Turkish President Recep Tayyip Erdogan (R) with US President Trump's senior adviser and son-in-law Jared Kushner on February 27, 2019, in Ankara. Photo: AFP/Kayhan Ozer/Turkish Presidential Press Service

US President Donald Trump this week opened a new chapter in his “trade wars,” with his latest move to remove India and Turkey from the duty-free imports system, the Generalized System of Preferences.

Under the GSP, eligible countries can sell certain products to the American market without facing any import tariffs. The news comes as a bad surprise to Turkey, whose vulnerable economy is increasingly dependent on export revenues, given continuously weakening domestic demand.

The Office of the US Trade Representative on Monday said Washington “intends to terminate India’s and Turkey’s designations as beneficiary developing countries under the GSP program because they no longer comply with the statutory eligibility criteria.”

It said Turkey, after being designated a GSP beneficiary in 1975, has demonstrated a higher level of economic development, meaning it could be graduated from the program.

The US move came only two weeks after Turkish President Erdoğan hosted Trump’s senior adviser, and son-in-law, Jared Kushner in his palace in Ankara with his own son-in-law, Finance Minister Berat Albayrak.

After the joint meeting, the sons-in-law had a separate talk to discuss economic relations between the two countries. The Turkish side seemed satisfied enough with the talk, as Albayrak tweeted after the meeting: “In a head-to-head meeting with Mr. Kushner, we discussed steps to increase economic cooperation between our countries.” 

It was clear that Turkey had not been expecting this move from President Trump.

Diplomatic roller-coaster

For the past three years, relations between the United States and Turkey have been a roller-coaster ride. Ties sank to a new low in August of last year, when – amidst a diplomatic stand-off – Trump announced via Twitter that the US would be doubling the tariffs on imported Turkish steel and aluminum, helping plunge Turkey into one of the worst currency crises in its modern history.

Two months later, the murder of Washington Post columnist Jamal Khashoggi in the Saudi consulate in Istanbul, and the evidence of Saudi culpability in Turkey’s possession, offered Erdoğan fresh leverage to engage with Trump and Turkey-US ties saw a notable improvement.

Then, in February, American-Turkish Council chair James Jones paid a visit to Ankara and had several high-level meetings. These resulted in an optimistic target of increasing the bilateral trade volume between the two countries to US$75 billion, or more than triple its 2018 level of $20.7 billion.

In response to Trump’s latest move, Turkish Trade Minister Ruhsar Pekcan on Tuesday tweeted that the US decision to end preferential trade with Turkey was at odds with the goal of raising trade volume between the two countries to $75 billion.

Turkey would nevertheless continue to work on increasing the volume of trade, viewing the US as astrategic partner, she added.

Turkey is now in the midst of a new campaign season, with local elections scheduled for March 31. Erdoğan, addressing the latest trade challenge in a TV interview, said: “It is interesting that after sending his son-in-law to Turkey to talk about improving economic relations and increasing the trade volume between the two countries, Trump made this move to remove Turkey from the GSP program.

Turkey is taking all necessary precautionary measures,” the president said, adding that no country should try to teach Turkey a lesson with such moves. But even if the Turkish leader did not seem to panic, the news was not good given the current state of the country’s economy.

Emphasizing the sharp fall in domestic demand, the Organization for Economic Co-operation and Development (OECD) has dropped Turkey’s 2019 growth forecast from 0.4% to -1.8%.

After growing at 7.4% in 2017, the economy steadily deteriorated in 2018 (See Table 1). Government expenditure and exports, thanks to a weak Turkish lira, are the only legs to run the economy.

Desperate measures

Erdoğan is trying to postpone the worst days until after local elections, as he did just before snap elections in June 2018 and previous polls before that. But economists estimate the economy already started contracting in the final quarter of 2018 at rates between -4% and -6%.

Domestic demand is very weak, and Turkish consumers are not helped by the consumer price index hitting 20%. High inflation, coupled with increasing unemployment – 12.3% in November 2018 – has reduced the purchasing power of households. Consumer confidence has in turn steadily decreased since August 2018.

Food prices, in particular, have rocketed 25% higher, pushing the government to open public vegetable stalls in cities across the country. These government stalls sell basic vegetables and fruit with discounted prices to “fight against inflation.”

The government has, meanwhile, been pressuring banks to decrease interest rates for consumer credit to encourage domestic demand. The Banking Regulation and Supervision Agency for its part is now allowing monthly credit card payments – as opposed to 10 times per year – to support consumption.

Setting aside desperate, make-up measures, foreign demand seems to be the only source which Finance Minister and son-in-law Albayrak hope will offset the drastic fall in domestic demand.

Turkey’s current account deficit decreased to 3.9% in 2018 from 5.6% in 2017, which Finance Minister Albayrak hailed as a sign of “balancing in the economy.” This data is no surprise, however, given that demand from Turkish firms for imported intermediary and investment goods is contracting sharply, down 25% in the second half of 2018.

More importantly, it is a sign the economy is contracting on the production and consumption side, as Turkey’s firms are heavily dependent on intermediary and investment goods to produce. Reflecting this, the Industrial Production Index for the final quarter of 2018 decreased by 7% relative to 2017.

The construction sector, the main engine of the economy, has also been contracting for the last couple of years. Mortgage sales decreased 81% in the final quarter of 2018 amid high interest rates. As can be seen in Figure 2, Turkey’s economy structurally gives a current account surplus in times of recession.

However, as heavily indebted firms do not show any sign of movement, exports only rose 6% in January, relative to the same month in 2018. Despite a 27% drop in imports, the economy saw a $2.5 billion trade deficit.

Turkey’s main trade partner remains the European Union. The US market receives only 5% of Turkish exports, and of those, only 18% are exported via the Generalized System of Preferences.

In normal times, the impact of removing Turkey from the GSP program would not have been cause for concern. However, given the current state of the economy, which is rapidly descending into stagflation, Erdoğan does not have the luxury of brushing off Trump’s latest move.

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