Durmuş Yılmaz: Green shoots - how vigorous and how sustainable?
Speech by Mr Durmuş Yilmaz, Governor of the Central Bank of the Republic of Turkey, at
the Conference on "Green shoots - how vigorous and how sustainable", IMF-World Bank
Annual Meetings 2009, Istanbul, 5 October 2009.
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Ladies and gentlemen,
First of all, I would like to welcome everyone to Istanbul. It is a great pleasure for me to be
here addressing such a distinguished audience as we convene for the 2009 Annual
Meetings.
"Green shoots" has been a popular metaphor to describe the recovery process. And today, I
will try to elaborate on our path to build a career as a prudent gardener. I want to begin with
discussing the path that brought us to this crisis. Then, I will talk about the recovery signals in
both global and Turkish economy. I will conclude my speech with my thoughts on the solidity
and sustainability of these signals.
As is well known, financial strains originated in advanced economies abruptly mutated into a
full-blown crisis and had a devastating effect on international capital markets. As the crisis
intensified, measures of perceived risk escalated to record levels and major financial
institutions suffered massive losses. At the same time, liquidity shortages, tighter credit
conditions, and heightened uncertainty were associated with a sharp decline in both private
consumption and investment spending. In fact, many economies fell into recession or have
seen their growth rates decline sharply. As a consequence, global trade contracted, financial
flows dried up, and unemployment rates soared.
The global financial system is still under stress; but one can see some signs of recovery in
the global financial markets and economic indicators around the world. Unprecedented policy
reactions to the crisis taken by governments and central banks worldwide have managed to
stabilize the financial markets and reduced liquidity concerns. Especially, thanks to ease of
tension in the global financial markets, emerging market equities have boosted and spreads
have narrowed. Commodity prices have rebounded from their recent low levels while
capacity utilization and industrial production have globally recovered modestly. As a
consequence, international institutions like the IMF and OECD announced that the global
economy will recover sooner than expected and they are getting more and more optimistic
regarding their projections.
In the words of Winston Churchill who had seen the sunlight after the darkest days of the
Second World War: "This may not be the end. It is not even the beginning of the end. But it
is, perhaps, the end of the beginning."
Dear Guests,
A key characteristic of the recent crisis was that it combined an acute international financial
crisis with an outright global recession. At the same time, synchronized countercyclical
policies were implemented by both advanced and emerging economies in response to global
turmoil. In my opinion, it would be better to briefly elaborate on these distinctive features of
the recent crisis to have a better understanding of the nature of the recovery going forward.
Recent research highlights that episodes of financial stress are more likely to be associated
with deeper and longer downturns. This is particularly true for banking-related financial
stress, and helps explain the severity of the recent crisis. Another factor that exacerbated the
fallout from the recent crisis was the aggressive use of certain financial instruments. While
derivatives can be effectively used for hedging purposes, use of these instruments for
speculative gains with high leverage also allows for potentially unlimited losses.
The global recession was another distinctive feature of the recent crisis. The downturn in
economic activity was virtually synchronized across both advanced and emerging
economies.
Increasing interdependence owing to the rapid pace of globalization, as well as the rising
contribution of emerging economies to global growth is among the main factors behind the
synchronous behavior of global economic activity. Taken together, this implies that there may
be less of a role for exports during the recovery. Also the unprecedented fiscal and monetary
policy initiatives implemented across major economies makes this crisis truly unique. The
awareness regarding the threat to financial and economic stability has emerged across both
advanced and emerging economies. To this end, policy dialogues - particularly those
fostered during international forums - served to catalyze simultaneous fiscal stimulus
packages across some of the largest advanced and emerging economies.
On the monetary policy side, at first, many economies cut interest rates sharply with waning
inflationary pressures. However, as the financial stress intensified and the economic
contraction deepened, policy rates rapidly approached the zero interest rate floor. With their
economies still under acute strain, central banks in some advanced economies responded by
implementing a series of unconventional measures. The goal of these measures was to
provide markets with ample amounts of liquidity to help restore the health of financial
systems balance sheets, and thereby to reactivate the provision of credit to the real
economy. However due to stress in the financial sector, the effectiveness of the transmission
mechanism of monetary policy may be hampered to some extent. And the usefulness of
conventional countercyclical monetary policy may be relatively limited during financial crises.
