A Perfect Mess
May 03, 2007
By Serhan Cevik | London
The military’s foray into politics has introduced an unexpected risk. Turning points usually become apparent in retrospect, but it was clear that the 2001 crisis in Turkey represented an inflection point in economics as well as politics. Following the aftershocks of financial dislocation and economic recession, I turned ‘bullish’ in August 2002 when the fragile coalition government of the time called for early elections. Indeed, Turks voted for an unprecedented political consolidation by penalizing parties that ruled throughout the ‘lost decade’ of the 1990s and granting a disproportionate power to a new party. Markets were initially concerned about the Justice and Development Party’s roots in political Islam, but the AKP leadership moved away from self-defeating rhetoric, embraced a center-right stance, and pursued prudent economic policies and structural reforms. As a result, with a favorable global backdrop, Turkey has disentangled itself from the boom-bust growth cycle and experienced the longest stretch of uninterrupted economic expansion in the past five years. Moreover, with a series of far-reaching institutional reforms, the ‘new’ Turkey also achieved its lifelong ambition to start accession negotiations with the European Union. Therefore, despite occasional bursts of financial volatility, I maintained the positive assessment of economic and institutional prospects. Unfortunately, that was the case until I checked newswires in the late hours of last Friday and realized the re-emergence of a risk that I thought would never bother me again in the ‘new’ Turkey.
The latest political saga hurts institutional convergence towards Europe. In the midst of an election period, the Chief of Staff of the Turkish military released a statement condemning “endless efforts to undermine the fundamental values of the republic”. Even though it does not directly target the government, this is still a disturbing development and weakens the country’s democratic institutions and its accession negotiations with the EU. Indeed, among all the possible repercussions, what I care most about is its effect on Turkey’s already difficult relationship with Europe. Of course, market participants now focus on short-term developments and may find a (limited degree of) relief in efforts to ease the tension. For example, the Constitutional Court’s decision to annul the first round of voting in the presidential election is welcomed, leading a small rally in financial markets. However, Turkey is still facing a serious political challenge and a higher degree of uncertainty, in my view. The Court has ruled that there must be no less than 367 members of parliament present in the general assembly to start the voting procedure. Therefore, the AKP, with only 352 MPs, needs the support of other parties to elect the new president. Since no such support is forthcoming, the failure to elect the president in the new round of voting will automatically lead to the dissolution of parliament and early elections. In fact, Prime Minister Tayyip Erdogan has already suggested possible election dates (June 24 or July 1) and proposed a number of amendments to the constitution, including a public vote on presidency for two five-year terms (instead of a seven-year term) and reducing the parliamentary term from five years to four years. Although one of the opposition parties has expressed its support for these changes, it still may not be possible under the current conditions to undertake such a complicated restructuring of the political system. Social polarization increases the risk of ending up with a fragmented parliament. Secularism is not under threat in Turkey, as the number of people opposing a regime based on religious principles stands at 76% of the society and 68% even among those who identify themselves as ‘Islamist’ (see The Litmus Test for Liberal Democracy, April 9, 2007). Nevertheless, fear-driven politics remain a major source of social polarization, especially after recent developments and with the prevailing distrust within the society. The best way to move out of the impasse and to shorten the period of uncertainty, without creating further tension, is letting the voters decide on the future trajectory of politics. Of course, while bringing the election date forward is the right move at this stage, it would not necessarily deal with the underlying fragilities. This is why I think that political dynamics now imply a higher degree of uncertainty. No one was expecting to see the AKP winning as many seats as it has today, but recent developments may have also altered the voting behavior in surprising ways. The Turkish economy is strong, but a higher degree of uncertainty could become a drag. I remained an unwavering ‘optimist’ in the past five years, but I am now having second thoughts for the first time. Although I still believe that the Turkish economy stands on stronger footings and do not expect an outright military coup, the risk of ending up with a fragmented parliament is now higher, and this could become a drag. However, my main worry is about the possible erosion of confidence if Turkey loses the EU anchor that has played a significant role in attracting foreign (direct) investment. In other words, while the abundance of global liquidity may still keep Turkey as a carry-trade magnet, political fragilities could seriously disrupt institutional convergence. In my view, only voters could re-energize Turkey for a ‘big bang’ in democratization and economic development and keep the accession process on track.
