TCMB Monetary Policy Decision 2005
Central bank: tcmb | Type: decision | Date: 2005-12-05

No: 2005-45 December 5, 2005
GENERAL FRAMEWORK OF INFLATION TARGETING
REGIME and MONETARY AND EXCHANGE RATE POLICY
DECEMBER 2005
TRANSITION TO INFLATION TARGETING REGIME
Introduction
1. Inflation targeting is a successful monetary policy regime im plemented not only in
developed but also developing countries. The number of countries which have
adopted inflation targeting have been increasing steadily. The Cent ral Bank of the
Republic of Turkey (Central Bank) emphasized in its announcement of earl y 2002
pertaining to the general framework of monetary policy that the fi nal target of
monetary policy was the adoption of inflation targeting regime, but as the
reliability of the regime would suffer in case this adoption was made prematurely –
without satisfying the necessary pre-conditions – first there wil l be a waiting
period to allow the factors that restrict the efficiency of mone tary policy to
weaken. It was also pointed out in the same announcement that “implici t inflation
targeting” would be implemented until the adoption of the inflation-tar geting
regime. In line with this, inflation targets were set jointl y with the government.
While utilizing short-term interest rates efficiently in the fight against inflation,
base money was set as an additional anchor with a view to increasing the reliability
of inflation targets. This policy, supported by fiscal discipline, ongoing structural
arrangements and the progress made towards Central Bank independence, paved
the way for significant gains on the road to price stability.
2. In time, harmonization with the floating exchange rate regime incr eased and
considerable progress was made in the formation of a suitable envir onment for the
transition to an inflation targeting regime: all inflation targets were met, confidence
was heightened and inflation expectations converged with the targets. Today,
inflation is at its lowest in thirty years. While debates on t he sustainability of
public debt stock used to be at the top of the economic agenda in the past, this is no
longer the case. Worries pertaining to the continuity of fiscal di scipline have eased
considerably. Financial markets started to become deeper, and the f inancial sector
has become less fragile.
3. Progress made towards economic stability started the reverse-dollarization process,
and although it was interrupted from time to time and more progress is necessary,
the weight of Turkish lira denominated investments began to increase in portfolio
preferences.
4. In the same time-span, six zeros were dropped from the Turkish lira and New
Turkish Lira (YTL) was adopted. This step, we refer to as monet ary reform, was a
demonstration of our trust in the permanent nature of the gains achieve d.
5. Following the agreement with the IMF, the announcement of the medium- term
program and the start of the negotiation process with the European Union for full
membership, the predictability of fundamental macroeconomic variables further
increased.
6. During the period 2001-2005, very significant steps were taken pertaini ng to the
improvement of the institutional infrastructure of monetary policy, and this is
another pre-condition for the transition to the inflation-targeting reg ime. During
this process, the Central Bank rendered its institutional framewor k more efficient,
defined its communications policy in a more transparent way, expanded i ts
information set and improved its inflation forecast methods. Besides these factors,
significant progress was made during this time in the area of C entral Bank
independence, pertaining to its practice. This development strengthene d
expectations that the chronic inflationary process will not return.
7. All these developments pointed to the fact that the pre-conditions of t he inflation-
targeting regime had, to a large extent, been met and the appropri ate time was
approaching. The Central Bank did not adopt the regime in 2005 due not only to
the changes made by the Turkish Statistics Agency in the price i ndices released by
the agency, but also to the monetary reform that took place. Yet, the Central Bank
announced that this was the final preparation period for the transition t o the
inflation-targeting regime. Steps taken in this preparation period for further
institutionalization of monetary policy brought the practice of monetar y policy
strategy one step closer to the inflation-targeting regime. I n the said period,
Monetary Policy Committee meetings began to be held at pre-set and pre-
announced dates and times, and interest rate decisions – taking into ac count the
deliberations made at the meetings - began to be made public at 9 a. m., the next
day. Such meetings were followed by the prompt release of a text outlining the
rationale behind the decisions as well as providing the opinions of the m embers of
the Monetary Policy Committee. These texts not only justify the immediate
decisions but also provide signals for the future course of interest rate decisions. In
addition, during the same period the organizational structure of the ins titution was
renewed and the terms of reference pertaining to monetary policy w ere clarified.
As a result, during the last four years, and especially during t he last year, the
predictability of monetary policy evidently increased, and signifi cant
developments took place pertaining to institutional infrastructure and transparency.
inflation targeting, within the framework of the institutionalizat ion process of
monetary policy in 2006. Together with this regime, it is planned to move towards
the process of “price stability” from the “disinflation” process of recent years.
Within this context, there will be increased transparency and account ability in the
upcoming period, in terms of inflation targets and the policies for r eaching these
targets, within the general framework of monetary policy. This press release
should be perceived as a main policy text for the framework of the i nflation-
targeting regime.
THE GENERAL DEFINITION OF INFLATION TARGETING REGIME
9. The primary objective and main priority of central banks is to achi eve and
maintain price stability. As for inflation targeting, it is a monetary policy strategy,
becoming more widely used with the aim of achieving price stabili ty. Although
there are various definitions in academic literature, practice s point to two main
factors differentiating the inflation targeting regime from ot her regimes:
i. The central banks implementing an inflation-targeting regime announce their
inflation targets numerically, commit themselves to achieving these targets
and are accountable to the public in case targets are not attained.
ii. As monetary policy decisions affect on the economy with a tim e lag, central
banks control future inflation rather than current inflation. With this aim,
they develop inflation forecasts periodically and make them public. T hat is
why the inflation-targeting regime is also frequently called “ inflation forecast
targeting”. Along the same lines, the consistency of the foreca sts with the
inflation target and the risk of deviating from the target are e xplained to the
10. The monetary policy implemented in Turkey has gradually approached the
inflation-targeting regime. Following the new steps to be taken i n 2006 regarding
transparency and accountability, the current monetary policy of that t ime will from
then on be described as the inflation-targeting regime. Analysis of other countries,
as well as Turkey’s past experiences suggest that the inflati on targeting regime is
not an end in terms of monetary policy, but on the contrary, a component of an
uninterrupted “evolution” process. Certainly, this evolution process holds true for
not only the policy makers, but also for all the other economic units. Enhanced
mutual interaction and information sharing with the public during this proc ess will
render the regime more functional and efficient. In line with this, the main items on
the agenda for the Central Bank in the upcoming period will be to raise the level of
transparency, accountability and predictability. The fundamentals of monetary
policy in the coming period are summarized below.
