Of Lemons and Dinosaurs
Mar 02, 2006
Serhan Cevik (from Ankara)
Microeconomic factors influence production patterns in the Turkish economy. Turkey’s current account deficit widened from an average of 1.1% of GDP in the 1990-2003 period to 5.2% in 2004 and 6.2% last year. Is this because of an overvalued exchange rate and, more importantly, an immediate threat to economic stability? We tried answering these questions in our earlier research notes (see, for example, Big Picture, December 7, 2005), but want to reiterate our view that there are cyclical as well as structural factors determining external imbalances. First, about 90% of the increase in the deficit last year was a result of higher fossil-fuel prices. Second, thanks to macroeconomic normalisation, above-trend output growth and the recovery in business investment appetite have raised the demand for imports of intermediate and capital goods. Though we do not see these trends as alarming at this stage, we need to look beyond macro figures to fully grasp underlying structures and changes that have influenced the country’s production pattern and macroeconomic performance.
The Turkish economy is moving away from labour-intensive manufacturing sectors. The rise in imports of intermediate and capital goods reflects, in our view, the pace of output growth that has exceeded even our above-consensus estimates and, more significantly, structural changes in the composition of industrial production. Together with the globalisation of supply chains, domestic factors driving the marginal cost of labour higher relative to the cost of capital have accelerated the transformation away from labour-intensive sectors into capital-intensive production. Of course, this continuing shift from traditional sectors with low import content to new business lines that require, at least, at this stage of the cycle, higher import content means an increasing elasticity of import demand with respect to output growth. In other words, to produce t-shirts, you would not need much imported inputs, but when you move on to manufacturing cars and electronics, you would require higher import content, particularly, if your domestic suppliers are not competitive enough in today’s globalising economy. Labour-intensive sectors with structural weaknesses struggle against competitive pressures. The decline of traditional sectors, as manifested by secular shifts in the composition of industrial production and exports from labour-intensive to capital-intensive goods, is in fact a propitious process of creative destruction. However, as we argued in our previous report (After Normalisation, March 1, 2006), it also reflects structural weaknesses at micro level and labour-market rigidities that lead to a higher capital/labour ratio. The best gauge to assess these fundamental changes is productivity. Although the productivity revival, bringing a 36.6% rise in output per hour-worked and a 40.5% drop in unit labour costs, has been the key factor in raising real GDP by 32% in the past four years, there are significant sectoral divergences. For example, the clothing sector, in which only 21.9% of firms invested in new technologies, experienced a 1.8% drop in labour productivity, whereas electronics companies, 80.6% of which adopted new technologies, enjoyed a 60.4% productivity surge in the post-crisis period. The structure of Turkey’s corporate sector is the real culprit, in our view. In the midst of political upheavals and economic shocks, no one really cared much about the structure of Turkey’s corporate sector. But, now, the normalisation of political and macroeconomic landscapes is fast unveiling institutional constraints and micro-level shortcomings in the business sector. The first layer of the problematic structure is the closed-economy development strategy promoting large (family-owned) conglomerates — chaebols as Koreans call or the keiretsu in Japan. These ‘holding’ companies, with an irrationally diversified range of activities, have dominated the Turkish economy and consequently contributed to an unbalanced industrial composition. The second layer — indeed, a by-product of the first layer of ‘chaebols’ –– consists of small firms populating traditional sectors. Unfortunately, these undercapitalised small businesses struggle with operational and financial bottlenecks that shut them in technological backwardness and lower productivity. Turkey’s real challenge is developing high-quality, innovation-based companies. The 2001 recession caused a massive margin squeeze and forced companies to correct their balance sheets. However, the majority of family-controlled firms failed to carry this adjustment beyond simple cost cutting to restructuring business models. Furthermore, even successful firms, like Vestel, a household goods producer, that has a 23% share in the European market, face new hurdles, as the profitability of ‘original equipment manufacturer’ model keeps declining. Yet, the future is not absolutely grim, thanks to the emergence of new entrepreneurs, (see New Entrepreneurs (without Rich Fathers), February 28, 2005). Take a look at, for example, a company called NanoSis that produces nanotechnology microscopes or Havelsan that manufactures high-end flight simulators. In our view, Turkey’s real challenge is not how to engineer a ‘competitive devaluation’ in order to protect ‘lemons and dinosaurs’ of the closed economy, but to develop high-quality, innovation-based firms that would move the entire economy up on the value-added chain. It is no doubt a demanding endeavour, but not a flight of fancy, we believe, especially, in the era of open innovation.
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Inflation Rose 17.9% YoY on Food Prices
Mar 02, 2006
Deyi Tan (Singapore) and Denise Yam, CFA (Hong Kong)
Inflation rose 17.9% YoY: Consumer prices rose 17.9% YoY in February, 50bps shy of the 18.4% peak in November, and higher than the 17.0% seen in January. On a month-on-month basis, prices rose 0.6%, after a 1.4% MoM rise in January. Food prices drove higher inflation: The acceleration in inflationary pressures came from food prices (+18.3% YoY) which, originally sustained at elevated levels due to higher transport costs, have now been pushed up further by bad weather. Meanwhile, inflationary pressures in other segments such as housing (+13.3% YoY), clothing (+8.4% YoY) and healthcare (+7.3% YoY), education (+8.1% YoY) and transport (+44.2% YoY) continued to climb marginally higher. Core inflation rose to 10.2% from 9.7% in January. Electricity tariffs to cause immediate upside risks: The government will decide on the electricity tariff revision after the February audit study. This means electricity tariffs will be revised by 2Q the earliest. The expected tariff revision is between 18-48%. Tariffs revisions would be staggered and would fall more heavily on industries (as much as 100% in some cases). Our current forecast of 13% for the full year has not factored in the revision yet. Making some adjustments to total electricity sales and gross domestic product should give us a rough indication of electricity costs in total operating costs generally, which leads to our expectation that the impact on inflation should range from 0.6%-pt to 1.7%-pt. Inflation and Interest Rate Policy: Bank Indonesia is meeting again on 7 March. The interest rate decision should be based on the growth and inflationary outlooks. 4Q05 growth showed slowdown signs. Inflation has been somewhat steady but likely implementation of one-off factors means inflationary pressures could accelerate further rather than turn down as we originally expected. Before that happens, we think growth concerns would trump inflationary concerns in the next meeting. We expect hikes to be put on hold.
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