Finding Common Sense
Aug 16, 2006
Serhan Cevik (from Mardin)
Decades of instability turned Turkey into a country without common sense. Like the rest of Mesopotamia, Anatolia is the cradle of civilisations. It would indeed take an encyclopaedia to write about history and cultural richness of the world’s first cosmopolitan centre, but we want to focus on how a country with multi-ethnic, multi-cultural roots has lost its common sense and how it can move beyond the confines of self-defeating nationalist rhetoric and identity politics. We thought that one of the best places to start such an analytical journey is Mardin — a south-eastern city housing a diverse collection of ethnic and religious identities over the course of the last 6,500 years. Unfortunately, this multi-cultural social structure is no longer perceived as an advantage that once attracted people like Alexander the Great, but curiously seen as a threat to the integrity of the state. Consequently, with fear-driven politics, conspiracy theories have replaced rational analysis and paralysed institutional and economic progress. But how could a community that had prospered throughout history become so resistant to change? This is a complex question with no simple answer. In fact, we can trace the early signs of institutional paralysis back to the dying days of the Ottoman Empire. However, the real damage, in our view, has occurred after the first military coup in 1960 and especially in the chaos of the 1970s. With decades of political and economic instability, Turkey has developed an apprehensive national psyche that still resists dealing with historical baggage and social dilemmas. And why should we, as market participants, care about these non-economic issues? Because political sociology is key to understanding political dynamics and hence the country’s economic and financial prospects.
The consolidation of the fragmented political landscape has given a new opportunity for rationalisation. The 1990s turned into a lost decade, as the fragmented political landscape brought forth unsustainable, populist coalition governments and bursts of volatility in all macroeconomic and financial indicators. For example, income volatility, measured by the standard deviation of the growth rate of real per capita GDP, increased from an average of 2.43 in the 1970s to 2.70 in the 1980s and then surged to 5.37 in the 1990s. Structural weaknesses and irrational policymaking fuelled the boom-and-bust cycles and finally led to the devastating collapse in 2001. The crisis, however, turned out to be a wake-up call, resulting in an unusual political consolidation in the 2002 elections and giving a new opportunity for the rationalisation of public administration and policymaking. Indeed, the first single-party government over a decade has risen to the occasion and surprised many by adopting prudent economic policies and accelerating institutional convergence required for the start of accession negotiations with the European Union. In our opinion, overcoming vested interests in the status quo and moderating mental inertia across the society are the most valuable aspects of the accession process. Turkey’s own experience has clearly demonstrated that outdated and dysfunctional institutions create vicious circles in politics and limit socio-economic progress. Thus, membership preparations can improve the quality of institutions and deliver paradigm shifts beyond economic considerations (see From Gemeinschaft to Gesellschaft, June 1, 2004). The European project has helped Turkey to accelerate institutional progress. No country needs an external anchor to maintain structural dynamism, but even just the prospect of EU membership could be a powerful instrument driving the transformation process while reducing associated costs. Indeed, Turkey’s astonishing progress in the last five years is mainly a result of its commitment to the European project. But our enthusiasm is not just about the ‘convergence trade’ in financial markets. We do care about the sustainability of macroeconomic gains, and that requires political and judicial reforms supporting the rule of law and the development of liberal democracy (see Law and Order, November 26, 2004). Even though Turkey has already moved forward with numerous legislative reforms, one crucial area that remains problematic is public administration. Unfortunately, every reform proposal immediately turns into a ‘regime’ discussion, slowing and diluting the reform process. This is why holding on to the ‘EU anchor’ is the most feasible approach to move beyond taboos and dogmas. Turkey needs more political openings to strengthen liberal democracy. Although Turkey is certainly enjoying the best economic performance in more than three decades, creating opportunities for the disfranchised poor requires not just macroeconomic normalisation but also modern institutions that embrace liberal democracy. This is no easy task, despite encouraging initiatives like demilitarising the political landscape and abolishing the isolationist stance on the Cyprus dilemma. The state-centred governing philosophy is well entrenched throughout public administration and still makes it extremely difficult to address problems like the Armenian question and socio-economic backwardness in the southeast. In other words, democratic modernisation entailed by the EU accession process would not only unchain Turkey’s economic potential, but also help dealing with mental inertia and destructive marginalisation.
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Growth Acceleration - Is it Sustainable?
