Macroeconomic Outlook and Monetary Policy in Turkey
Remarks by
Murat Çetinkaya
Governor
Central Bank of the Republic of Turkey
at
J.P. Morgan Turkey Macro and Credit Conference
London
9 February 2017
Dear Participants,
My speech will try to elaborate on the recent macroeconomic outlook, monetary
policy framework and the coordinated policy actions to support the fundamentals of
the Turkish economy.
1. Macroeconomic Outlook
Turkish economy was hit by concurrent shocks in recent years. Geopolitical
tensions, global shocks, security related issues and a failed coup attempt have
created significant policy challenges. Despite the intensity and size of the shocks in
recent years, the growth rate has been quite robust until recently, outpacing
emerging market average by a large margin (Figure 1). The resilience of growth in
recent years can be attributed to factors such as prudent macroprudential policies
reducing the sensitivity of economic activity to capital flow volatility, dynamic
domestic market, market flexibility of exports, and the fall in energy prices.
Figure 1.
Growth Rates in Turkey and Emerging Economies
(Percentage Change, Annual)
12
10
8
6
4
2
0
Developing Countries excluding China and India
-2
Turkey*
-4
03.12 06.12 09.12 12.12 03.13 06.13 09.13 12.13 03.14 06.14 09.14 12.14 03.15 06.15 09.15 12.15 03.16 06.16 09.16 12.16
* Forecast for 2016 Q4.
Developing Countries excluding China and India: Brazil, Chile, Colombia, Czechia, Hungary,
Indonesia, Malaysia, Mexico, Morocco, Peru, Philippines, Poland, Romania, Russia, S Africa,
Thailand, Turkey, Ukraine.
Source: Bloomberg, CBRT.
However, the growth has posted a marked slowdown in the third quarter of 2016,
following the failed coup attempt. GDP has contracted year-on-year terms for the
first time since the global financial crisis. The weakness in economic activity was
driven by a sharp fall in domestic demand and the sizeable drop in tourism
revenues (Figure 2).
Figure 2.
Annual GDP Growth and Contributions
(Percentage Points)
Net Exports
15
Final Domestic Demand
13
Other*
11
GDP
9
7
5
3
1
-1
-3
-5
09.11 12.11 03.12 06.12 09.12 12.12 03.13 06.13 09.13 12.13 03.14 06.14 09.14 12.14 03.15 06.15 09.15 12.15 03.16 06.16 09.16
*Contains stock movements and residual item.
Source: TURKSTAT.
One important question was whether the third quarter would stay as a temporary
slump or more slowdown was on the way. Recent indicators suggest that the
contraction in economic activity was short-lived. We observed a rebound in the final
quarter of the year as depicted by the rapid recovery in the industrial production
(Figure 3). Some of the recovery can be attributed to corrections due to technical
factors such as shifting holidays and associated changes in the number of working
days. Therefore, looking through temporary factors, we assess that economic
activity has expanded at a moderate pace during the final quarter of 2016 (Figure
4). We expect that the recovery will continue to be mild and gradual throughout
2017, which will leave the output gap at the negative territory. Main drivers of
growth this year will be public investment expenditures and exports.
Figure 3. Figure 4.
Industrial Production Industrial Production
(QoQ, Seasonally Adjusted) (YoY)
5
8
3,9
4
6
3
2
4
2,0
1
2
0
-1
0
-2
-2
-3
-2,9
-3,1
-4
-4
1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4
1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4
2012 2013 2014 2015 2016
2012 2013 2014 2015 2016
Source: TURKSTAT, CBRT. Source: TURKSTAT, CBRT.
On the external side, I would like to note that the Turkish economy has been
undergoing a persistent rebalancing process in recent years. Current account
deficit has come down from a peak of 9 percent to less than 4 percent recently
(Figure 5). Although improvement was partly reversed after mid-2016 due to sharp
fall in tourism revenues, we expect the deficit to continue to shrink gradually
throughout 2017. Main drivers of the improvement in the current account balance
will be the recovery in exports and the weaker imports due to real exchange rate.
Figure 5.
Current Account Balance (CAB)
(12-Month Cumulative, % of GDP)
0
-1
CAB/GDP CAB/GDP (excl. gold)
-2
-3
-3,9
-4
-4,1
-5
-6
-7
-8
-9
-10
1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4
2010 2011 2012 2013 2014 2015 2016
Source: CBRT.