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Modest Slowdown Alert (Follow-up)
May 03, 2007
By Takehiro Sato | Tokyo
Concerns for future growth, despite strong growth in the past Based on data available as of April 27, we estimate that the economy will show real annualized growth of 3% in January-March, outpacing US growth in the same period of 1.3%. We therefore think that Japan will demonstrate a balanced growth pattern in terms of internal and external demand, even after achieving strong growth in October-December. However, just because the economy showed strong growth in the past does not necessarily mean it will stay in good shape. In fact, a series of economic data announced at end-April have amplified concerns for the outlook. Some uncertainty around consumer spending in summer Concerns have emerged first of all on the consumer spending front. According to a bunch of industry data and the Household Survey, the boost to March consumption from consumers buying up spring merchandise early was short-lived and the April-June launch-pad is likely to be lowered. In April, it seems some department store sales figures are showing an ongoing decline in sales, driven by sluggish clothing sales. Disposable income is likely to decrease from June, due to an effective increase in resident tax, and above all a tax increase looks set to dampen spending levels in July-September. Another factor to keep in mind is that once the Upper House election of July 22 is over, regardless of the election outcome, consumption tax issues that have already been signed off on are likely to come to the fore again as top government priorities, along with the issue of revising Japan's Constitution. In this environment, we expect consumer sentiment to be on the cautious side. Although the government’s implicit target for raising the consumption tax is 2009, we have 2010-11 in mind, as we expect the next general election to take place in summer 2009. So, even if a consumption tax hike and its ensuing impact on spending are unlikely for some time yet, the airtime given to the tax hike issue alone is likely to constrain consumer spending in the meantime. With this in mind, we will be closely monitoring the government’s consumption tax rhetoric after the election. Production over the summer could show increasing signs of a temporary correction Industrial production in March was a negative surprise, falling considerably short of expectations. Excluding automobiles, production by processing and assembly industries either fell or was much lower than METI forecasts. In terms of the gap between actual production and the estimated production index, IT-related activity was particularly weak. In electronic component and device industries, the inventory ratio continued to increase steadily, presenting the risk of a correction. In terms of the inventory and shipment ratio for individual types of electronic components, there was an improvement for LCD panels; meanwhile, semiconductor ratios are still low overall, but are edging up steadily and in some cases are higher than their levels in 2004, when the economy entered a soft patch. As if to underline these trends, DRAM and other semiconductor prices have been weak to date. Production cuts in January-March are expected to be followed by a production increase in April-May, as part of the introduction of new mobile phone models. However, as production has been lackluster in comparison to the estimated index, particularly in IT-related areas, we still see the risk of production falling short of forecasts. Expected production cuts in April, particularly for IT-related products, are linked to the slowdown in the US economy and are somewhat of a concern. There are also concerns about the impact on automobile-related production, which was brisk through October-December, which could be dampened by the spreading of sub-prime loan problems in the US. At the moment, concerns around inventory adjustments are limited to some IT-related goods and production is not that constrained within the overall manufacturing inventory cycle. Therefore, even if there is a correction in the near term, we think that production is likely to only show a short-term lull. Nonetheless, we take a relatively cautious stance on summer production trends, which we will be monitoring closely. Incidentally, we assume that in January-March the US economy essentially pulled out of the worst of its recent trend, driven by a correction on two fronts: housing investment and capital expenditure. However, in Japan we think that inventory adjustment pressure in North America could cause exports to slow, particularly automotive exports to the US, and we anticipate a reactionary increase in imports from Asia in April, following the sharp decrease in March. Both factors could generate a correction in April-June net external demand, which was healthy in January-March. This is another reason why we see the risk of a slight slowdown in Japan from April-June. Prices — another economic indicator — are in negative territory Price movements, which are another indicator of economic health, have not been overly positive, reflecting economic trends and the YoY decrease in gasoline prices. In March, Japan’s core CPI fell YoY for the second month in a row. Although gasoline prices were raised ahead of the string of public holidays in Japan, we expect the core price index to remain below zero. Unless there are noticeable improvements in the so-called core-core CPI, we could see the core index move further into negative territory between now and July-September. Despite the current rise in oil prices, we could even see prices remain in negative territory throughout 2007. Policy and market implications As we have outlined, we think there is a risk of a slight slowdown in summer. Nonetheless, in its outlook report issued on April 27, the BoJ generally maintained its bullish growth scenario and forward-leaning stance on monetary policy. However, when we look at the report in more detail, we sense some level of hesitation by the BoJ across the board, possibly due to changes in some areas of demand components, as we describe above. For example, it has taken a half-step back in terms of the wording it has used regarding its future monetary policy management. In the report’s conclusion, the BoJ says it will adjust the level of interest rates gradually in accordance with improvements in the economic and price situation. This compares with its previous outlook report in October, when it said will adjust the level of interest rates gradually in light of developments in economic activity and prices. In other words, we interpret its latest wording to mean that it will adjust interest rates in accordance with improvements in the economy and prices, but if there are no improvements it will leave rates unchanged (i.e., we think it has shifted from a forward-looking to a backward-looking stance). Thus, we think the market is unlikely to bring forward its expectations of a third rate rise on the back of the BoJ outlook report, given the slight change in the BoJ’s wording, the increasing uncertainty around the global economy, and the decrease in prices. While it seems quite likely that prices will remain in negative territory in the near term, we think the market is still unlikely to respond to the BoJ’s rate hike campaign. We expect fairly bullish GDP data on May 17, but we do not think this will be enough of a catalyst to bring forward rate hike expectations, as the market has already factored in the strong growth of the quarter. We would prefer not to be entirely pessimistic for the following reasons. First, in regard to consumer spending, the weather can affect the timing of spending, but we do not see this factor as important in terms of the overall spending trend. More important in our view is the outlook for employment and personal income. Regarding employment, the recent drop in the job offers to applicants ratio is somewhat of a concern, but this is partly the result of the authorities taking a tougher stance on monitoring job offer content, rather than a reflection of the true economic situation. In real terms, we expect the labor market to remain tight, partly due to structural factors such as the increase in employees reaching retirement age. Regarding wages, there is little upside from a macroeconomic viewpoint due to ongoing restructuring by small to medium-sized companies and the public sector, as well as demographic changes. Nonetheless, the increase in employment is steadily pushing up total employees’ income, in terms of ‘wages x employment’. Second, regarding a rise in the consumption tax, we think that the government is likely to present this to the public in its most palatable form, which is as a tax aimed at achieving greater social security. In other words, we think that the opposition parties and the public are prepared to pay more tax to build a social security base that can cope with changes ahead. If the government commits to using additional consumption tax revenue to meet the minimum needs of its ageing population, including their healthcare needs, a rise in the consumption tax could have a positive impact on spending through the non-Keynesian effect of boosting future expectations (increasing permanent income). However, this assumes adequate public confidence in fiscal and social security policy. In any case, although it is easy to come up with reasons for being pessimistic, pessimism could change to optimism, depending on how things play out. The scenario we are backing is that growth slows slightly in summer, but that the economy resumes steady growth thereafter amid ultra-low inflation.
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