THE GENERAL FRAMEWORK OF INFLATION TARGETING REGIME IN
11. The Central Bank has been working on the inflation-targeting regime s ince the
year 2000. The experiences of more than 20 - developed or developing - countr ies
implementing the inflation targeting regime were used while cons tructing the main
framework of the regime for Turkey. The country examples showed that , there is
no system, which is “the unique and the best for all countries”. Ther efore, it has
been taken into consideration that a model specific to Turkey needs to be formed
while constructing the general structure within the framework of a n inflation-
targeting regime.
Inflation Target and the Period of Targeting
12. Owing to the advantage of being easily understood by the public, as we ll as its
communication advantage, the inflation target was set as “a point target”. As it is
an indicator easily followed by all members of society and an eff ective way of
accurately measuring the cost of daily life, the Consumer Pric e Index was the
preferred means of defining the inflation target. Along these line s, the target
variable is the end-year rate of inflation calculated by the annua l percentage
change of the Consumer Price Index with the base year 2003. Bearing i n mind the
transition from 2006 onwards to a three-year budget practice, the announce ment of
a three-year target path is believed to increase the internal consistency of inflation
targets and their harmony with other macroeconomic projections. There fore,
during this initial stage of the inflation-targeting regime, t argets are announced for
a three-year period. In harmony with the Pre-Accession Economic Pr ogram and
three-year budget plans, the end-year targets for 2006, 2007 and 2008 are s et as 5
percent, 4 percent and 4 percent, respectively. The target for e nd-2009 will be
announced in 2006.
Interpretation of the Target
13. End-year inflation targets for the period of 2002-2005 were announced within t he
framework of implicit inflation targeting, and inflation was rea lized below the
targets for the first three years in a row. It is predicte d that the realization for 2005
will most probably be below the target as well. Under normal condit ions where
inflation has stabilized at low levels, it can be considered as unfavorable for
inflation to remain systematically below the target. However , as the primary
objective while moving from the chronic inflation environment to sing le-digit
figures in the 2001-2005 period was to bring down the high level of inflation,
remaining below the target did not affect expectations adversely. On the contrary,
it bolstered perceptions that the disinflation process would continue. He nce, in this
period, the fact that inflation was below the targets was conside red to be a more
acceptable situation compared to inflation realizing above the targ ets. Within this
context, the targets announced by the Central Bank were implicitly perceived as
the “upper limit”. However, it is inevitable that this situat ion will change in the
coming years. This is due to the fact that in economies where inf lation has
stabilized, monetary policy is in a position to aim for the coherenc e between
inflation and the targets, rather than inflation realizing below t he targets. Along
these lines, in the process of the inflation-targeting regime, the Central Bank will
from now on assess upward or downward deviations from the target on equal
footing. This also means that an explanation will be made to the public in both
substantial upward and downward deviation of inflation from the target.
Deviation from the Target and Accountability
14. Measured by the Consumer Price Index, which is a comprehensive index, the
course of inflation may show fluctuations arising from the factors outside the
control of monetary policy. Factors such as developments in oil price s, changes in
international liquidity conditions and global risk perceptions, indirect t ax and
public price adjustments, and unforeseen movements in the prices of unproc essed
food may lead to volatilities in inflation from time to time. C onsidering the data
and model uncertainty in the economy in addition to the factors mentioned a bove,
it is obvious that inflation realization is quite unlikely to be exac tly the same figure
as the point target That is why it is not possible for the Centra l Bank to ensure that
inflation will not make even the slightest deviation from the point targets.
15. However, this does not stand for the lack of accountability. In case of a significant
deviation from the target in any period, the Central Bank shall expl ain the reasons
behind the said development to the public in its reports, in the framew ork of the
inflation-targeting regime. In this context, the Central Bank wi ll continuously be
obliged to account for its actions to the public through the publication of i ts
reports. Nevertheless, it is of paramount importance that the Ce ntral Bank
establishes a separate mechanism, which will explain the situa tion to the public in
cases where inflation realizations display an excessive deviat ion from the target.
Thus, the provision in Article 42 of the Central Bank Law states t hat “The Bank
shall submit information to the Government in writing and inform the p ublic
disclosing the reasons of incapability to achieve the determined ta rgets in due time
or the occurrence of the possibility of not achieving such targets a nd the measures
to be taken thereof.” As the said article provides accountability, it shall be
implemented with utmost care in the framework of the inflation-ta rgeting regime.
16. At this point, the main question to be answered is how to establish this mechanism.
As it is stated explicitly in paragraph 14, the probability of achie ving the point
target is almost zero. In this case, will the accountability principle also apply to a
small deviation, which can be defined in decimal or even in percenta ge points?
How big should a deviation be in order to require such an explanation? It is clear
that size matters however the perception of size is much more i mportant.
Determination of the size of the deviation stands for the expression of an
“uncertainty band” per se. The critical point is that this band should not be
perceived as a band for the inflation target.
17. Building a band around the target is an implementation preferred by m ost of the
central banks that adopted inflation targeting and announced a point target . 1 The
fact that central banks build a band around the point target does not indicate a slack
monetary policy. It should be emphasized once more that the uncertainty band
should not be perceived as any type of target. It is only an indicat or for the bi-
directional and “excessive deviation” thresholds of the band target, which was
announced for 2006, and an element that facilitates the communication polic y of
the Central Bank. In the overall scenario in which big exogenous shocks do not
occur, the public should understand clearly that the aim of the Central Bank is to
be as close to the point target as possible and therefore, the Bank will consider
upward and downward deviations from the 5 percent-target in the same m anner.
Furthermore, it should be noted by the economic agents that the uncertainty band is
likely to shrink as a result of further approaching price stability in the upcoming
18. In light of the statements above, the “uncertainty band” for 2006 is se t as 2-
percentage point in both directions. The inflation path consistent with t he end-year
target and the uncertainty bands around the path are shown below. In case figures
go outside the band, the Central Bank shall submit a separate report to the
Government disclosing the reasons of the incident and the measures to be taken
TABLE 1. INFLATION PATH CONSISTENT WITH THE END-YEAR TARGET
AND THE UNCERTAINTY BAND
Uncertainty Band (upper
limit) 9.4 8.5 7.8 7
Path Consistent with
the Target
7.4 6.5 5.8 5
Uncertainty Band (lower
5.4 4.5 3.8 3
1 International Monetary Fund, 2005, “Does Inflation Targeting Work In Emerging Markets?”, World Economic
Outlook, 4, Part 4, p.161-186, September Washington DC.
