March 10, 2008	Monday	Rabi-ul-Awwal 1, 1429

United Kingdom

UK economic growth is seen moderating slightly from around 2.75 per cent in 2007 to around 2.5 per cent in 2008 as the effects of higher interest rates and the US slowdown feed through. This is similar to the latest average independent forecast, but at the bottom end of the Treasury’s forecast range. The differences between these various estimates, however, are relatively small compared to the normal margin of error for such forecasts. At present, risks to main scenario for growth appear broadly balanced, although the consequences for business may be more severe if the downside risks emerge.

Consumer spending growth is expected to remain relatively modest at around 2.5% in 2007 and 2.25 per cent in 2008. This reflects the dampening effect on household discretionary spending power of higher interest rates and high household debt levels. If the housing market slows sharply in 2008, which is possible as mortgage rates rise, this would tend to reduce consumer spending through confidence, collateral and wealth effects. But if the housing market remains as strong as in 2006 and early 2007, driven by supply shortages, there could be some upside potential. Business investment is the largest component of total fixed investment, which also includes house building and government investment. In recent years, however, government investment has been the fastest growing category within total fixed investment should continue to grow relatively strongly in our main scenario, although this will be offset by a planned slowdown in public sector investment. Net exports are projected to make a broadly neutral contribution to GDP growth in 2008, although the risks to global growth and thus to UK exports may be weighted somewhat to the downside at present in the light of the possibility of a hard landing in the US. The future path of oil prices also remains a considerable source of uncertainty for the world economy.

Growth in the UK manufacturing sector is expected to continue to lag some way behind the services sector in 2007-08. Business and financial services are likely to continue to lead the way in the short term, although this is vulnerable to any major adverse shocks to global financial markets, which could also derail the current mergers and acquisitions boom.UK GDP growth would be consistent with inflation (CPI) moving back down towards or possibly somewhat below its two per cent target rate by early 2008 as UK retail energy prices come down during the course of the year, following earlier declines in wholesale prices. In this case, official short-term interest rates are assumed to rise to 5.75 per cent in the short term and could rise further to six per cent by the end of this year before stabilising.

Public debt as a proportion of GDP in Britain was one of the lowest in the G7. However, when put in terms of the budget deficit, the UK seems not doing very well when compared to the rest of the G7. This meant that in order to meet the country’s public investment demands, the British Government has been able to run modest deficits in the medium term and so the UK is not in a position to give fiscal stimulus. Net debt, as a proportion of GDP compared with most other G7 economies was quite low. Meanwhile, Economic adviser with Deloitte Roger Bootle is of the opinion that the UK economy is about to enter its weakest period of growth since the Exchange Rate Mechanism crisis of 15 years ago. There is a risk the economy will slip into a full-blown recession. The increasing vulnerability of the housing market is at the heart of the downturn. The UK economy escaped a major economic downturn in 2004-05, when the housing market experienced its first ever “soft” landing. But the “big one” might now be upon us.

Not only is the interest rate environment far less favourable, but the global financial crisis and the associated credit crunch have brought an end to the period of easy credit that in recent years has been the bedrock of the rapid rises in house prices. Without this support, house prices may fall sharply, perhaps by around 5% this year and by something like 8% in 2009. Slower employment growth together with sluggish income growth could undermine the housing market yet further and significantly reduce the ability of household spending to propel the economy forward.

And unlike in 2005, the UK economy will not be bailed out by a strong world economy. The US economy has entered a period of weakness as the housing market undergoes a substantial correction and US consumers, for so long the driver of global economic growth, finally rein in their spending. US economic growth will slow to zero in the first half of this year, with a good chance of an outright recession. Even assuming a modest recovery in the second half, helped by much lower interest rates, the US economy is expected to grow by just 1.3 in 2008 as a whole and by a similarly below-par two per cent% in 2009.

