In 2017 the Turkish economy grew above the expectations of many international organizations. With figures examined it becomes clear that this performance was driven by both domestic and foreign demand. Stimulus packages and support provided to the real sector by the government and the tax reductions addressing consumers contributed to the recovery of the economy to a great extent. A substantial increase in total export last year made 2017 one of the best years for Turkey in terms of export performance since the global economy crisis in 2008. All these developments indicate that the Turkish economy is more than ready to take off when appropriate policies are implemented and when clouds of uncertainty over the country dissolve.

Leaving a highly positive year behind, the Turkish economy welcomed the new year with high hopes. The Turkish economy is expected to grow around 5 per cent in 2018. The high rate of capacity utilization ratio in industry and a raising appetite to invest in new areas show that the wheels of the Turkish real sector are turning again. The global economy is also expected to display a strong performance in 2018, which constitutes a positive indicator in terms of Turkish export performance.

Although there are some signals that the government will gear down to a certain degree, several important economic factors that will help revive the economy – such as credit guarantee funds and employment incentives – are expected to remain in certain proportions this year. The omnibus bill proposal the government submitted to Parliament includes incentives that will revive investments and employment. Given that easing monetary policy will be difficult in 2018 due to high inflation and volatile exchange rates, the role of fiscal policy in reviving the economy comes into prominence. While it is reasonable for the government to slow down a little by taking several parameters such as inflation into account, gearing down more than necessary, as occurred in 2012, could have a negative affect on economic activity. This year, it would be more reasonable for the government to adopt a more selective and target-oriented approach in terms of the incentives given to medium and large sized companies. More, the regular cash flow in the real sector can be a priority while supporting small sized companies.

Since Turkey’s costs of imported intermediate goods and energy soar in periods when the country enters a phase of rapid growth, an increase in its current account deficit is unavoidably being experienced. Diversifying incentives on exports and supporting companies that have a potential to produce imported intermediate goods are of critical importance in terms of enabling a sustainable 5 percent growth and minimizing Turkey’s vulnerability to external shocks by decreasing the current deficit. In this scope, it is crucial to implement the plans to incent domestic production of intermediate goods that Turkey has imported, which is included in the Input Procurement Strategy Action Plan (2017-2019) issued by the Ministry of Development.

In order to decrease the current account deficit, Turkey needs to diversify its export markets. Although countries have become keen to protect their own markets with new types of measures, Turkey should utilize available opportunities to diversify its export markets with a focus on regions like Asia, Africa and Latin America.

Increasing domestic energy generation is also crucial to reduce Turkey’s current account deficit. The geopolitical risks and increases in demand driven by global growth contributes to the rise in oil prices. Oil prices that could possibly see $70 this year are creating pressure over the current deficit. The Ministry of Energy and Natural Resources took considerable steps last year in regards to increasing domestic energy generation. Policies aiming to diversify domestic energy sources are expected to continue at the same pace during 2018.

While the Turkish economy experienced significant progress in growth and export last year, statistics regarding inflation and unemployment were worse than expected. Inflation and unemployment rates were in double digits almost the entire year. With the loss of value of the Turkish Lira, rising food and energy prices were the main triggers of this high inflation rate. While it is possible that inflation will return to single digits at the beginning of the second quarter of 2018, the future of exchange rates along with the prices of food and energy will decide whether such single digit rates will be sustainable or not. With Fed signaling that it will continue to increase interest rates, uncertainty regarding the future decisions of the European Central Bank, and due to high inflation and volatile exchange rates, the Central Bank of the Republic of Turkey is expected to maintain its tight monetary policy.

Since the high inflation rate is mostly being caused by supply-side factors, implementing a tight monetary policy will not be enough to achieve the inflation target alone. Structural reforms regarding problems that hinder domestic production and increase its costs are necessary for the inflation rate to return back to single digits. Policies regarding agriculture and livestock sector, and domestic energy projects that will diversify energy resources are of utmost importance regarding medium to long-term inflation trends.

Another reason for the CBRT’s insistence on a tight monetary policy is highly volatile exchange rates. Speculative movements caused by the increased regional risks during the northern Iraq referendum process, fabricated news suggesting that some European banks will stop lending to Turkey, the visa crisis with the U.S., and the Iran sanctions case in the U.S. caused great fluctuations in exchange rates during the previous year. Latest developments in Syria and the result of the trial process in the U.S., which will be announced in April, will be closely followed by the financial markets. Decisions of major central banks, especially of Fed, regarding interest rates will be another factor that will affect the course of exchange rates.