Adoption of a Medium-Term Perspective
19. There is a close relation between building an uncertainty band and a “ medium-
term perspective”. In order to minimize macroeconomic fluctuations while
struggling against the exogenous shocks that increase or decrease i nflation
remarkably, we need an “uncertainty band” around the point target to se rve as a
reference. Rather than temporary fluctuations in inflation, what m atters to the
Central Bank in the medium-term is that inflation becomes 5 percent in one year
and 4 percent in two years by displaying a gradual decline and achieves a degree of
stability. It should be noted that a medium-term inflation target stands out in such
an implementation. In a medium-term perspective, the Central Ba nk does not
instantly react to the temporary impacts of large exogenous shocks on inflation, but
spread out the policy reactions over a period of time by putting emphas is on
medium-term targets. In this context, the Central Bank will cl early explain to the
public how a shock that threatens the inflation target is handled (such as the
evaluation of temporary or permanent features of a shock). In the fr amework of
Article 42 of the Law mentioned in paragraph 15, the Central Bank wil l not only
implement policies aimed at reconvergence to the target but also notify the
political authority of the steps to be taken and inform the public of the amount of
time needed for converging to the target again.
20. For instance, it is a widely accepted idea that central banks s hould not have a
reaction to the primary effects of an increase in oil prices. However, as the
implementation of this idea requires certain flexibility, an uncer tainty band should
be built around the target.
21. Let us explain this matter with an example: In a scenario in which oil prices rise by
USD 100 per barrel and maintain their high trend throughout 2006, their prima ry
impacts on inflation might reach 3 or 4 points and naturally, the Centr al Bank
would let the end-2006 inflation exceed the 5-percent target. In case t he Central
Bank strived to reach the 5-percent target in 2006 in spite of the suppos ed increase
in oil prices, the Bank might be obliged to increase interests si gnificantly and
therefore, cause a negative impact on social welfare by crea ting a contraction in
economic activity. Instead of this, the Central Bank in the supposed situation,
would allow the deviation from the 2006 target, but pledge to decrease the inflation
to 4 percent in 2007 in order to prevent secondary effects and keep expectat ions
under control. A similar action plan could be followed against probable
developments such as changes in international liquidity conditions, adjust ments in
indirect taxes and public prices, pricing differentiations of instit utions stemming
from structural adjustments and sudden movements in agricultural product prices.
22. The important point here is that in the periods where inflation deviat es from the
target, the Central Bank clearly explains the reasons for the de viation to the public
and informs them
of the timing of re-convergence to the target and the relevant
monetary policy. There is no doubt that the said time band may differ according to
the type and size of shocks. As various shocks may have different i mpacts on
inflation according to timing and periods, in case of a significant di version from
the target, the re-convergence period shall be announced after the occurrence of the
shocks and the determination of their sources.
Special CPI Aggregates
23. The CPI occasionally displays unpredictable changes as a result of fluctuations in
energy, unprocessed food and public prices and in indirect taxes. Therefor e, the
CPI inflation, which is taken as the target criteria in the framework of the inflation-
targeting regime, may occasionally be affected by factors t hat are beyond the
control of monetary policy. For this reason, in order to achieve a be tter
understanding of the main inflation trend, Special CPI Aggregates (SCA) will
continue to be a part of the forward-looking inflation analysis of the C entral Bank
and its communication policy. As the shocks affecting inflation may differ
according to their periods, there is a very small probability tha t a sole “core
inflation” indicator excludes all the factors that are outside the control of monetary
policy. Therefore, instead of considering a single so-called core indicator, more
than one indicator is used in the differentiation of various exogenous shocks. There
is no doubt that some of the said indicators may stand out in the future. However,
for now, core inflation it is not likely to be defined with a single indicator. In this
process, the Central Bank will openly inform the public of the type of relevant
indicator and the degree of its importance. Moreover, after reachi ng a satisfactory
number of observations, new indices can be compiled based on different
techniques and SCA definitions can be updated according to the changing
economic conditions.
Conditions for Changing Targets
24. A pre-announced inflation target shall only change in the event that v ery sharp and
long-term deviations from the target are expected or medium-term targets no
longer make sense due to factors beyond the control of monetary policy. At this
point, a new target will be set with the Government with respec t to the Law.
25. Temporary shocks can change inflation forecasts rather than inflati on targets. For
instance, even though a one-off adjustment in indirect taxes diverts inflation from
the targets, a change in the target will be out of the question due to its limited
effect on one-year ahead inflation forecasts. Instead, the short-t erm forecasts will
be changed. In this case, the points of reference to be used by economic agents will
be inflation forecasts for the short term and the inflation target for the medium
term. In conclusion, it is fundamental in the upcoming period that the t argets do
not change except in cases of extraordinary developments.
Public Sector’s Role in the Inflation Targeting Regime
26. Sound monetary policy is a necessary condition on the way towards price stability,
but not sufficient. In order to attain price stability, the continuit y of fiscal
discipline should be maintained in the upcoming years as in past years . In Turkey,
fiscal discipline has the potential to affect the inflation-tar geting regime through
four channels. The first channel comprises long-term expectations. F urther
enhancement of fiscal discipline through its continuity will increase the
effectiveness and predictability of monetary policy by extending the bor rowing
maturities and reducing the risk premium and the volatilities in ri sk premiums and
contribute to the credibility of the inflation targeting regime.
27. The second channel works through the prices of goods and services produced by
the public sector itself. Naturally, the consistency between the prices of goods and
services produced by the public sector and inflation targets is cruc ial for attaining
price stability.
28. The third channel works through the incomes policy of the public sector. O ne of
the main determinants of the expectations for price and wage inflat ion in Turkey
are the wage increases made by the public sector to its own employ ees. In this
context, the consistent trend of the incomes policy with the inflation target is a sine
qua non for the success of the inflation-targeting regime.
