A Not Very Gloomy Post?

David has been suggesting that I might be a gloomy person, so I’d like to try and kill that idea stone dead, and quick as a flash, with an extraordinarily optimistic post about a key EU topic: Turkey.

Now despite what David says, I am not entirely gloomy, even about the future of the EU. We have opportunities, if we embrace them. I am only ’gloomy’ since I don’t see our current leadership ready to embrace very much that is really imaginative, and really interesting.

Very high on my agenda would be the idea that we need to accept with dignity - balding with grace as Tobias has it - that the current distribution of income, weath and power we have on this planet cannot continue. And in accepting embracing this reality we need to look for ways in which we can make a coherent transition towards a different world order. One part of this is embracing the new. Europe has an ageing population, then let’s look towards partnerships with some younger countries. Case in point: Turkey. (Another case in point and for another day: Morrocco).

Now it turns out that these days the Turkish economy isn’t exactly the disaster story it used to be, or that many of you imagined it was. In fact it is one of the few real success stories to be associated with the EU in recent times, for Turkey, along with Brazil (another of the recent golbal mini success stories) has been advancing well with institutional reform, fiscal management and inflation targeting, to the extent that the endemic inflation tendency seems finally to be coming under control, and interest rates, in consequence, are steadily dropping. A viruous circle, and one, surely not entirely by chance, which coincides with the ’sweet’ demographic moment. Let Morgan Stanley’s Cerhan Cevic give some of the detail:

The latest data support the case for single-digit inflation rates, in our opinion. The consumer price index posted a month-on-month increase of 0.7% in January, lowering the annual inflation rate to 16.2%, from 18.4% at the end of last year and 73.2% in 2002. The outcome is better than our below-consensus forecast of 1.2% and confirms that Turkey is moving rapidly towards single-digit inflation rates. On our estimates, the annual rate of change in the CPI will move below this year’s official year-end inflation target of 12.0% much earlier than expected, with an increase of 11.8% in April. Although inconsistent policy decisions remain a risk, we are comfortable lowering our year-end forecast from 11.5% to 11.0% with risks skewed towards the downside.

It’s time to smell the coffee — Turkey’s disinflation process is not a temporary phenomenon. Though currency movements play a notable role in driving inflation mechanics of highly dollarised economies, disinflation in Turkey has not been just a by-product of exchange-rate valuation. We believe that it is unfair to take currency appreciation for granted and overlook fundamental factors driving both exchange-rate and inflation dynamics. First, the favourable pass-through effect is a result of fundamental improvements such as a rebalancing of residents’ portfolio allocations and productivity-driven export growth. Second, monetary discipline assisted by fiscal consolidation and structural reforms has played a critical part in improving institutional credibility. Third, productivity gains that have resulted in a remarkable drop in unit labour costs help lower the rate of price increases. And last, but not least, economic slack as manifested by the cumulative output gap and labour-market developments has accelerated the pace of disinflation.

In a challenging year for emerging markets, Turkey offers a distinctive transformation story, in our view. The increasing possibility of higher interest rates in the US has triggered a nervous reaction in global capital markets. Of course, depending on the timing, pace and magnitude of such an adjustment, lower risk appetite may put emerging-market asset prices under pressure. Having said that, we believe Turkey presents a distinctive transformation story with improving economic fundamentals and encouraging political developments. In short, the downward trajectory in domestic interest rates should continue to support our recommendation to own two-year government bonds and equities in Turkey.