We think that exports will be one of the main drivers of growth in 2017. The main
contribution to exports is expected from the European demand. Turkish exports are
highly sensitive to the demand from Europe which constitute more than half of our
total exports. Latest projections suggest that EU demand will continue to support
Turkish exports in the forthcoming period (Figure 6). Moreover, recently improved
relations with our neighbors have also started contributing to the export growth
again after a long stagnation period. Recently, there is some slight recovery in
exports to our main major trading partners such as Iraq and Russia. The recovery
process is expected to continue throughout 2017. Overall, we anticipate a sizeable
contribution from exports to growth in 2017.
Figure 6.
Exports to EU and EU's Final Domestic Demand
15 160
EU's Final Domestic Demand (billion €)
14
140
Exports to EU (2010=100, right axis)
13
120
12
100
11
80
10
60
9
40
8
7 20
2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
2016* 2017*
* Forecast.
Source: Eurostat, IHS CBRT.
Another factor that will lead to an improvement in exports and current account
balance is the depreciation of the Turkish lira. As of January, the real effective
exchange rate index has fallen to 88.2, which is the historically lowest level in the
past 15 years (Figure 7). The most recent data show that export growth has been
outpacing import growth and we expect this picture to become more evident during
the first half of 2017.
Figure 7.
Real Effective Exchange Rate
(CPI Based, 2003=100)
140
130
120
110
100
90
80
01.03 01.04 01.05 01.06 01.07 01.08 01.09 01.10 01.11 01.12 01.13 01.14 01.15 01.16 01.17
Source: CBRT.
Regarding external finance, current account deficit is financed predominantly by
FDI flows and long term borrowing (Figure 8). Most recently, we still see a sizeable
contribution from FDI and long term borrowing by banks and non-financial
corporates, whereas portfolio inflows have been relatively weak. The share of long
term debt in total debt has been increasing steadily. The banks and firms are able
to roll their debt comfortably, and the roll-over ratios are still above 100%.
Figure 8.
Financing of Current Account Deficit
(12 Month Cumulative, Billion USD)
100
80
60
40
20
0
-20
FDI and Long Term Portfolio and Short Term CAD
-40
02.07 11.07 08.08 05.09 02.10 11.10 08.11 05.12 02.13 11.13 08.14 05.15 02.16 11.16
*Long term inflows are sum of banking and real sectors' long term net credit and bonds issued by
banks and the Treasury. Short term capital movements are sum of banking and real sectors' short
term net credit and deposits in banks.
Source: CBRT.
Dear Participants,
Now, let me turn to inflation developments. In the past few months, we have
observed a marked increase in the CPI inflation, while the core inflation indicators
have shown a milder upward movement (Figure 9). The main driver of inflation in
the most recent data was unprocessed food prices, most of which can largely be
attributed to adverse weather conditions. Tax hikes and the exchange rate pass-
through have also had a visible impact on inflation in recent months. The rise in
core inflation was relatively subdued, despite the sharp exchange rate depreciation.
Although recently observed pass-through seems lower than historical estimates
due to subdued demand conditions, exchange rate movements still pose upside
pressures on inflation.
Figure 9.
Headline CPI and Core Price Indicator
(Annual Percentage Change)
11
10
9
8
7
6
CPI H
5
4
05.13 07.13 09.13 11.13 01.14 03.14 05.14 07.14 09.14 11.14 01.15 03.15 05.15 07.15 09.15 11.15 01.16 03.16 05.16 07.16 09.16 11.16 01.17
Source: TURKSTAT, CBRT.
Going ahead, the lagged pass-through impact and the base effects resulting from
previous year's food price volatility will continue to weigh on inflation. On the other
hand, the impact of tax adjustments on CPI inflation is likely to fade away
throughout 2017, given the government's clear statement of no additional tax hikes
in 2017 (Figure 10).
Figure 10.
Contribution of Tax Adjustments to Inflation
(Percent)
1,6
1,4
1,2
1,0
0,8
0,6
0,4
0,2
0,0
2011 2012 2013 2014 2015 2016
Source: TURKSTAT, CBRT.
Our recent Inflation Report provides the updated inflation and output gap forecasts.