29. The fourth channel is the direct spending channel. The public sector’s di rect
purchases of goods and services are reflected on inflation via tota l demand. The
powerful position of these channels indicates the critical importance of the
continuity of fiscal discipline in a period where the memories of c hronic inflation
are still fresh. In conclusion, continuity of fiscal discipline and c onsistent
implementation of fiscal policies with targets are fundamentals in the success of
the inflation-targeting regime.
Inflation Targeting Regime and IMF Conditionality
30. With the adoption of the inflation-targeting regime at the beginning of 2006, in the
scope of “IMF Program Requirements”, Net International Reserve s will continue
to be performance criteria, however performance criteria for M oney Base and the
indicative target for Net Domestic Assets will be replace d with the “inflation
consultation criteria”. To this end, from 2006 onwards, a path will be established
consistently with the end-year target at the beginning of every y ear and this path
will be used for the revisions made with the IMF within the fram ework of the
program. As of the end of 2005, the inflation figures consistent with t he end-year
target are calculated for end-March, June, September and Decembe r; and the
figures, which are set out in paragraph 18, appeared in the Letter of Intent.
31. Graph 1 shows the quarterly path of inflation consistent with the end-y ear target of
2006, which was prepared to be used in reviews within the framework of the
agreement signed with the IMF. The specified path has been formed by taking into
account factors such as base effect and seasonality. The path for 2007 is going to
be formed at the end of 2006.
32. As seen in Graph 1, revision criteria around the target-consistent path are
established. For each quarterly period, if inflation remains below or above the
target-consistent path by one or more points, there will be negotiat ions with IMF
staff in each review. In case of such a development, the Centra l Bank will inform
the public of the causes of the deviation via the issue of periodical reports.
33. If inflation falls below or exceeds the target-consistent path by two or more points,
since such a fall or rise will be considered as a violation of t he program
conditionality, the Bank will announce the measures to be taken within the
principles of the program. These measures will also serve the principle mentioned
above in the part concerning accountability, which reads: “In case of a two-point
deviation in the target-consistent path in either direction, the Ce ntral Bank will
prepare a separate document that will serve to inform the public of the causes and
measures to be taken, and also provide the Government with a writte n statement”.
The public announcement to be made in case of a likely violation of the pr ogram
conditionality will also be presented to the IMF and thus a certain level of
transparency will have been established.
GRAPH 1. PROGRAM CONDITIONALITY: INFLATION PATH CONSISTENT WITH
THE END-YEAR TARGET*
Target: 5%
* Inner band: +/- 1 percentage point
Outer band: +/- 2 percentage points
34. There is a critical point that needs special emphasis: The progr am conditionality
outlined above does not mean that monetary policy will focus on quarterl y periods.
The path designed within the framework of the program will have rel ative
significance in evaluating the consistency between the yearly c ourse of inflation
and targets, and the Central Bank will maintain its medium-term perspective in
making monetary policy decisions. For instance, if it is anticipated in January 2006
that a significant deviation from the target-consistent path wil l be observed in
March, this anticipation will be shared with the public, while monet ary policy will
not react as long as the inflation outlook is consistent with medium-t erm targets.
Inflation Report and Forecasts
35. With the transition to the inflation-targeting regime, the quarte rly issued Inflation
Report will be the main communication instrument of monetary policy. In 2006
dates of issue of the Report have been determined as the last wee ks of January,
April, July and October. The first issue of the Report will be r eleased at the end of
January 2006. The Monetary Policy Report, which has been issued quarterl y, will
not be issued in the new period.
36. In the Inflation Report, inflation and general macroeconomic developments will be
discussed in depth. The greatest change in the Report will be the i nclusion of the
inflation forecasts of the Central Bank. In case of a change in t he forecasts of a
previous Report, the new Report will provide information explaining why upda ted
forecasts differ from those of the previous period. Moreover, the R eport will also
contain signals of likely future policies along with a general ev aluation of the
factors influencing inflation. In this way, a significant step wi ll have been taken
towards ensuring transparency and accountability stipulated by the infl ation-
targeting regime.
37. There is no doubt that the process of forming monetary policy and infla tion
forecasts involves many uncertainties due to exogenous shocks or the cont inuous
transformation process in the economy. The said uncertainties apply t o all
economies in the world but are much higher in economies such as Turkey t hat
undergo a structural transformation. It is inevitable that all t hese likely shocks and
uncertainties will influence inflation forecasts. In this context, it is extremely
important that the public becomes aware that forecasts reflect the stance the
Central Bank takes about inflation during the issue period of the Report. Therefore,
inflation forecasts may change in line with unexpected developments t hat can
emerge during the time between the two reports as well as wit h any new
information acquired. What is more noteworthy here than the change in for ecasts
itself is that causes of the change will be clearly explained to the public through the
Inflation Report. In other words, the Central Bank will always be liable to be called
to account.
Minutes of the Monetary Policy Committee Meeting
38. Along with the Inflation Report, minutes of the Monetary Policy Comm ittee
meeting will also be a significant instrument of communications pol icy in the
inflation-targeting regime. The Inflation and Outlook Report, which ha s served a
similar purpose so far, will be replaced with a dual reporting sy stem: Immediately
after the monetary policy decision is made, a brief report on the decision and its
rationale will be issued. The other report summarizing the evalua tions of the
Monetary Policy Committee and its stance about the inflation outlook w ill be
issued within five working days following the meeting.
Other Instruments of Communication
39. Press conferences and presentations will constitute another signifi cant instrument
to be used in the context of the communications policy in the inflation-t argeting
regime. The Central Bank will share the general framework of the inflation-
targeting regime with the public through presentations it will gi ve in universities
and non-governmental organizations from time to time. On the date of r elease of
the Inflation Report in January 2006, the content of the Report will be out lined in a
press conference. Every succeeding quarter, the main message of the Inflation
Report will be conveyed to the public once again in a press conference .
40. Technical reports issued by the Central Bank, notes that would enable better
perception of the transmission mechanism and presentations about the met hods
used in inflation forecasts will form another pillar of the communications policy. A
forecasting and policy analysis system has already been developed within the
Central Bank in order to support monetary policy decisions. However, t he Central
Bank will not rely on a single model at this stage. The Bank beli eves that due to
uncertainties in the functioning of the transmission mechanism and the r apidly
changing structure of the economy, it would not be reasonable to stick t o a single
model and it is important in monetary policy decisions that various m odels with
various assumptions are evaluated together in light of the views of specialists.
