Erdem Başçi: Recent economic and financial developments in Turkey
Speech by Mr Erdem Başçi, Governor of the Central Bank of the Republic of Turkey, at the
press conference for the presentation of the January 2016 Inflation Report, Ankara,
26 January 2016.
* * *
Distinguished Guests,
Welcome to the briefing held to convey the main messages of the Inflation Report of January
2016.
The report typically summarizes the economic outlook underlying monetary policy decisions,
shares our evaluations on macroeconomic developments and presents our medium-term
inflation forecasts, which were revised in view of the developments in the last quarter, along
with our monetary policy stance. In addition to the main text, the report includes seven boxes
entailing up-to-date and interesting analyses on various topics. The boxes in this Report look
into the sources of the changes in end-2015 inflation forecasts, offer projections about the
repercussions of base effects on inflation in 2016, and analyze the dynamics of inflation in
Turkey. Moreover, there are boxes that elaborate on Turkey's changing export market share,
study the relationship between consumer confidence indices and financial volatilities, analyze
the effects of minimum wage hikes on overall wages, and scrutinize the relationship between
loans and growth by sectors. The titles of the boxes are shown on the slide. All of these
analyses shed light on noteworthy issues in the Turkish economy. I strongly recommend that
you read these boxes, which will soon be published on our website.
I would like to commence my speech by reviewing the global economic outlook, given its
ongoing influence on our policies. Volatilities in financial markets continue amid uncertainties
about global monetary policies and concerns over global growth. Interest rate volatility
experienced some decline right after the anticipated first Fed rate hike in December 2015;
however, volatilities began increasing as of early 2016 mainly due to worries about the
Chinese economy and geopolitical developments (Chart 1). The global economic slowdown
since 2014 continued into the second half of 2015, especially across emerging market
economies. Commodity prices remained on the decrease as well. Developing economies
were largely affected by the global fluctuations in this period. Portfolio inflows stayed weak
and exchange rate volatilities remained high (Chart 2).
The effects of global market volatility were felt in the Turkish economy as well. However,
reduced domestic uncertainty and the CBRT's tight monetary stance and other liquidity -and
financial-stability- oriented policies limited these effects.
Chart 1. Chart 2.
VIX and US Interest Rate Volatility Index Portfolio Flows to Emerging Economies
(MOVE Index) (Basis Points) (4-Week Moving Average, Billion USD)
and Currency Volatility Index (JPMVXYEM) (Percent)
Source: Bloomberg. Source: EPFR, Bloomberg
1. Monetary policy and financial conditions
As you all know, we released a road map on 18 August 2015 regarding the policies to be
implemented before and after the normalization of global monetary policies. In line with this
road map, we kept our policy stance tight against the inflation outlook, stabilizing for the FX
liquidity, and supportive of financial stability. In order to simplify the operational framework of
the liquidity policy, we terminated the lower interest rate on borrowing facilities provided for
primary dealers by the CBRT and simplified collateral conditions following the announcement
of the road map. We aimed to enhance the efficiency of banks' liquidity management by
adopting the use of foreign exchange deposits as collaterals against Turkish lira transactions.
Moreover, we took further steps to support foreign exchange liquidity, core liabilities and
long-term borrowing.
In view of inflation expectations, the pricing behavior and other factors affecting inflation, we
maintained the tight monetary and liquidity stance throughout 2015. Accordingly, we kept the
one-week repo rate, the overnight lending rate and the overnight borrowing rate unchanged
at 7.5, 10.75 and 7.25 percent, respectively, during the last quarter of 2015 and the first
month of 2016. One-week repo auctions continued to be the main tool for the CBRT funding,
while the share of the marginal funding remained high (Chart 3). Thus, the average funding
rate settled at around 8.9 percent as of January 2016, higher than the one-week repo rate.
Additionally, we kept the interbank overnight repo rates at the upper band of the interest rate
corridor (Chart 4). Our future monetary policy decisions will be conditional on the inflation
outlook. Taking into account inflation expectations, the pricing behavior and the course of
other factors affecting inflation, we will maintain our tight monetary policy stance as long as
deemed necessary.