Aug 16, 2006
Chetan Ahya (Mumbai) and Mihir Sheth (Mumbai)
Corporate Revenue Growth at New High The recent trend on growth data indicates that after a steady deceleration for a period of five quarters, growth rebounded sharply during the quarter ended June 2006. This is evident from the quarterly data for aggregate BSE 200 companies’ sales trend. The aggregate BSE 200 corporate sales growth (excluding energy companies) accelerated sharply to a new high of 28% YoY during the quarter ended June 2006 from 18% during the quarter ended March 2006. The official industrial production data also point towards re-acceleration in growth during the last 3-4 months. Automobiles sales, within one of the most growth economic-growth sensitive sectors, have also witnessed a significant bounce-back. Which Segments Are Driving the Re-acceleration? The heavy-weight material sector, which grew at 34% in the quarter ended June 2006, contributed to 53% of the acceleration in sales growth over the previous quarter. This sector contributed to 5.5% point out of the total 10.4% point acceleration in aggregate sales growth. The stronger growth in the materials sector was driven primarily by sharp acceleration in the metals sector (reflection of both higher volumes and prices). Cement sector also helped acceleration in materials sales growth. Some of the other sectors which have contributed to the overall acceleration in sales growth are utilities, consumer discretionary, engineering and construction. Pick-up in Domestic Demand Explains the Acceleration Goods trade data as well as the port traffic trend indicate a continued deceleration in export demand. Hence, most of the acceleration in growth appears to be driven by domestic demand, which in turn has been supported by a sharp rise in bank credit, in our view. Bank credit growth has accelerated to a new high of 33%, making the current credit cycle the longest in the past 35 years. Indeed, over the last three-four months the government also has been borrowing aggressively to fund acceleration in its expenditure growth. The government is continuing to pursue the policy of “borrowing from future”. Apart from this aggressive leveraging trend supporting growth, the government is also protecting the domestic demand by choosing to not pass on the full cost of higher oil prices. How Sustainable Is this Reacceleration? We believe that while household leveraging remained strong until the quarter ended June 2006, anecdotal evidence suggests that banks have started slowing their lending growth in this area over the last few weeks. Aggregate banking system credit growth also witnessed marginal deceleration during the month of July. We believe the credit cycle is about to reverse considering the lagged effect of the steady rise in real rates over the past few months, increasing supply constraint in banks’ balance sheet (i.e. low deposit growth) and the Reserve Bank of India’s measures to control aggressive credit by increasing risk weights for banks lending to select sectors. As regards government spending, the finance ministry has also clarified that the spike during the quarter ended June 2006 was due to bunching up of the expenditure and they expect it to slow down. We believe the acceleration of growth during the quarter ended June 2006 is unsustainable. Hence, even as the support from corporate capex remains positive, the weaker trend in the other three drivers including external demand, government spending and household spending should result in a slow down in growth again from the quarter ended September 2006. If Growth Acceleration is Maintained, Risk of Macro-instability could Rise Sharply If the growth acceleration trend is sustained by household and government borrowing at a time when the corporate credit demand remains strong on account of capex, it could raise the risks of macro challenges in the form of higher inflation, a trade deficit and a spike up in cost of capital: Inflation: The recent rise in metals prices (yoy) is about to be reflected in the metal products component and headline WPI inflation rate, taking the inflation rate above 5%. The WPI component excluding food and global commodities (akin to core inflation) has also begun to rise again. If acceleration in domestic demand growth is maintained this component could rise significantly, taking inflation above RBI’s comfort zone of 5-5.5%. Trade deficit: The acceleration in domestic demand over the last few months has again started pushing the trade deficit higher. Although this may not be a major issue from the external stability perspective, it will still weigh on the accretion of foreign exchange reserves and supply of liquidity. Most importantly, continued strong credit growth at a time when the supply of liquidity in the form of global capital inflows has been receding and time deposit growth remains relatively low, could cause a further spike up interest rates, resulting in an aggressive landing of the growth cycle. Even if global capital inflows were to surprise positively, the Central Bank is unlikely to allow the absorption of this liquidity as it remains concerned on inflation and the banking system’s ability to avoid a credit quality problem if the current growth rate is maintained.
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Better Paid, But More Worried
Aug 16, 2006
Gerard Minack (Sydney)
No one at the RBA will be upset that the latest rate increase has put a big dent in consumer confidence. While confidence and consumer spending are roughly correlated, the one-month drop in the confidence index is not by itself an alarming sign. After all, confidence took a hit after the March 2005 rate increase, but subsequently regained its poise. Of course, I am bearish about the outlook for the consumer. But that’s a matter of higher rates, significantly higher leverage – households have increased their debt by around A$125bn since the March 2005 hike – and the prospect for weaker employment growth. The bottom line is that this is yet another reason for the RBA to wait for more data to see how the recent tightening affects growth. Today’s wage cost index data will also allow the RBA some breathing room: the very moderate acceleration in the index – to annual growth of 4.1% from 4.0% over the year to March – is not a concern. But there are two odd things to point out regarding the labour cost data. First, the wage cost index is meant to be a pure read on wages growth, controlling for hours worked and labour force changes. But its purity seems to make it less useful as an indicator of wage pressure. Typical expedients seen in a tight labour market – on-paper promotions, bonus sign-ons, ancillary benefits – are typically not captured by this series. The average weekly earnings data (to be released tomorrow), and the national account labour compensation series, both do a better job at capturing these things. The hourly compensation series from the national accounts is significantly stronger than the wage cost index. It is, however, worth noting that one thing that appears to be keeping the wage cost index in check is softer wages growth in consumer-related sectors – something reflecting the rebalancing of growth from consumer- to investment- and export-driven sectors. The second point to note is that the strength in total compensation is boosting unit labour costs. In fact, unit labour costs have been outstripping average selling prices over the past year. This should be squeezing domestic profit margins. Yet the poor performance of stocks through the current reporting season seems more a matter of profits falling short of (elevated) expectations, rather than outright margin pressure. Something’s not adding up.
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