Academic literature and central banking experiences are also in c onsensus on the
above-mentioned views. For this reason, no specific model will be put forward at
this stage. As a matter of fact, many developing countries li ke the Czech Republic,
Poland and Brazil did not develop any models during the first years of inflation
targeting, either. 2
41. So far, the Central Bank has at times shared its views about t he functioning of the
economy with the public through various presentations, reports and working
papers. Although it has become clearer compared to previous periods, t he
transmission mechanism in Turkey still harbors a significant lev el of uncertainty
like other country examples. Nevertheless, the Central Bank has t o share its
economic views with the public as a necessity for transparency pri nciple. In this
respect, the Central Bank will continue to share its views wit h the public about the
effects of monetary policy on inflation through reports and presentations. In
addition, studies in this direction will continue at an accelerated pace and
information as to how inflation forecasts are made within the Centr al Bank will be
shared with the public in stages.
42. It is of critical importance that the public properly follows and e valuates the
reports and other documents issued by the Central Bank, particularly a fter the
transition to the inflation-targeting regime in 2006. An example wil l be helpful
here: Following the announcement of inflation figures for October 2005, som e
remarks were made by the public claiming that “the Central Bank acted more
cautiously in October since inflation figures were above the expect ed level”. In
order to increase the effectiveness of economic policies, the shor t-term point of
view underlying such remarks should be abandoned as soon as possible and our
reports should be followed closely. As a matter of fact, the prec eding Inflation and
Outlook Report had anticipated there would be high price increases in October. For
this reason, this development was not taken as a new and significant piece of
2 Schaechter Andrea, Mark R. Stone, and Mark Zelmer (2000): “Adopting Inflation Targeting: Practical Issues
for Emerging Market Countries”, IMF Occasional Paper, No 202
information in the monetary policy decision made in November. Factors that affect
the level of the Central Bank’s cautiousness are projections about the consistency
between targets and the outlook of inflation in the medium-term, rathe r than
seasonal price increases in certain goods in any month.
Decision-Making Process
43. After the transition to an inflation-targeting regime, the Monet ary Policy
Committee will assume a “decision maker” role instead of an “a dvisor” role.
Unless an emergency arises, the Monetary Policy Committee wi ll continue to meet
once a month in 2006 as it has done since 2001, as stipulated by Central Ba nk
Law. Unlike 2005, meeting dates will not fall on the same day eac h month.
However, in line with the principle of transparency, meeting date s for the whole
year will be announced to the public in advance. As can be seen in the m eeting
dates of 2006 listed in the Annex, meeting dates are arranged so as to coincide with
the second half of each month. Meeting dates have been determined by t aking into
account such factors as official holidays, national and religious fe stivals, the data
flow process in a month and announcement dates of national income data. In the
upcoming period, inflation projections will be renewed and the Inflation R eport
will be issued quarterly, following the announcement of national income figures.
Hence, four of the twelve Monetary Policy Committee meetings he ld in a year will
coincide with the release of the Inflation Report.
44. In the new period, meetings will be held in two sessions between 2. 00 pm and
5.00 pm. The first session will host Central Bank authorities and spe cialists as well
as authorities from the Undersecretariat of Treasury. In this session, related bodies
of the Central Bank and authorities of the Undersecretariat of Treasury will present
to the Monetary Policy Committee their reports on evaluations about economic
developments, which will then be opened to discussion. In the second sessi on, to
be held on the same day, members of the Monetary Policy Committee will make
the final evaluations about the outlook and put the decision to a vote. Aft er the
voting is concluded, members of the Monetary Policy Committee wil l prepare a
brief report explaining the rationale of the decision. The decision and its rationale
will be announced by the Central Bank in a press release between 5.00 pm and
7.00 pm on the same day, and it will also be posted on the website of t he Bank.
II. EXCHANGE RATE POLICY, FX BUYING AUCTIONS AND
LIQUIDITY MANAGEMENT
Exchange Rate Policy and FX Buying Auctions
45. On 20 December 2004, the Central Bank shared with the public the general
framework of the current exchange rate policy and FX buying auctions in a press
release called “Money and Exchange Rate Policy in 2005”. According t o this;
i. The economic transformation process experienced after the 2001 cris is has
enabled significant achievements in macroeconomic stabilization and helped
reduce the “dollarization” effect created by unstable macroeconomic policies
and high inflation in the past. The main tendency of economic agents has
been to hold increasing amounts of Turkish currency denominated assets
since 2002. This “reverse dollarization” process, combined with favor able
developments in the balance of payments, has supported the increase in
foreign exchange supply in the economy.
ii. Taking into account the likely contribution of a strong foreign excha nge
reserve position to boost confidence in the current program, foreign debt
payments of the Treasury and the need to gradually reduce the number of
high-cost remittances accounts in the long-term, which are peculiar to
Turkey and make up a significant part in the liabilities side of t he Central
Bank’s balance sheet, the Central Bank held foreign exchange buying
auctions to build up reserves at times where foreign exchange supply
constantly increased compared to foreign exchange demand. Foreign
exchange buying auctions, which have been held since 1 April 2002, also
continued in 2003 and 2004 at bands as long as market conditions allowed.
iii. The main principles of a floating exchange rate regime ar e that the exchange
rate is not used as a monetary policy tool and the Central Bank does not have
any exchange rate target. That is why the Central Bank, which fol lows a
moderate reserve-raising strategy, makes foreign exchange purc hases via
auctions, whose terms are announced in advance, in order to affect the supply
and demand conditions in the foreign exchange market and thus the level of
exchange rate at a minimum level and to abide by the basic principle s and
functions of a floating exchange rate regime.
iv. In the light of its prediction that the introduction of a new thre e-year
economic program involving primarily fiscal and monetary discipline and
structural reforms and the favorable developments in the process of
negotiations aimed at full membership to the European Union will have a
positive effect on both the reverse dollarization process and the bal ance of
payments, the Central Bank announced that it will resume foreign excha nge
buying auctions, which had been suspended for a period of time, effective
from 22 December 2004. Moreover, the Central Bank has decided to
announce an annual program in order to minimize the impact of foreign
exchange auctions on foreign exchange. The Central Bank has also decided
not to make any amendments to the program, unless extraordinary
differences are observed in foreign exchange liquidity.
v. Meanwhile, it was emphasized once again that the Central Ba nk will
continue to closely monitor the volatility in exchange rates and wil l directly
intervene in the markets in the event of excessive volatility t hat might occur
in either direction. It was also underlined that volatility interv entions are not
only carried out by considering past data with a mechanical rule, but by
evaluating the causes of realized and potential volatility in all aspects.