Chart 3. Chart 4.
CBRT Funding* CBRT Rates and BIST Interbank O/N Repo Rates
(2-Week Moving Average, Billion TL) (Percent)
*Marginal funding is O/N funding quoted at the upper limit of the corridor.
Source: CBRT. Source: BIST, CBRT.
The yield curve, which was nearly flat in the last quarter of 2015 as in the entire year,
assumed a positive slope in January 2016 (Chart 5). This was mainly due to long-term rates
that rose amid the uncertainty surrounding global markets, geopolitical risks and heightened
inflation expectations, which also affected the spread between 5-year market rates and the
BIST overnight interbank rates. After remaining negative across the fourth quarter of 2015,
the spread turned slightly positive in the first weeks of January as a result of rising 5-year
market rates (Chart 6).
Chart 5. Chart 6.
Money Market Rates
Yield Curve Between October 28, 2015- January 22,
(Percent, 5-Day MA)
2016 (Percent)
Maturity (Year)
Source: Bloomberg, Source: Bloomberg, BIST.
Regarding our Turkish lira liquidity policy, there has been some decline in banks' FX swap
deals with the market for short-term funds owing partly to changes we made to the guidelines
for the use of FX deposits as collateral following the announcement of our road map.
Considering that banks' need for FX swaps can be further reduced through a rise in the use
of this option and in the limits allotted to banks, we increased these limits from USD 3 billion
to USD 3.6 billion and from EUR 900 million to EUR 1.8 billion as of 7 January 2016.
Moreover, we raised the maximum ratio of 50 percent that banks are able to pledge as
FX-denominated collateral against their borrowings at the CBRT Interbank Money Market to
70 percent effective 13 January 2016. We expect this arrangement to play a stabilizing role
against the stress likely to be experienced in credit risk pricing due to global factors and
boost the demand for FX-denominated bonds issued abroad by the Treasury. Detailed
information about our Turkish lira liquidity policy of 2016 can be found in the "Monetary and
Exchange Rate Policy for 2016" we published on 9 December 2015.
Besides interest rate and liquidity policies, we continue to promote prudential borrowing by
employing other policy instruments that support financial stability. We have enacted a series
of measures since end-2014 with regard to FX required reserves and remuneration rates on
TL required reserves which aim to support core liabilities and extend the maturity of non-core
liabilities. These policies have proved effective in extending the maturity of FX liabilities and
suspending the upward trend in the loan to deposit ratio (Chart 7). In order to reduce the
intermediation costs of the banking system and provide additional support to core liabilities,
we raised the remuneration rates on TL required reserves by 50 basis points each month in
September, October and December 2015. Additionally, we made some adjustments to the
coverage of reserve requirements on 9 January 2016. Accordingly, some funds at
participation and investment banks were made subject to reserve requirements and the
coverage of non-core liabilities was expanded.
Chart 7. Chart 8.
Maturities of Non-Deposit Liabilities ROM Reserves, FX Deposit Facility and External FX Liabilities
(Percent)
of the Banking Sector Due in 1 Year
(Billion USD)
Source: CBRT. Source: CBRT.
In the road map released in August, we also included some measures to enhance the
flexibility of the foreign exchange liquidity management. To this end, we hiked the transaction
limits for banks at the CBRT Foreign Exchange and Banknotes Markets on 1 September
2015. Consequently, the sum of FX deposit limits allocated to banks and gold and foreign
exchange assets held at the CBRT under the reserve option mechanism (ROM) reached a
level that is considerably above the external debt payments of banks which are due within
one year (Chart 8). Moreover, in the "Monetary and Exchange Rate Policy for 2016", we
announced further steps to strengthen the stabilizing feature of the ROM. All these measures
taken in line with the road map have increased Turkey's resilience against global volatility.