We have revised the output gap on the downside, whereas short-term inflation
projections have been revised upwards. Disinflationary impact of weaker economic
activity was more than offset by the exchange rate pass-through effect for the near
term forecasts. Inflation is expected to further edge up in the short term before
gradually coming down to 8 percent at the end of the year (Figure 11). Tighter
monetary policy along with more coordinated fiscal policy conduct should contain
the second round effects of the cost-push developments. Accordingly, we see
inflation at 6 percent at the end of 2018 as the pass-through effect diminishes over
time.
Figure 11.
Inflation and Output Gap Forecasts*
(Percent)
Forecast Range* Uncertainty Band Year-End Inflation Targets Output Gap
11 11
Control
Horizon
9 9
7 7
5 5
3 3
1 1
-1 -1
-3 -3
1215 0316 0616 0916 1216 0317 0617 0917 1217 0318 0618 0918 1218 0319 0619 0919 1219
* Shaded area denotes the 70 percent confidence interval for the forecast.
Source: CBRT.
2. Monetary Policy
Dear Participants,
I will devote the final section of my speech to the policy response to recent
developments. The main focus will be on the CBRT policies, but at the end I will
also try to elaborate briefly on how the other policies on the macroprudential and
fiscal side are coordinated to address the associated trade-offs.
Central Bank of Turkey has taken a series of steps in 2016 to simplify the monetary
policy framework. The intention was to gradually withdraw from the multiple policy
rate setup in order to improve the effectiveness of monetary policy and enhance
policy predictability. We were able to stick to our plan until the end of the year, even
after the currency pressures increased after the US elections. In fact, our interest
rate hike in November was the first conventional interest rate response since 2008.
However, the situation in early January necessitated an alternative approach. We
have witnessed price movements in the FX market which could not be justified by
economic fundamentals. The volatility increased sharply, which could be
detrimental for both price and financial stability. The response to this
unprecedented episode had to be swift, strong, and targeted. Given the significant
downside risks to the economic activity and the credit supply, we decided to
implement a monetary tightening which would strongly address the direct cause of
the problem, with less significant implications on the real side of the economy. To
this end, we have tightened the liquidity supply and induced a sharp increase in the
short term interest rates at the interbank market. Moreover, to further strengthen
our control on the short-end of the yield curve, we have devised a new tool which is
practically equivalent to a currency swap. This facility not only sets a benchmark for
the price formation in the FX market but also supplies temporary FX liquidity to the
market when needed.
At our January MPC meeting, we have increased the overnight repo and late
liquidity window rates, delivering a strong monetary tightening in order to contain
the deterioration in the inflation outlook. The MPC statement underlined that the
CBRT will continue to use all available instruments in pursuit of the price stability
objective.
We have also stated that inflation expectations, pricing behavior and other factors
affecting inflation will be closely monitored and, if needed, further monetary
tightening will be delivered. Moreover, the statement signaled that necessary
liquidity measures will be taken in case of unfounded pricing behavior in the foreign
exchange market that cannot be justified by economic fundamentals.
The figure depicts the two main interest rates that matters most for the monetary
transmission mechanism (Figure 12). The first one is the cost of central bank
funding (shown by the red line), which recently has increased by 200 basis points
to around 10.3 percent. The second one is the interbank rate (orange line), which
has sharply moved up and have been consistently close to 11 percent since our
latest MPC meeting. These two rates clearly indicate that monetary policy has been
tightened to a great extent.
Figure 12.
CBRT Interest Rates
(Percent)
14 Non-CBRT Average O/N Funding Rate in BIST
CBRT Average Funding Rate
1 Week Repo Rate
13
Late Liquidity Window
12
11
10
9
8
7
6
5
01.16 02.16 03.16 04.16 05.16 06.16 07.16 08.16 09.16 10.16 11.16 12.16 01.17 02.17
Source: TURKSTAT, CBRT.
I would like to underline that the recent policy we have been implementing is not
equivalent to the previous discretionary monetary policy under a flexible corridor
framework where the policy stance shifted at daily and weekly frequencies. This is
a clear and stable policy tightening which will be preserved until we see a
considerable improvement in medium term inflation dynamics.