Even though the Turkish economy is creating new job opportunities, the demand for labor falls short of the supply due to the high labor force participation rates among the youth and women. Combined with the disparity between the skills taught by the education system and demanded by the job market, the Turkish economy fails to achieve its targeted unemployment rate.

In order to solve the unemployment problem, the government has begun to provide important support and incentives addressing employers. Through these incentives and the high economic growth rate, unemployment decreased from 13 to 10.3 percent. Such a decrease is an important achievement. However, there is room for improvement regarding unemployment. To ensure that the increase in welfare caused by economic growth reaches the entire population, the unemployment rate must fall below 10 per cent in the short and stay around 7-8 percent in the medium to long-term. If the Turkish economy does grow around 5 percent this year (as is expected), it can be estimated that the unemployment rate will fall back to single digits. This is likely especially when considering the fact that incentive programs aimed at decreasing unemployment rates last year are still continuing and new incentives aimed at increasing employment among women, young people, and people with disabilities are going to be implemented. However, to reach unemployment levels of 7-8 percent, structural reforms are needed in a wide range of critical subjects such as education, immigration policy and labor regulations.

The strong economic performance Turkey displayed in 2017 despite formidable problems has increased hopes and expectations for 2018. Turkey will enter 2019, a year with two critical elections, much stronger if economic growth continues and certain improvements are made in fields that currently seem problematic.

Recent data indicates that the Turkish economy is recovering from the stagnation prevalent in 2016. The first indicator in this respect came with the announcement of the growth rate observed in the first quarter of 2017. The unexpected 5 percent growth rate raised the expectations regarding the following quarters and the annual growth of 2017. The subsequent indicators of the inflation rate also illustrate that Turkey will see a single-digit inflation rate through the year. Furthermore, this recovery has occurred without an increase in the current account deficit, which demonstrates that the growth is not solely driven by domestic demand. As a result of these developments, exchange rates have been stabilized while the BIST 100 index has eyed 110.000 levels. In addition to this, employment figures also started producing positive signals, which is particularly crucial for economic and social life. The only negativity in this positive framework is the high trajectory of interest rates. This article aims to take a closer look at unemployment and inflation since these two matters are the leading ones that concern society and affect expectations.

The correlation between growth and unemployment

Unemployment has been one of the most prominent challenges the Turkish economy has confronted all along. While successful results have been yielded on many issues, the unemployment rate could not be permanently decreased below 9 percent. It must be noted that unemployment is the leading challenge of economies in general as economic crises firstly affect employment figures. As the expectations regarding the depth and persistency of the crisis worsen, a high-speed and severe shrinkage occurs in employment. However, as the crisis is tackled and growth kicks off, the increase in employment unfortunately does not comply with this trend. One of the main reasons for this is the fact that the employer does not begin hiring new employees before being convinced that the crisis is over. Another reason is that the employer finds alternative ways to do the same job with fewer employees during the period of shrinkage and prefers to continue with fewer employees also in the period of expansion. For such reasons, the increase in employment always follows growth with delay, and consequently the increase in employment always takes longer than economic growth. The graphic below shows the unemployment rates in the U.S. between the years of 2008 and 2016. Having been increased by 2.5 times within two years due to the crisis, the unemployment rate returned to its previous levels in six years.

It is possible to contend that this period is shorter in Turkey. Another detail that must be considered is the relation between growth rates and unemployment in general.

The figure above shows the unemployment and growth rates between 2005 and 2016. As a matter of fact, while a longer time period must be taken into account for better insight, the period shown above is enough to indicate necessary results. First to note is the fact that rapid growths following crises in Turkey increase employment quite quickly.  To a certain extent, it is possible to make the same observation for the aftermath of 2001.  More importantly, it has been observed that an annual growth rate below 6 percent brings higher unemployment rates in Turkey. Having undergone a structural transformation beginning from 2000, an average of 800.000 people participates in the labor force annually and almost all of these employments are non-agricultural. This means that unemployment will roughly remain stable even though the Turkish economy creates the same amount of employment each year. Of course, this rapid growth in the labor force participation will slow down after a while. As the economy grows, a lower growth rate will create the same amount of employment. Based on this, it is possible to estimate roughly that Turkey is required to achieve at least 7 percent of annual growth in average in order to decrease the unemployment rate to 8 percent by 2023.

