FIFTH YEAR OF STRONG GROWTH IN TURKEY

UNCLAS SECTION 01 OF 02 ANKARA 000801 SIPDIS TREASURY FOR INTERNATIONAL AFFAIRS - JONATHAN ROSE SENSITIVE SIPDIS E.O. 12958: N/A TAGS: EFIN PGOV EU TU SUBJECT: FIFTH YEAR OF STRONG GROWTH IN TURKEY ANKARA 00000801 001.2 OF 002 1.(U) Summary: Despite sharply higher interest rates, the Turkish economy (GDP) grew 6.1% in real terms in 2006, surpassing expectations and the official target of 5.0%. Per capita income reached $5,477 almost doubling from $2,642 in 2002. The Turkish economy has grown by an annual average of 7.2% over the past five years. A relative slowdown in this growth pace is expected in 2007, but the 2007 target of 5.0% is still within reach. Ongoing reforms will be required to sustain high growth and investment rates into the medium-term. End Summary. -------------- ECONOMY RECOVERED FROM MID- 2006 TURMOIL -------------- ¶2. (U) According to fourth quarter 2006 growth figures released April 2, the Turkish economy grew faster than projected in 2006. Despite global market volatility and tight monetary policy in 2006, GDP growth in the fourth quarter of 2006 came in at 5.2% -- well above market expectations. Overall GDP growth in 2006 was 6.1% and GNP growth was 6.0%, whereas the target was 5% and most analysts were expecting growth to come in between 5% and 5.5%. The data suggest the economy has recovered from the market turmoil in the second quarter of 2006. -------------- Growth Driven by Exports -------------- ¶3. (U) The principal sources for the high 2006 growth on the expenditure side were private sector capital formation and trade (both imports and exports). On the production side, the main drivers were services and industry (2.7 points and 2.2 points respectively),followed by the booming construction sector with 0.9 points for the whole year. The construction sector's weight in GDP growth increased significantly in the past five years. ¶4. (U) The construction sector grew 16.1% in the last quarter and total growth in the sector reached 19.4%, on the back of strong performances in the first three quarters of the year (27.1%; 14.9%, and 21.3% respectively for the first three quarters). The agriculture sector also grew by 9.7% in the last quarter after poor performances in the second and third quarters of the year (-0.4% in Q2 and 0.5% in Q3). For the full year, growth in the agriculture sector thus reached 2.9%. ¶5. (U) The 2006 growth data also showed significant change in the structure of growth in Turkey as the motor of economic growth shifts from domestic demand to exports. Private consumption growth declined from 11.5% in Q2 to a mere 0.1% in Q4. In addition, the contribution of government spending to growth has also declined. Whereas the rate of growth of government spending was 18.3% in Q2, in Q4 it declined sharply to 0.7%. -------------- Strong Private Investment Spending -------------- ¶6. (U) Domestic demand growth (2.7% year-on-year; year-on-year) contributed 2.8 percentage points to the overall 5.2% GDP growth registered in Q4, but the bulk of this came from private sector investment (1.2 percentage points) and inventory growth (1.3 percentage points). Both private and public sector consumption growth (0.1% year-on-year and 0.7% year-on-year, respectively) remained subdued and contributed a mere 0.1 percentage points to overall GDP growth, each. Meanwhile net exports continued to recover, adding 2.5 percentage points to overall GDP growth. -------------- Relative Slowdown Expected in 2007 -------------- ¶7. (U) Relatively robust economic growth is expected to continue in 2007 although perhaps at a slower pace, with industry and construction expected to be key drivers. The Central Bank's tight monetary policy to bring down inflation to the 4% target from a current annual level of 10.92% will be quite challenging, and if the high interest rate policy continues, it may be contribute to slower growth of domestic demand in 2007. -------------- Highest Growth Rates in OECD -------------- ¶8. (SBU) The Turkish economy grew an average of 7.2% in the past five years, one of the highest rates of growth -- perhaps the highest -- in the OECD. Per capita income in dollar terms nearly doubled since 2002, from $2,642 to $5,477. Even allowing for the ANKARA 00000801 002.2 OF 002 unevenness of income growth, this dramatic improvement must be having an impact on individual Turks' sense of financial well-being. The AK Party Government can point with pride to the fact that the period of sustained strong growth -- the longest in recent memory in Turkey -- has coincided with the AK Party's period in power. Stronger-than-expected growth also improves ratios to GDP that are considered indicators of vulnerability: in particular, Net Public Debt to GDP is now only 44% -- down from 90% after the crisis -- and the Current Account Deficit to GDP, while still high, is 7.8%, projected to decline to 7.2% in 2007. -------------- --- But Sustaining High Growth Requires More Reforms -------------- --- ¶8. (SBU) To sustain Turkey's strong growth well into the future, the next Government will need to keep moving forward with a second generation of reforms. As the Central Bank often reminds the Government, labor market reforms, judicial reform and revamping the educational system to build a skilled labor force will raise Turkey's growth potential in Turkey and will help attract Foreign Direct Investment, perhaps even greenfield investment. WILSON