Distinguished Guests,
The global economy is still in unchartered territories creating lots of confusion among the
policymakers on the consequences of the monetary and fiscal stimulus steps taken so far
globally. Most governments have taken fiscal measures to mitigate the effects of global
turmoil either by decreasing tax rates or increasing public investment spending and
expenditures. So far we see a consensus about the need for accommodative monetary
policies around the globe. On the other hand, high public debt of the most developed
economies has aroused serious concern on debt sustainability. According to the OECD
projections, by 2017 gross public debt as a share of GDP is expected to rise sharply to 125%
in the US, 160% in the UK, 125% in France, and over 100% in Spain.
Sooner or later, with the recovery of global economy, money supply pumped up to the
system involves the risk of inflation if the central banks miss the soft spot in the timing of the
exit strategies. The solution I believe is the announcement of credible consolidation plans
going forward in stabilizing global economy in order to reduce the risk of wilting the green
shoots.
Therefore, it is vital for both monetary and fiscal authorities resolve the issues of long term
fiscal sustainability and price stability.
Esteemed Guests,
Following my opinions about the recent developments in global economy, I would like to talk
about the Turkish economy and our recent implementation of monetary policy.
The global turmoil has adversely affected financing facilities and external demand, and led to
a significant slowdown in economic activity in developing countries. We also had our fair
share of it. The Turkish economy, which had been growing for 27 quarters in a row,
experienced a severe contraction during the last quarter of 2008 and the first quarter of 2009.
The higher share of cyclically sensitive exports, firms' dependence on external financing, and
high level of production capacity were all factors that exacerbated the severity of the
recession.
Parallel to the contraction in aggregate demand coupled with the sharp drop in commodity
prices, inflation plummeted markedly. Easing of concerns over inflation enabled us to focus
on containing potential adverse effects of global financial turmoil on the domestic economy
without compromising our price stability objective. With the reversal of global developments
fueling inflation in the last quarter of 2008, the Central Bank took prompt action to cut interest
rates and adopted a pioneer role among emerging markets. The analysis conducted by the
CBT indicates that policy rate cuts of a total of 950 basis points have alleviated the severity
of excessive volatility in economic activity.
The developments since November 2008 in domestic financial markets and falling inflation
have confirmed the accuracy of our projections and the policy rate-cut decisions, increasing
the confidence in monetary policy. As a consequence of the measures taken and the limited
recovery in risk perceptions, the level of market interest rates today is below the pre-global
crisis level in both nominal and real terms. Having neutral interest rates at lower levels during
economic recessions is an expected development in well-functioning economies, but it has
never been experienced in Turkey before. This development should be perceived as an
indicator of the normalization of the Turkish economy.
Despite the marked deterioration in economic activity in Turkey, there were at least three
factors that prevented an outright depression. These factors were the soundness of the
financial system, low levels of Turkish household indebtedness, and an assertive monetary
policy stance, which aimed at mitigating the impact of the crisis on the domestic economy.
Reviewing these factors, albeit briefly, would allow a better understanding of Turkey's
economic prospects.
The Turkish financial system proved to be resilient to the financial crisis relative to many
other emerging economies. Unlike some of its peers, the Turkish banking system did not
require any rescue packages or other forms of government support throughout the crisis. The
robustness of the Turkish financial system was to a large extent a consequence of the
financial reforms implemented in the aftermath of the 2001 financial crisis we experienced in
Turkey.
Therefore, in contrast to many other countries that have recently revised or put into practice
restructuring, supervisory, and regulatory frameworks, many of these were already
established in Turkey several years ago. Furthermore, leading into the recent crisis, the
Turkish financial system was well capitalized - with capital adequacy ratios exceeding 18
percent - and had relatively low loan-to-deposit and leverage ratios, as well as low levels of
foreign exchange rate exposure. Relative strength of the financial sector enabled the
implementation of rapid and front loaded rate cuts. No bail out scheme or other forms of
public support needed during this period. This has provided room for expansionary fiscal
policies.
