turkey's current account rebalancing will progress at only a slow pace in the coming years as developed state yields rise, reducing investor appetite for risky emerging market assets, this implies that attracting sufficient foreign capital will require higher domestic interest rates that will limit growth in domestic demand and imports. This underpins our below consensus growth forecast for Turkey in 2014 and 2015.

Risks To Outlook

Given the combination of political and economic risk in Turkey as US yields rise, further volatility in the financial account has the potential to lead to a much sharper slowdown in domestic growth than we currently anticipate. This would lead to a more visible rebalancing of the current account in the short term through a contraction of import growth.

On the other hand, a deterioration of the developed state growth outlook that leads to investor expectations of ultra-loose monetary policy to go on longer than currently anticipated could prop up demand for emerging market assets and bring down borrowing costs in Turkey. A strong pick-up in financial account inflows towards 2013 levels would imply a robust growth outlook for Turkey in 2014, at the expense of any significant current account rebalancing.

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Related sectors of this article: Economy, Balance of Payments
Geography: Turkey, Turkey
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