The sheer pace of growth in Turkey looks increasingly like a cause for concern and there is mounting evidence that the economy is overheating, Capital Economics warned on March 14.

There are clear signs that demand is outstripping the productive capacity of the economy and will ultimately lead to a slowdown which could cause GDP growth for Turkey to come in at just 3% this year, the consultancy said. That puts Capital Economics at the bottom of the consensus range. On March 13, the Organisation for Economic Co-operation and Development (OECD) raised its forecast for Turkish GDP in 2018 by 0.4pp, upgrading the forecast to 5.3%. However, on March 8 Moody’s Investors Service cut Turkey further into junk, saying that the Turkish government—which has injected huge stimulus into the economy since the downturn that followed the July 2016 attempted coup—seems focused on short-term measures, undermining effective monetary policy and economic reform. 

“Turkstat has yet to release Q4 GDP data but, on the basis of our GDP Tracker, we think growth in Turkey’s economy is now running at close to a six-year high,” said Yasemin Engin, an assistant economist at Capital Economics in London. She added: “All told, we reckon GDP grew by around 7% in 2017 as a whole, which would be the fastest pace of expansion since 2011. This would ordinarily be good news. However, there are signs that rapid growth is causing the economy to overheat… causing macroeconomic imbalances to build.”

Engin noted that Turkey’s seasonally-adjusted unemployment rate has fallen and is now close to the recent lows, while wages are rising faster than productivity. “And capacity utilisation in the manufacturing sector is at one of the highest levels seen in Turkey since the 2008-09 global financial crisis. Based on our estimate of potential GDP – the level of output when economic resources are fully utilised – Turkey now has a positive output gap equal to around 2% of potential GDP,” she said.

Capital Economics’ analysts were also concerned that underlying price pressures have been building in Turkey. “Admittedly, headline inflation has fallen from its peak of 13.0% y/y in November to 10.3% y/y in February. But that has largely reflected swings in food inflation that are unrelated to macroeconomic conditions. Core inflation (which strips out food and energy prices) has spiked over the past 18 months and is now running at around 12% y/y. That leaves it inconsistent with the central bank’s inflation target range of 5±2%,” Engin said.

A further anxiety is that the strength of domestic demand has driven up imports, causing the current account deficit to start widening again. On a 12-month sum basis the deficit was equivalent to 6.2% of GDP in January—up from 4.8% of GDP only 12 months ago. “Turkey’s large current account deficit and corresponding dependence on foreign capital inflows to finance it makes the economy particularly vulnerable to external shocks,” added Engin.

Turkey is no stranger to an overheating economy. It suffered similar problems in late-2011 and mid-2013, Capital Economics observed, with both episodes followed by a sharp fall in the Turkish lira and steep interest rate hikes. Annual GDP growth slowed by an average of 7%-pts in the subsequent 12 months.

“This time around, the financial excesses aren’t as extreme as they were back then – credit growth has actually slowed in recent months and asset prices arguably look less frothy. Even so, the signs from the recent data are ominous,” Engin concluded.