The significant tightening in the monetary policy stance can also be observed
directly by looking at the yield curves. The left side figure shown below compares
the most recent yield curve with the one materialized in early January, right before
the CBRT response (Figure 13). It is clear that the short-end has shifted up and the
longer-end has fallen, which is a typical response after a credible monetary
tightening. As another indicator of the monetary tightening in time dimension, the
right side figure below shows the evolution of the slope of the yield curve at the
cross currency swap market, which also clearly reveals a flattening in the yield
curve (Figure 14).
Figure 13. Figure 14.
Yield Curve 5 Year-3 Month Differential in Swap Rates
(Treasuries, Percent) (Percent)
3,5 3,5
12,0 12,0
January 9, 2017
3,0 3,0
February 3, 2017
11,5 11,5
2,5 2,5
2,0 2,0
11,0 11,0
1,5 1,5
10,5 10,5 1,0 1,0
0,5 0,5
10,0 10,0
0,0 0,0
-0,5 -0,5
9,5 9,5
-1,0 -1,0
9,0 9,0
-1,5 -1,5
0.25 0.5 1 2 3 4 5 7 8 9 10
Term (Year)
01.16 02.16 03.16 04.16 05.16 06.16 07.16 08.16 09.16 10.16 11.16 12.16 01.17 02.17
Source: Bloomberg. Source: CBRT, Bloomberg.
Were these policies effective? More time is needed to assess the ultimate impact,
but the initial response is encouraging. Turkish lira, which has depreciated relative
to peer currencies in the second half of 2016, has stabilized after the policy
tightening, partly containing the upside risks on the inflation outlook (Figure 15).
Figure 15.
TL and EM Currencies Against USD
(01.01.2016=1)
Emerging Markets
1,45 1,45
Average
CBRT
Turkish Lira Moody's US
Coup Policy
1,40 1,40
Attempt Downgrade Election
Response
1,35 1,35
1,30 1,30
1,25 1,25
1,20 1,20
1,15 1,15
1,10 1,10
1,05 1,05
1,00 1,00
0,95 0,95
0,90 0,90
01.16 02.16 03.16 04.16 05.16 06.16 07.16 08.16 09.16 10.16 11.16 12.16 01.17 02.17
Emerging markets include Brazil, Chile, Colombia, Hungary, Indonesia, Malaysia, Mexico,
Philippines, Poland, Romania, S. Africa.
Source: Bloomberg.
The policy we adopted has been also effective on the volatility indicators. The last
figure I would like to show you pertains to the volatility in the FX market (Figure 16).
As you can see, the implied volatility of Turkish lira has moved up sharply in early-
January, but eased significantly after the implementation of the recent CBRT
measures.
Figure 16.
Options Implied TL Volatility
(1-Month, Percent)
30 CBRT Policy
US
Coup
Response
Election
Attempt
25
20
15
10
5
0
01.16 02.16 03.16 04.16 05.16 06.16 07.16 08.16 09.16 10.16 11.16 12.16 01.17 02.17
Source: Bloomberg.
Dear Participants,
Let me wrap up my speech by highlighting the value of close policy coordination.
Turkey has faced a series of significant shocks in the past years. Most recently, the
slowdown in the economic activity, tightening in financial conditions, sharp currency
depreciation, and rising inflation have necessitated a coordinated action by all
relevant authorities.
Central Bank has mainly focused on inflation and FX developments during this
period. We used our rich toolkit to tighten monetary policy, but at the same time
provided liquidity support to FX market through reserve requirements and other
tools.
As part of the coordinated policy mix, other authorities have taken a series of
measures to support the credit channel and economic activity. In order to stimulate
the loan supply and demand, the bank regulation authority has released some of
the buffers accumulated in recent years, including the maturity restrictions and
loan-loss provisions. The government has announced a stimulus package to
contain a possible adverse feedback loop between economic activity and loan
supply. To this end, collateral conditions were eased for corporates, several
incentives were provided to stimulate investments and exports, direct support for
SME loans were provided through government guarantee schemes and loan
restructuring processes. Most recently, tax cuts have been introduced for certain
durable products to support demand and production without generating inflation.
Moreover, as a reflection of the enhanced fiscal-monetary policy coordination, the
finance ministry announced clearly that no tax hikes are envisaged in 2017.
We anticipate that these concerted efforts will not only bring inflation gradually
towards our medium term target of 5 percent but also support the economic
recovery in the forthcoming period.
Thank you for your attention.