46. With respect to foreign exchange buying auctions held in 2005, it was announc ed
on 20 December 2004 that the Central Bank would buy maximum USD 45 million
in daily foreign exchange auctions, with USD 15 million of auction amount and
USD 30 million of optional selling amount (200 % of the total amount sold). These
amounts were not changed throughout the year. At foreign exchange buying
auctions, which commenced as of 22 December 2004, USD 7,1 billion in total was
bought until 2 December 2005. At a total of 231 auctions held during the said
period, the average buying sum amounted to USD 30.9 million.
47. Furthermore, the Central Bank intervened in the foreign exchange mar kets six
times in 2005 due to excessive realized or expected volatility in e xchange rates.
Within the transparency framework, which is a prerequisite for t he implemented
monetary and exchange rate policies in and has, the Central Bank has started to
announce the data relating to direct foreign exchange buying/selling i nterventions
in the section “Data/Financial Markets Data/Foreign Exchange Buy ing-Selling
October 2005.
48. In 2005, net foreign exchange purchases through auctions and interventions
became USD 21.5 billion by 2 December 2005. The amount of net foreign
exchange purchases by the Central Bank since 2002 is shown on an annual basis in
the following Table. The sum of foreign exchange purchases in 2005 is the highest
amount that has been bought by the Central Bank in a calendar year to date. Hence,
the amount of net foreign exchange purchases reached USD 37.5 billion in t he
2002- 2005 period.
TABLE 2. THE CENTRAL BANK’S NET FOREIGN EXCHANGE
(2002-2005; Million, USD)
* As of 2 December 2005
49. The economic program and the accession to the European Union, are expecte d to
have a favorable effect on both the reverse dollarization process and the balance of
payments. The general framework for exchange rate policy implement ation
announced in our press release of 20 December 2004, which is summarized i n
Article 45, will be valid for 2006. In other words, it was decided t o carry on daily
foreign exchange buying auctions, predicting that foreign exchange supply w ill
continue to pursue a high course in 2006. The amount of daily buying in auctions
will be raised to USD 20 million from USD 15 million in 2006. Unless
extraordinary differences in foreign exchange liquidity are observed, the program
will remain the same.
50. Guidelines for foreign exchange auctions are as follows:
Year FX Buying
Net FX Buying
Interventions
Total Net FX
2002 795 4 799
2003 5.652 4.229 9.881
2004 4.104 1.274 5.378
2005* 6.900 14.565 21.465
Total 17.451 20.072 37.523
i. The total daily amount of auctions is determined as USD 20 mill ion for
2006, starting from 2 January 2006.
ii. Auctions will not be held on public holidays of the United States, even if it is
a working day in Turkey. Neither will auctions be held on half working da ys
or if when the Central Bank has started to intervene in foreign exc hange
market prior to auction hours.
iii. The additional optional selling amount priced over the average price of the
auction will only be granted to the winner parties. The optional amount will
be 200 percent of the total amount sold in the auction by each bank.
Accordingly, the maximum daily amount that can be bought will be USD 60
million, with USD 20 million of auction amount and USD 40 million of
optional selling amount.
iv. The auction number will be posted on Reuters page CBTQ at 1.30 p.m . and
institutions may bid between 1.30 – 1.45 p.m.
v. After the auction results are posted on the CBTQ page of Reute rs, the
institutions may exercise their right to sell the optional amount ti ll 2.00 p.m.
vi. The other rules for the foreign exchange buying auctions have not cha nged
and will be applied as before.
vii. On the other hand, the CBRT may, with prior notice, suspend the a uctions
temporarily in cases where the depth of the foreign exchange market has
been lost and thus there is excessive volatility in exchange rate s, in addition
to when unhealthy price formation is observed due to a serious exogenous
shock or unforeseen extraordinary developments.
51. In conclusion, exchange rates will continue to be determined by supply and
demand conditions in the foreign exchange markets in 2006 as well. The key
determinants of foreign exchange supply and demand are the monetary and f iscal
policies and the economic fundamentals determined by the structural re form
process and expectations. Undoubtedly, the deteriorations in economic
fundamentals and adverse developments in the stability program and expect ations
may lead to volatility in exchange rates. It should be borne in mind that in a
floating exchange rate regime, economic agents operate in an envir onment of
exchange rate risk. Nevertheless, as repeatedly emphasized by t he Central Bank,
exchange rate risk is a manageable risk and economic agents should e stablish the
mechanisms that will enable the efficient management of this r isk.
52. The Central Bank had announced in its press release of 2 January 2002 titl ed
“Monetary Policy and Exchange Rate Policy in 2002 and Prospective
Developments” that it would gradually strip itself of its inter mediary function in
Foreign Exchange and Banknotes Markets and would keep up its intermediary
function only for the foreign exchange deposits of the state-owned banks tha t were
taken over from the Savings Deposits Insurance Fund (SDIF) banks. How ever,
foreign exchange deposits of state-owned banks, which were transferred to them
from SDIF banks and used by these banks in the CBRT Foreign Exchange and
Banknotes Markets, will be closed as of 26 December 2005 and the interm ediary
operations of the Central Bank in Foreign Exchange and Banknotes Markets will
end as of the said date. On the other hand, banks will be able to borrow foreign
exchange in terms of USD and euro from the Central Bank within predet ermined
limits with a one-week-maturity at the Foreign Exchange and Banknote s Market-
Foreign Exchange Deposit Market in the coming period. Moreover, the
transactions of purchase/sale of ”foreign exchange against foreign exchange”,
“foreign exchange against foreign banknotes” and “foreign banknotes agains t
foreign banknotes” conducted between the Central Bank and institutions
authorized to operate in the Foreign Exchange and Banknotes Markets will
Liquidity Management
53. Following the February 2001 crisis, the Central Bank purchased government
securities worth TL 14 quadrillion from state-owned banks and banks transf erred
to the Savings Deposit Insurance Fund (SDIF) in order to meet their liquidity
needs. The intensive purchase of foreign exchange in 2003 and 2004 and the
purchase mentioned above created a substantial amount of excess liquidit y in the
market during the 2001-2004 period. The Central Bank sterilized the exces s
liquidity in the market in an active manner, by means of Turkish li ra deposit
operations in the Interbank Money Market and reverse repo transactions c arried
out within the framework of open market operations in the Repo and Reverse Repo
Market of the Istanbul Stock Exchange. Accordingly, overnight interest rates were
steadily realized at the level of the borrowing rate of the Ce ntral Bank. Within this
framework, the borrowing rate of the Central Bank has become an indic ator for
money markets.