In addition to the sound structure of the financial system, low levels of household
indebtedness relative to other emerging economies also contributed to the resilience of the
Turkish economy during the crisis. Monetary tightening implemented by the Central Bank
between 2006 and 2008 played a critical role in curbing the lending growth and checking the
rise in household debt. Prudent and preemptive measures taken by the Banking Regulatory
and Supervision Agency in the last 7 years prevented the spread of exchange rate risk
among households. The share of foreign currency-denominated loans in the current debt
stock of households is rather small compared to other emerging economies, especially those
in Central and Eastern Europe. Financial markets seemed to have appropriately appraised
these factors, as the risk premium in Turkey deteriorated by a smaller extent when compared
to many other emerging economies during the peak of the crisis.
Relative stability in financial markets of Turkey has provided our bank more policy space
relative to many other emerging economies. The Central Bank of Turkey has used this
opportunity to guide expectations. As expectations were further aligned with the policy
intentions of the CBT, bond yields decreased to historically low levels. This is an important
development, because in previous crises real interest would tend to increase, thereby
exacerbating the severity of the economic contraction. Current situation reflects the improved
effectiveness of Turkish monetary policy and highlights the transformation of Turkish
economy.
Dear Participants,
Turkey has always had a great climate for Green Shoots to blossom. Our recent crisis in
2001 was followed by a strong "V" shaped recovery process. However, despite the signs of
partial improvement in domestic consumption in recent months, its strength and durability is
questionable. We expect that demand uncertainty and low levels of capacity utilization will
continue to weigh down on investment spending and employment. High unemployment will
continue to contain private consumption demand and blur the prospects for a solid recovery.
Despite some recent easing, tightness in financial conditions still persists and the tightening
of business loan lending standards continued - albeit at a slower pace - during the second
quarter.
We predict that bank lending rates for consumer loans would follow gradually, as the lagged
effects of cumulative easing of 950 basis points since November 2008 would start to ease
credit conditions towards the last quarter of this year. However, the current unfavorable labor
market conditions are expected to restrain the recovery in consumption, and therefore
domestic demand conditions would continue to support disinflation.
The fiscal discipline is crucial in maintaining low levels of medium and long-term interest
rates for the recovery of both consumption and investment. The implementation of a credible
fiscal framework would bring down risk premiums further, and hence lead to a permanent fall
in longer-term interest rates. This, in turn, would foster investment and labor demand, and
thereby support the recovery process, providing the Green Shoots with the breathing room.
Therefore, the determined execution of the medium-term program to ensure fiscal discipline
and debt sustainability would have an expansionary rather than contractionary impact on
economic activity.
In sum, while Turkish economy contracted sharply during the recent crisis, its well capitalized
and sound financial system is likely to support the economic activity along the recovery. In
fact, recent GDP releases suggest that economic activity in Turkey displayed a solid rebound
in the second quarter. Therefore, we feel that the worst episode of the crisis is now behind
us, which should in turn support Turkey's economic prospects.
However, it remains to be seen whether recent improvements in leading indicators will
translate into a long lasting and durable recovery, since part of the rebound reflects the
impact of the fiscal stimulus packages. The situation is similar across the globe: recovery has
started in the global economy, yet the extraordinary policy measures taken since the last
quarter of 2008 makes it harder to interpret the underlying trends. Given the elevated levels
of unemployment and ongoing de-leveraging process, the recovery is likely to be gradual.
Distinguished Guests,
Let me close my speech by turning to the main theme of this session. Overall, I am
encouraged to recognize initial signs of recovery but also I am anxious that the green shoots
that have sprouted may still expose to a spring frost. "Green shoots" may not be vigorous
enough and important downside risks still remain.
However, unlike a couple of quarters ago, we should also acknowledge that we can now at
least talk about upside risks - that is, "blossoming shoots".
Thank you.