Unemployment estimated to fall to single-digit levels in 2018

Turkey has a potential to reduce unemployment rates to single-digit levels. Frankly, the past 15 years have illustrated the potential of what can be accomplished when political stability is ensured and when the economy is in safe hands. The most impressive achievement among all is the performance displayed within the recent period under the shadow of all the negative developments and assaults. While Turkey registered an annual growth of 2.9 percent in 2016,  this rate climbed up to 5 percent in the first quarter of 2017.

With this achievement in mind, it is appropriate to estimate that the second quarter will see a 6 percent growth, and it will be no surprise if the growth rate hits around 7 percent at the end of the year. The same success can also be observed in unemployment figures. The unemployment rate, which was 12 percent (seasonally adjusted) at the beginning of the year, decreased to 11.3 percent by the end of April. As mentioned above, considering the factor that the increase in employment follows growth with delay, it is possible to argue that the unemployment rate will near single-digit levels by the end of the year. The following year’s growth rate is likely to be above this year’s unless a hot war or an extensive instability emerges. From this point, it can be argued that the unemployment rate will decrease to around 9 percent again.

Inflation will close the year in single-digit levels

Another data remaining from 2016 and giving way to pessimism has been the inflation rate. Starting to climb as of November, the inflation rate hit 11.87 in April 2017, the highest level since 2008.

Inflation is accepted to have two main grounds: sudden increases in input prices (cost-push inflation) and increases in overall demand nationwide. Naturally, the cost-push inflation does not connote a constant price rise. An increase in input prices (e.g. energy prices) leads to a general increase in prices following period. However, if no other increase occurs in energy prices, it is no longer possible to see a cost-push increase in the general level of prices. Therefore, cost-push inflation cannot be the ground of longstanding increases in prices. It can also be said that if the inflation rise occurs in a country due to costs, the increase will tend to decelerate after a while. Demand-pull inflation, on the other hand, might be continuous.

Another concept that needs to be touched upon in this scope is the exchange rate transitivity. This concept denotes the effect of a currency unit’s loss in value on the general level of prices in the country. The level of the exchange rate transitivity determines how the changes in exchange rates will affect the general level of prices and the rate of this change. This transitivity is much higher in the countries where dollarization is at high levels. To put otherwise, an increase in exchange rates affects the inflation almost to the same extent in a short span of time. In this respect, it can be said that the exchange rate transitivity is a structural problem. On the other hand, the main determinants of this transitivity are the level of competition in the country (how easily the cost increases could be reflected in prices) and the market expectation regarding the persistency of the increase in the exchange rate.

Although the effects of it have been diminished, Turkey has a long-standing dollarization history, which is still ongoing. Among various reasons causing this, the leading one is the years with high inflation we had in the past. Fortunately, those days are left behind. Despite that, the effects of dollarization are still felt. Although it is not at alarming levels as in the past, it must be noted that the exchange rate transitivity is still higher compared to some other countries.

The main reason of the state of inflation in our country over the past 7 or 8 months is that it has increased the general level of prices through the increase in the exchange rate and exchange rate transitivity. Between July 2016 and April 2017, the U.S. dollar rose in value by around 30 percent. The rate in the currency basket consisting of Dollar and Euro is also close to this. The academic studies conducted on this matter indicate that in Turkey, 10 percent increase in exchange rate affects inflation by around 1.5-2 points within a year. Departing from this, it can be estimated that the 30 percent increase in the exchange rate over the course of six months will affect inflation by around 5 points, which is of course an effect that will roughly spread over a one-year period. In this case, it can be roughly estimated that around 3.5-4 points of the inflation rate will come from the exchange rate increase at the end of 2017 unless another leap occurs. We estimate that the annual inflation rate of 2017 will be slightly above 9 percent. If this rate is achieved and the contribution of the exchange rate transitivity occurs as we claim, we can suggest that the annual inflation rate will not diverge much from the targets of the Central Bank.

In conclusion, it can be said that the Turkish economy has been on an upward trajectory in 2017 due to the results of the referendum and the sound decisions made by the economic administration. Unless a major problem is witnessed in the global economy, in the following years the targets regarding inflation rates are likely to be achieved along with the increases in growth and employment rates.