54. In its press release, “Monetary and Exchange Rate Policy in 2005” , dated 20
December 2004, the Central Bank had announced that the excess liquidity
observed in the 2001-2004 period would gradually shrink in 2006, based on the
main scenario, even it was not possible to make an accurate predic tion for the
entire amount of the Central Bank’s foreign exchange purchases and the
Treasury’s net foreign exchange borrowing. Furthermore, the liquidity
management strategy to be followed in case of liquidity shortage w as explained in
55. Accordingly, the Central Bank did not allow any excessive volatili ty in money
market rates, when a liquidity shortage appeared from time to ti me. The Central
Bank efficiently met the liquidity requirements of banks through repo a uctions and
the liquidity facilities offered to the primary dealers. Howev er, even if temporary
liquidity shortages were experienced, the excess liquidity conditions continued
throughout the year as a result of Central Bank’s foreign exchange purc hases via
foreign exchange auctions and direct buying interventions, far above the amount
foreseen under the main scenario. The amount of excess liquidity in the market
reached YTL 6.6 billion by 2 December 2005.
56. According to available data, for the rest of this year and 2006;
i. The rise in demand for base money,
ii. Coupon and principal redemption by the Treasury to the Central Bank,
iii. The increase in Treasury accounts will have a lowering e ffect on the amount
of liquidity, while
i. The Central Bank’s net foreign exchange purchases,
ii. Interests payments to be made by the Central Bank for reser ve requirements
and for excess liquidity absorbing transactions,
iii. The utilization of the Treasury’s net foreign exchange inflow s for the
reimbursement of TL borrowing will have an increasing effect on l iquidity.
57. Unlike the previous periods, the Treasury’s income-expenditures balance in terms
of foreign exchange will have a more significant effect on liquidi ty, since
privatization revenues and revenues from SDIF sales of assets will reach high
amounts. It is predicted that the part of these revenues, which wi ll be transferred to
the Treasury accounts with the Central Bank, will primarily be in terms of foreign
exchange. Therefore, the Treasury’s foreign exchange transactions might not have
a decreasing effect on the liquidity in the market. In other words, in the rest of
2005 and in 2006, the income of the Treasury from privatization revenues a nd
SDIF sales of assets, and the amount of FX borrowing may cover t he FX debt
repayment, including external and domestic debts, or it may lead to an insignificant
deficit, unlike in the previous years.
58. Therefore, as in the previous years, it is not possible to make a precise forecast
regarding the net foreign receipts of the Treasury and the Centra l Bank’s amount
of foreign currency purchases, which are the basic factors affec ting liquidity.
Depending on the fluctuations of these amounts, the market liquidity can change
significantly. However, based on the assumption that the foreign exc hange inflow
of the Treasury would match the foreign exchange outflow, and by taking the
Central Bank FX buying auction program into consideration, the continuity of
excess liquidity conditions in the markets in 2006 as well as the continuation of the
indicator status of the Central Bank borrowing rate, are most like ly.
59. In the arrangements regarding the liquidity management strategy of the Central
Bank in 2006, some technical interest rate changes for narrowing the potential
volatility margins of the overnight interest rates are needed w hen the significant
decreases in the New Turkish Lira interest rates are taken i nto consideration.
However, such changes do not mean a change determined considering the i nflation
target of the Central Bank. Because, in the current excess liqui dity conditions, the
interest rate that the Central Bank determines for the daily bor rowing transactions
is a benchmark interest rate and no change has been made in the afore mentioned
interest rate to that end. In this context, the 2006 liquidity managem ent strategy
will be as follows:
i. The Central Bank will continue announcing overnight
borrowing and lending interest rates between 10.00 – 12.00
and 13.00 – 16.00 in the Interbank Money Market. In case of
a liquidity shortage during the day, banks can borrow at the
Central Bank’s lending interest rate within their limits. In c ase
of a fall in the interest rates as the result of increasing
liquidity, banks can
make unlimited New Turkish Lira
deposits at the Central Bank borrowing interest rate. Also,
beginning from 2 January 2006, by lowering the lending
interest rate by 1 point, the spread between the borrowing and
lending interest rate which is currently 4 points will be
lowered to 3 points.
ii. The Central Bank will continue to provide the Late Liquidity
Window facility between 16.00-16.30 such that banks may
borrow from the Central Bank against collateral without any
limit or lend to the Central Bank. Moreover, starting from 2
January 2006, the Central Bank (CBRT) lending interest rate
within the framework of the Late Liquidity Window facility
will be determined as 3 points higher than the daily lending
interest rate, and the borrowing interest rate will be
determined as 4 points lower than the daily borrowing interest
iii. Especially during the periods of interest rate decisions, t he
announcement made by the Central Bank’s on one-week
maturity borrowing interest rate leads the excess liquidity to
be absorbed by the Central Bank, which causes market
liquidity to decrease. Thus, there may be temporary
fluctuations in overnight interest rates. To prevent such
fluctuations, the Central Bank will not announce one-week
maturity borrowing interest rate at the CBRT Interbank
Money Market and at the Istanbul Stock Exchange Repo –
Reverse Repo Market starting from 2 January 2006.
iv. In case of a temporary or permanent liquidity shortage, the
Central Bank will continue to carry out liquidity management
through one-week maturity repo auctions. When there is
liquidity shortage in the market, the Central Bank will
announce the amount of repo auction for that day on Reuters’
CBTF page at 10.00. While determining the amounts of the
auction, the Central Bank will endeavor to maintain the
average of auction interest rate at approximately 1 point over
the Central Bank daily borrowing interest rate announced at
the Interbank Money Market.
v. The weekly repo auctions will be executed at 11:00 and the
results will be posted on Reuters’ CBTG page no later than
11:30. The traditional auction method will be used in
auctions, in other words the successful bidders will be
evaluated with their own rates.
vi. In case of unforeseen excessive liquidity shortage, which
would exert excessive pressure on interest rates in the money
market during the day, the CBRT may announce “Intraday
Repo Auctions” in addition to the regular ones.
vii. The Central Bank will continue to provide TRY liquidity to
the primary dealer banks through open market operations.