Amid an economic environment fraught with prolonged global uncertainties, it is important to
contain negative spillovers into the Turkish economy. In terms of the fundamentals of the
economy, the significant improvement in the current account balance over the past few
years, reasonable growth rates in loans and a loan composition that supports price stability
and financial stability all contributed to reducing economic fragilities. These developments
were due to the tight monetary policy and the measures taken regarding financial stability as
well as the sharp fall in commodity prices in the case of the current account balance.
Moreover, the effective use of the measures presented in the August road map has
alleviated the excessive fluctuations in exchange rates and loan rates. Our current tight
monetary policy reduces the economy's sensitivity to global shocks, thus supporting financial
stability. We maintain the view that the tight monetary policy may be implemented within a
narrower interest rate corridor, should the global volatility decline persistently or policy
measures that would maintain and improve the gains in external balance and financial
stability be implemented effectively.
In 2015, the annual growth rate of loans extended to the non-financial sector, which
decelerated partly due to our tight monetary policy stance, and the macroprudential
measures introduced by the BRSA regarding consumer loans excluding mortgage, fell to
13.6 percent, adjusted for the effect of exchange rates. The noticeable slowdown across
consumer and commercial loans that started in the third quarter continued into the fourth
quarter, causing these loans to post an annual growth rate of 8.7 and 16.2 percent,
respectively, at the end of the year (Chart 9). Thus, commercial loans continued to grow at a
faster pace than consumer loans in the fourth quarter of 2015, following the same pattern
since early 2014. We expect that these developments in loan growth and loan composition
will contribute to the rebalancing process and financial stability as well as limit the effects of
the recent cost pressures on inflation. The annualized growth rates of 13-week averages
show that consumer and commercial loans lagged far behind past years' averages; the
former across 2015, the latter mainly in the second half of 2015. However, as reflected by
13-week averages, both loans, particularly commercial loans, saw a modest rise during the
last quarter of 2015 (Chart 10). The recent adjustments made to the risk weights of
consumer loans are likely to support loan growth in the upcoming period. Yet, due to ongoing
tight financial conditions, we expect annual loan growth rates to remain at reasonable levels
in the coming months.
Chart 9.
Chart 10.
Annual Credit Growth Rates
Annualized Credit Growth Rates (Adjusted for Exchange
(Adjusted for Exchange Rate, Percent)
Rate, 13-Week Moving Average, Percent)
Source: CBRT.
Source: CBRT.
2. Macroeconomic developments and main assumptions
Now, I will talk about the macroeconomic outlook and our assumptions on which our
forecasts are based. First, I will summarize the recent inflation developments, and then
continue with the domestic and foreign demand outlook upon which we based our
projections.
In the fourth quarter of 2015, consumer price inflation (CPI) increased by about 0.86 points
quarter-on-quarter to 8.81 percent, overshooting both the projections of the October Inflation
Report and the uncertainty band around the year-end inflation target (Chart 11).
Unprocessed food prices were the main drivers of this higher-than-forecasted rise in annual
inflation. In fact, inflation excluding unprocessed food and tobacco was close to the October
Inflation Report forecast in this period (Chart 12). The lagged effects of the Turkish lira
depreciation were particularly evident through the core goods channel. Yet, the continued fall
of import prices in the fourth quarter limited the rise in CPI inflation.
Chart 11. Chart 12.
October Inflation Forecasts and Realizations (Percent) October Inflation Forecasts and Realizations
(Percent)
Excluding Unprocessed Food and Tobacco
* Shaded region indicates the 70 percent confidence interval for the forecast.
Source: TURKSTAT, CBRT.
In the fourth quarter, despite the decline in USD-denominated import prices, cost pressures
on inflation continued due to food prices and exchange rate developments. We see that
these rising cost factors limit the improvement of the underlying trend of core inflation
(Chart 13). Furthermore, we will monitor closely the effects of the adjustment in minimum
wages on overall wages and on inflation (Chart 14).
Chart 13. Chart 14.
Real Gross Minimum Wage
Core Inflation Indicators SCA-H and SCA-I
(2003 Prices, TL)
(Seasonally Adjusted, Annualized 3 Month Average,
Annual Percentage Change)
*Real gross minimum wage is obtained by dividing the average gross
minimum wage at current prices to the consumer price index in a given
year. Consumer price index is taken as 2003=1. Consumer prices in 2016
are based on January 2016 Inflation Report projections.
