Walk the Line
Mar 15, 2006
Serhan Cevik (Stockholm)
Simultaneous monetary tightening in developed markets is a challenge, not the end of the world. As the US Federal Reserve moves closer to a ‘neutral’ monetary policy position, both the European Central Bank and the Bank of Japan have started adopting a tougher stance on inflationary pressures and ‘excess’ liquidity in financial markets. Even though Morgan Stanley’s global economics team does not expect aggressive policy shifts, the approaching end of ultra-loose monetary conditions has already led to an unwinding of ‘speculative’ positions and shaken all, not just emerging, markets. Without a doubt, higher interest rates in developed countries, increasing the cost of financing carry trades, reduce the attraction of riskier asset classes and therefore may result in extensive adjustments in global asset allocations. However, before drawing broad conclusions from higher volatility and lower risk appetite, we need to make a distinction between countries that have introduced reforms and adopted fiscal discipline throughout this ‘excess liquidity’ cycle and those countries with no or an inadequate record of prudent policymaking and structural adjustment. When an ‘unexpected’ shock hits financial centres, investors may not pay much attention to countries’ distinguishing characteristics, but, as the shockwave starts fading away, fundamental factors would, once again, become the point of attraction.
Turkey’s macro normalisation is a result of prudent policies, not because of ‘easy’ money. The Turkish economy has put in an impressive performance in the past four years, with real GDP growth exceeding 32% and inflation declining from an average of 77.5% in the 1990s to single-digit territory. Identifying the underlying drivers of this ‘paradigm shift’ is crucial to assessing the country’s vulnerability to a reduction in investors’ risk appetite and a sudden unwinding of leveraged positions in global capital markets. In our view, even though Turkey, like many other developing countries, has benefited from abundant global liquidity, its macroeconomic progress is mainly a result of prudent policies and structural reforms (see The Case for Investment Grade, February 13, 2006). Easy money may have brought advantages, but cannot account for the drop in public-sector borrowing requirement — from 16.4% of GDP in 2001 to 0.8% last year — or the surge in total factor productivity growth — from an average of 0.5% in the 1990s to 4.8% in the post-crisis era. Hence, without denying possible challenges created by interest-rate-sensitive portfolio flows, we argue that Turkey’s macroeconomic policy framework based on a flexible exchange rate regime, an independent central bank focusing exclusively on price stability and fiscal consolidation will help absorb exogenous shocks. Fiscal consolidation moderates volatility and reduces the probability of negative output shocks. The Turkish economy, already enduring a variety of shocks ranging from geopolitical developments to monetary tightening in developed markets, has continued improving beyond the most sanguine expectations. Thanks to prudent fiscal policies, delivering a primary budget surplus of 6.1% of GDP, on average, in the past six years, and a credible commitment to disinflation, the Treasury’s cost of borrowing declined from an average of 62.7% in 2002 to 16.5% last year, lowering its interest payments from 23.3% of GDP in 2001 to 9.4% in 2005. As a result, not only did the public sector’s net-debt-to-GDP ratio improve from 90.5% in 2001 to 56.5% last year, but also the Treasury increased the average borrowing maturity in the domestic debt market from nine months to 27.7 months and lowered the share of foreign-exchange-denominated and -linked instruments from 57.3% to 38.9% over the same period. In other words, fiscal consolidation has moderated the exposure to interest-rate fluctuations and lessened the sensitivity of debt dynamics to exchange rate fluctuations. This is why we do not expect higher interest rates abroad to lead to a financial catastrophe in Turkey, as long as the government maintains fiscal discipline and the integrity of institutional arrangements. Moreover, even with adverse shifts in the global liquidity cycle, real interest rate differentials are — and, in our view, will remain — high enough to attract interest-rate-sensitive portfolio flows to Turkey’s financial markets (see The Irresistible Allure of Real Interest Rates, February 2, 2005). Policy continuity is the key for anchoring market expectations to multi-year targets. The withdrawal of global liquidity is, no doubt, a source of financial pressure for all emerging markets. However, countries that maintain prudent policies and continue addressing structural problems would benefit, not suffer, in a climate of uneasiness. Compared with a large number of developing countries that have failed to behave wisely in good times, Turkey will not only now enjoy the benefits of macroeconomic normalisation, but also can even lower record-low sovereign spreads. The key is to remain committed to multi-year fiscal programming and structural reforms. Indeed, in the Turkish context, keeping the fiscal correction intact and bolstering the credibility of monetary policy to achieve price stability are the best, and possibly the only, instruments to raise the economy’s actual as well as potential growth rates. That would not only continue reducing debt-to-GDP ratios and improving the operating environment for private enterprises, but also lead to rating upgrades towards the investment-grade status and a further compression of real interest rates, even when others experience a widening in sovereign spreads.
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Retail Growth Slightly Slower than December
Mar 15, 2006
Deyi Tan (Singapore) and Denise Yam, CFA (Hong Kong)
Slightly slower than expectations: January retail sales grew 4.8% year on year (YoY), slightly below our and market expectations of 5.5%. This represents a deceleration from December’s 7.4% YoY, but it was expected given that: 1) consumers usually ramp up on consumer spending around year-end, and momentum at the start of the year moderates on a month-on-month (MoM) basis (+3.2% MoM versus +16.9% MoM in December); and 2) the base effects turn less favourable. LNY spending bolstered certain segments: Nonetheless, on a YoY basis, LNY festival spending was obvious in certain segments. Retail sales in department stores (+11.6% YoY versus +11% YoY in Dec), supermarkets (+20.9% versus +7.9%), provision & sundry shops (+17.4% versus +7.4%), food & beverages (+34% versus +26.1%) and wearing apparel (+13.1% versus +10.3%) all picked up pace compared to December. Motor vehicle sales were flat; furniture sales lacklustre: However, sales of motor vehicles, which hold the largest weight in the retail basket (26%), were flat YoY, further confirming that momentum in this segment could be petering out as car replacements/sales slow after the prolonged surge following the vehicle tax reduction. Meanwhile, furniture and household equipment sales were relatively lacklustre (-1% YoY versus 0% in Dec), despite the recovery in the property market we are seeing. 2006 is a domestic demand story: Macro factors are supportive of near-term retail strength, in our view. Improving labour market conditions, rising wages, a recovering property market and not least the S$2.6bn (1.3% of GDP) handouts in the 2006 Budget should spur consumers to spend. We continue to look for sustained momentum in the broader retail sector with moderation pressures, if any, coming from the motor vehicles segment.
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