Currently, the overnight and one-week maturity interest rates
applicable to the repo facility provided to primary dealers are
determined 2 points higher than the Central Bank’s daily
borrowing interest rate. This facility will continue in 2006.
The primary dealer banks will be able to conduct repo
transactions between 10.00–12.00 and 13.00–16.00 hours.
viii. In case of a permanent liquidity shortage in the banking
system, the benchmark short-term interest rate will be the repo
auction interest rate not the Central Bank’s daily borrowing
interest rate. Therefore, in case of a liquidity shortage, the
interest rate taken as a benchmark by the market would have
become higher due to the decline in liquidity. In order to
avoid any negative effects, the Central Bank could revise its
interest rates – even in cases where the Inflation Outlook
remains unchanged- so as to counter the pressure created by
the liquidity shortage. To reiterate, such a change in interest
rates would only mean a change stemming from liquidity
conditions- therefore such a move should not be perceived as
a loosening or tightening of monetary policy.
ix. In case of a permanent liquidity shortage in the market, the
CBRT can terminate its transactions at the Istanbul Stock
Exchange Repo-Reverse Repo Market with a prior notice and
start to manage liquidity on its own markets, just like other
central banks. When the CBRT’s abovementioned liquidity
management strategy is taken into account, the termination of
CBRT transactions at Istanbul Stock Exchange Repo-Reverse
Repo Market is not expected to lead to any significant
fluctuations in market interest rates.
60. As stated in CBRT’s Press Release Regarding the Communiqués on Required
Reserves and Liquidity Requirement dated November 16, 2005, some new
arrangements have been introduced regarding required reserves and li quidity
requirement with the aim of helping banks make their liquidity manage ment more
effective:
i. With the termination of the liquidity requirement implementation, the banks
will no longer be obliged to hold government securities with the CBRT,
which will enable them to manage their liquidity more flexibly. T his is an
important step towards the harmonization of financial regulations wit h the
acquis communautaire.
ii. As of the end of 2005, the entire amount of TRY required reserves would be
maintained on average at free deposit accounts over a maintenanc e period
of 2 weeks. Currently, half of the TRY required reserves are obl iged to be
kept on average at free deposit accounts over a maintenance period of 2
weeks and the other half are held in blocked accounts. The new
implementation will enable the banks to manage required reserves m ore
flexibly at times of temporary liquidity shortage and help reduce fl uctuations
in interest rates.
iii. Meanwhile, the sanctions to be imposed in cases where banks fa il to deposit
required reserves on time or fail to deposit in full amount have bee n revised.
Accordingly, the practice of collecting the penalty interest to be imposed for
default on required reserves liabilities in cash at once has been abandoned.
Instead, two-folds of the deficient TRY required reserve amount and three-
folds of the deficient FX required reserve amount will be deposited in non-
interest bearing deposit accounts. The aim of the new practice is to alleviate
the prospective unfavorable effects on financial bodies of the banks.
61. The Central Bank deems stability and deepening of financial markets as a
supporting objective for conducting policies pertaining to price stabili ty
effectively. Actually, within the framework of the floating e xchange rate regime,
the Central Bank has taken measures towards maintaining financial stability
several times in the last four years as it did in the after math of the terrorist attacks
in Istanbul in November 2003. Therefore, the Central Bank, whose primar y goal
entrusted to it by law, is to establish price stability, will continue with its efforts
towards enhancing monetary policy and liquidity management in 2006.
Accordingly, the Central Bank may change both the liquidity management strategy
and interest rate margins in cases of unpredictable changes in market conditions
and according to new needs.
62. In our press release dated December 20, 2004, we had stated that liqui dity was not
homogenously distributed in the banking sector, however the banking system w as
expected to contribute to the development of secondary market operations by
taking into account risk management principles, with the ultimate a im of ensuring
liquidity flow to achieve a money market which functions effective ly. Although
currently liquidity is not evenly distributed in the banking system, i t is observed
that liquidity flow accelerated substantially in 2005 and money marke ts became
relatively more effective. The gradual improvement in this t rend would not only
help increase the effectiveness of the monetary policy of the CBR T but also the
deepening of financial markets.
63. While on the one hand, tight fiscal and monetary policies implemented since 2001,
the structural reform process and increased confidence in the economic policies
has helped financial deepening and growth in the overall balance sheet of the
banking system, on the other hand these factors slowed down the rise i n domestic
debt stock. Thus, a gradual and uninterrupted decline in the ratio of debt s tock to
national income has been achieved. This development also helps reduce t he share
of public debt stock in the total balance sheet of the banking system. Assuming
that fiscal discipline continued in 2006 and a substantial amount of privat ization
proceeds were attained, it is estimated that this process would further accelerate.
The Treasury’s debt servicing ratio, which is lower compared to previous years,
would lead to a further decrease in fiscal dominance this year. T herefore, a rapid
rise in the banking system’s real sector and consumer credits and i ncreased
competition and extension in maturities in the credit market are al l developments
likely to occur.
64. Obviously, under the floating exchange rate regime the Central Ba nk is able to
implement the TRY liquidity policy in a more flexible manner than i t can under a
fixed currency peg regime and can act more promptly and flexibly to meet the
TRY liquidity needs of the banking system. The Central Bank can prev ent
excessive fluctuations in interest rates as long as they are consistent with the
inflation target. The abovementioned liquidity management strategy manifests this
fact very clearly. However, the banking system should not slacken risk
management principles by simply relying on the more flexible and eff ective
liquidity management of the Central Bank. Quite the contrary, it is obvious that
increased competition, credit volume and extended maturities would neces sitate a
more effective risk management stance in the banking system.
MONETARY POLICY COMMITTEE MEETING DATES AND INFLATION
REPORT PUBLICATION DATES
MPC MEETING DATES INFLATION REPORT
23 January 2006 31 January 2006
23 February 2006
23 March 2006
27 April 2006 28 April 2006
25 May 2006
20 June 2006
20 July 2006 28 July 2006
24 August 2006
26 September 2006
19 October 2006 31 October 2006
23 November 2006
21 December 2006