Source: TURKSTAT, CBRT Source: Ministry of Labor and Social Security, TurkStat, CBRT.
In sum, annual inflation increased in the fourth quarter due to an ongoing rise in food prices
as well as the lagged effects of the Turkish lira depreciation throughout 2015. We believe
that the upcoming inflation outlook will depend on both the volatility in energy and
unprocessed food prices and the effects of the global market uncertainty on inflation
expectations. In addition, the large adjustment made to net minimum wages for 2016 will
have an impact on inflation. Therefore, we expect inflation to remain elevated for some time.
At this juncture, in addition to maintaining our tight monetary policy stance, fighting against
the structural elements of inflation also remains important.
Notwithstanding the significant external shocks in recent years, we were able to limit the
worsening in inflation and inflation expectations thanks to our current policy framework, but
price stability is yet to be achieved. Ten years of experience with inflation targeting has
shown that the fight against inflation requires collaboration from all relevant parties. We
believe that government income and wage policies as well as structural issues related to
food prices are important components in this endeavor. Moreover, macroprudential policies
towards prudential borrowing also facilitate the fight against inflation by supporting a
balanced growth. Thus, bringing inflation permanently down to the 5-percent target requires
all institutions to continue resolutely with the efforts made in recent years.
According to the GDP data of the third quarter of 2015, economic activity proved more robust
compared to the outlook presented in the October Inflation Report, and the GDP grew
steadily by 1.3 and 4 percent on quarterly and annual bases, respectively (Chart 15). On the
spending front, final domestic demand increased modestly in the third quarter, while external
demand contributed positively to the GDP after three quarters (Chart 16).
Chart 15. Chart 16.
GDP and Final Domestic Demand Contribution of Demand Components to Year-on-Year
(Real, Seasonally Adjusted, Billion TL)
GDP Growth (Percentage Points)
Source: TURKSTAT. Source: TURKSTAT.
The demand outlook for 2016 leads to expectations of stronger economic activity compared
to 2015. Amid waning domestic uncertainties, rising consumer and investor confidence may
boost domestic demand. Revival of investments, at least partially, in 2016 that were delayed
in 2015 due to domestic uncertainties and the effect of the strong post-crisis employment
performance coupled with the recent wage developments on the income channel are likely to
support domestic demand. Moreover, the projected fall in the current account deficit and the
strong public finances also provide room for policy responses against possible shocks. The
rebound in the EU economy continues to support our exports, while the uncertainties related
to the Middle East and Russia constitute downside risks (Chart 17). Moreover, volatility in
global financial markets and concerns over global growth may deteriorate financial conditions
and foreign demand. In sum, we expect that in 2016, domestic demand will prove slightly
stronger than 2015, while foreign demand will, despite the existence of geopolitical risks,
recover owing to the recovery in the EU. Accordingly, we project that maintained
macroprudential measures coupled with favorable developments in the terms of trade will
support the ongoing improvement in the current account deficit (Chart 18).
Chart 17. Chart 18.
Imports by EU Current Account Balance (CAB)
(Real, Seasonally Adjusted, 3-Month Average 2010=100) (12-Month Cumulative, Billion USD)
Source: Eurostat. Source: CBRT.
As you all know, food, energy and import prices also play a great role in inflation forecasts.
Therefore, before moving on to forecasts, I will briefly talk about our assumptions regarding
these variables.
The downtrend in commodity prices in international markets, chiefly oil prices, continued in
the last quarter of 2015 as well. Stemming mostly from the lack of demand from China and
other developing economies, this trend caused import prices in the Turkish economy to
recede in USD terms. Therefore, we made downward revisions to assumptions for crude oil
prices and USD-denominated import prices With regard to annual averages, we reduced
crude oil price assumptions from USD 54 to USD 37 for 2016. Also, we revised the
assumptions for annual percentage changes in average import prices downwards by
4.9 points for 2016. We revised the assumed inflation for food prices upwards from 8 percent
to 9 percent for 2016 due mostly to the effects of minimum wage adjustments on costs and
demand (Chart 19).