Much has been made of the potentially offsetting impact of the strength of the UK’s biggest export market, Europe, and the growing importance of rapidly expanding destinations such as China and India. Euro-zone growth is still likely to slow significantly this year. And although economies such as China and India will continue to expand at very robust rates, between them they buy less than five per cent of total UK exports. Accordingly, net trade looks set to have a less supportive effect on the economy over the next few years than it did in 2005, when it made a positive contribution to GDP growth and helped to offset the negative impact of the housing slowdown.

Turkey

Turkish economic growth last year slowed significantly because of a doubling in energy prices and a drought. According to the World Bank’s country director, Turkey’s economic growth in 2008 is likely to be less than last year as global factors are less favourable. Turkey’s gross national product data for last year is yet to be published, but is expected to show a rise of 4-4.5 per cent. The official growth target for 2008 is five per cent. Global economic factors are less favourable this year than last year and there will be an impact on Turkey.

Inflation is likely to trend downward. If the government continues to privatise, promote competition, attract foreign direct investment and make the labour market more flexible, it will help reduce inflation. Reducing inflation was critical to achieving the government’s economic growth targets. Turkey’s consumer price inflation in 2007 came in at 8.39 percent, twice the government’s four per cent target. The government, however, is optimistic about this year inflation in the medium term, which could be in the low single digits. Price stability is absolutely critical because without that it would be difficult to sustain to a medium-term seven per cent potential target rate for Turkey.

Turkey’s problem has always been the low level of employment limiting the speed of convergence. While the share of the working-age population in total population stands at 71.2 (compared to 64 per cent in Europe), the number of employed is just 45% of the working-age population (compared to 63.8 per cent in Europe). The employment rate is partly a function of the level of labour force participation, which unfortunately stands at 49.3 compared to 72 per cent in Europe. However, if Turkey improves the state of the labour market and brings its employment rate to the European level, the number of employed could increase by almost 50%, or by 11.6 million workers.

Turkey’s corporate sector carries significant risk to sudden shifts in exchange rates due to its foreign exchange-denominated debt. Currently, the country face a $51 billion net debt position in foreign currency. The Turkish corporate sector as a whole is exposed to foreign currency risk. The net foreign exchange position of the corporate sector is calculated as the difference between the stock of forex-denominated assets held by the corporate sector and the sector’s forex-denominated liabilities. Turkey lured $22 billion foreign direct investment in 2007.

Privatisation is gaining momentum. The government would speed up its privatisation drive in 2008, when Ankara hopes to sell off tobacco firm Tekel, a 75 per cent stake in Halkbank HALKB.IS, electricity distributions grids and sugar factories. The government would decide by March whether to sell its Halkbank stake to a strategic investor or via a secondary public offering, with a sale concluded by the end of the year. The Halkbank sale alone would generate $9 billion in revenues, according to EFG Istanbul estimates. Privatisation of the country’s electricity production assets would be completed in 2011 or 2012, rather than an initial 2010 goal.

Turkey’s financial sector was however much better placed than before to deal with global financial shocks. The liquidity ratios of Turkish banks and asset-loan ratios are very solid. They meet essentially all Basel criteria in terms of capital adequacy ratios. The World Bank has approved a four-year $6.2 billion financing programme for Turkey, making it one of the largest recipients of the bank’s loans. The bank would allocate a big chunk of its latest $6.2 billion loan to Turkey for energy and labour market reforms. The government should continue implementing the reforms to maintain its attractiveness for foreign investors and therefore for international financial markets.

Although Turkey applied for associate membership status in the European Economic Community in 1959, the EU waited until 1999 to confirm the candidacy status and until 2005 to start accession negotiations. Nevertheless, Turkey’s difficult relations with the EU have always played a fundamental role in its institutional and economic development. Despite the encouraging steps forward in recent years, Turkey still has a long list of political and socio-economic requirements to complete. One of the major concerns is the income inequality between Turkey and the EU and regional income disparities within Turkey.