Chart 19. Revisions in Oil and Export Prices*
Oil Prices* (USD/barrel) Import Prices* (USD, 2010=100)
* Shaded area indicates the forecast horizon. * Shaded area indicates the forecast horizon.
Source: Bloomberg, CBRT.
Source: Bloomberg, CBRT.
Effective as of January 2016, some items with administered prices saw price increases. We
estimate that the additional effect on the year-end inflation of the portion of these increases
that remain above 5 percent will be 0.4 points in 2016. In turn, we monitor meticulously how
the rise in the minimum wage will affect the budget balance and tax adjustments. As the
extent of the effect of wage developments on production costs, aggregate demand and
inflation depends on the fiscal policy and the change in employment, we monitor the
interaction between the rise in minimum wages and the fiscal policy closely. Our
mediumterm projections are based on an outlook that tax adjustments and administered prices,
excluding those already announced in January, will not exceed the inflation target and will
remain consistent with automatic pricing mechanisms. The medium-term fiscal policy stance
is based on the Medium Term Program projections covering the 2016-2018 period.
Conditional on this outlook, we expect inflation to improve gradually and reach the 5-percent
target in the medium term.
3. Inflation and the monetary policy outlook
Now, I would like to present our inflation and output gap forecasts based on the outlook I
have described so far.
Given a decisive policy stance that focuses on bringing inflation down, the 5-percent target is
expected to be achieved gradually; inflation is likely to stabilize around 5 percent as of 2018
after falling to 7.5 percent in 2016 and to 6 percent in 2017. In this context, inflation is
expected to be, with 70 percent probability, between 6.1 percent and 8.9 percent (with a
midpoint of 7.5 percent) at end-2016 and between 4.2 percent and 7.8 percent (with a mid-point
of 6 percent) (Chart 20).
Chart 20.
Inflation and Output Gap Forecasts
*Shaded region indicates the 70 percent confidence interval for the forecast.
We revised the year-end inflation forecasts for 2016 and 2017 upwards by 1 point and
0.5 points, respectively, compared to the October Inflation Report forecasts. As I have just
mentioned, driven mostly by oil prices, USD-denominated import prices have registered a
considerable decline since October 2015. When analyzed jointly with exchange rate
developments, the downward revision in the assumption for oil and import prices is expected
to pull down the end-2016 inflation forecast by 0.6 points compared to the October Report
forecast. On the other hand, the portion of January 2015 public price adjustments which
exceeds the inflation target, is likely to push the end-2016 inflation forecast up by 0.4 points.
Another influential factor on forecasts in this period proved to be the rise in net minimum
wages. Given the announced support by the government and the effects of this minimum
wage rise on demand and costs to the employer, we revised the end-2016 inflation forecast
upwards by 1 point. Considering the effect of the minimum-wage-rise, we attribute 0.3 points
of this to the food inflation, which we raised from 8 to 9 percent for 2016. Lastly, we estimate
that a higher-than-projected actual inflation rate at end-2015 compared to the October
Inflation Report forecast coupled with the rise in core inflation indicators will push the
end2016 inflation by 0.2 points. In short, of the total change in the year-end inflation forecast for
2016 compared to the previous reporting period, 1 point stemmed from the
minimum-wagehike, 0.4 points from administered price changes that are over and above the inflation target
and 0.2 points from the rise in the underlying trend of inflation. Meanwhile, the revision in the
assumptions for TL-denominated oil and import prices had a downward effect by 0.6 points.
In addition to these forecasts, we discuss alternative scenarios on the inflation outlook and
the global economy in the Risks section of the Inflation Report. You can examine the Report
for details.
While concluding my remarks, I would like to thank all my colleagues who contributed to the
Report, primarily those at the Research and Monetary Policy Department as well as the
members of the Monetary Policy Committee, and thank every one of you for your
participation.