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 April 2011 Inflation Report, Ankara, 28 April
2011.
* * *
Distinguished Members of the Press, Esteemed Guests,
Welcome to the press conference held to convey the main messages of the April 2011
Inflation Report.
The Report summarizes the economic outlook underlying monetary policy decisions, shares
our evaluations on global and domestic macroeconomic developments and presents the
medium-term inflation forecasts which have been revised in view of the last quarter
developments, along with our monetary policy stance. Moreover, the communication and
impact of our new monetary policy implementation are extensively analyzed in the Report
through Boxes.
Distinguished Members of the Press,
In the first part of my speech, I would like to very briefly summarize the global economic
developments and provide you with a short reminder of the new policy stance that we have
recently introduced.
The global economy continued to recover in the first quarter of 2011, while the growth
dynamics between advanced and emerging economies continue to diverge (Chart 1).
Downside risks in advanced economies remain critical, causing these economies to maintain
expansionary monetary policies, while domestic demand remains strong in emerging
economies amid accelerated capital inflows.
Chart 1.
Aggregated Growth Rates*
(Annual Percent Change)
* Weighted by each country's share in global GDP.
Source: Bloomberg, CBRT.
1. Monetary policy developments and monetary conditions
The mentioned discrepancy between advanced and emerging economies accelerates capital
flows into countries, such as Turkey, with strong economic fundamentals and relatively low
risk. Rapid credit expansion and widening current account deficit fueled by short-term capital
inflows increase risks to financial stability and carry the potential to hamper price stability
over the medium term. This gives rise to adopting different approaches that incorporate
financial stability into the monetary policy framework.
As you have been following very closely, we have designed and adopted a new policy
strategy as of the end of 2010. While our new policy approach maintains the priority of price
stability, we also observe financial stability as a supporting objective. In this context, in
addition to policy rates, we jointly use complementary tools such as reserve requirement
ratios and the interest rate corridor. The primary objective of this new approach is to contain
the negative effects of the ongoing global imbalances on the Turkish economy.
Now, I would like to summarize the decisions that we have made within the new policy
strategy. The downtrend in inflation during the last quarter of 2010 allowed the CBRT to give
relatively more weight to financial stability during this period. In this respect, in order to
reduce short-term capital inflows, we lowered policy rates on one hand and raised the
volatility in short-term interest rates by widening the interest rate corridor on the other hand.
Moreover, in order to slow down credit expansion, we increased required reserve ratios
(Chart 2). Meanwhile, in order to enhance financial stability by extending maturity of the
banking sector liabilities, we differentiated reserve requirements across maturities, with
higher reserve requirements for short-term liabilities. These measures led to a fall in net
short-term capital inflows, stopped the acceleration of credit growth and extended maturities
for deposits.
Chart 2. CBRT Policy Mix
CBRT Policy Rates TL Required Reserve Ratios
(Percent) (Percent)
Source: CBRT. Source: CBRT.
In the first quarter of 2011, both the faster-than-expected increases in oil prices and the
robust domestic demand required a more cautious stance regarding the inflation outlook.
Specifically, oil prices hovering significantly above our January Inflation Report's
assumptions led to an increase in cost pressures. Moreover, the ongoing rapid growth in
private consumption and private investment spending added to the need to contain domestic
demand in order to avoid secondary effects of the increases in oil and other commodity
prices.
Notwithstanding historically low inflation at 4 percent in the first quarter, I would like to
emphasize that we have acted with a medium-term perspective and started to highlight the
upside risks to inflation since February. Accordingly, in order to eliminate the risk of
deterioration in general pricing behavior, we have adopted a stronger monetary tightening
than was envisaged in the January Inflation Report's baseline scenario. Accordingly, the
policy rate has been kept constant since February, while the weighted average of reserve
requirement ratios for Turkish lira liabilities was hiked by 410 basis points in March and April
(Table 1). Meanwhile, in April, FX reserve requirement ratios were differentiated by maturity
where short-term FX reserve requirement ratios were increased slightly. Thus, the policy mix
composed of policy rates and reserve requirement ratios has been adjusted to deliver a
monetary tightening, implying a more cautious monetary stance (Chart 2).
Table 1.
Weighted Average of TL and FX Required Reserve Ratios
(Percent)
Decision Date TL Weighted Average FX Weighted Average
January 24, 2011 9.4 11
March 23, 2011 13.2 11
April 21, 2011 13.5 12
Source: CBRT.
Although credit growth slowed quarter-on-quarter in the first quarter, the rate of increase in
loans has yet to fall to levels compatible with financial stability (Chart 3). The upward trend in
loans is driven by both supply and demand side factors. While intense competition is
effective on the supply side; the favorable economic outlook and the improvement in
employment conditions help to keep demand for loans robust. However, we expect that
credit utilization will continue to lose pace in the second quarter due to the lagged effects of
the current monetary tightening.
Chart 3. Chart 4.
Loans TL Business Loan and Deposit Rates
(Nominal, January 2007=100) (Annual, Percent, 4-week Average)
Source: CBRT. Source: CBRT.
2. Inflation and monetary policy outlook
Distinguished Members of the Press, Esteemed Guests,
Having summarized our monetary policy stance and the impact of this stance on financial
markets, I would now like to talk about the macroeconomic outlook and assumptions
underlying our forecasts.
First, I would like to summarize the recent inflation developments and then I will compare our
short-term forecasts with the actual data recorded in the first quarter. As you might recall, in
the October 2010 Inflation Report, we drew attention to the price hikes due to increases in
unprocessed food and tobacco prices, which are beyond the control of the CBRT, and
concluded that these items would leave sizeable room for disinflation. In fact, during the
subsequent two quarters, inflation declined by 5.2 percentage points and dropped to
4 percent in March, a level close to the lower bound of our January Inflation Report forecast
(Chart 5).
Chart 5.
January 2011 Inflation Forecasts and Realizations
Forecast Range* Uncertainty Band Year-End Inflation Targets Output Gap
12
Control
10 Horizon
8
6
4
2
0
Percent
-2
-4
-6
-8
-10
Jun-10 Sep-10 Jun-11 Sep-11 Jun-12 Sep-12 Jun-13 Sep-13
Dec-09 Mar-10 Dec-10 Mar-11 Dec-11 Mar-12 Dec-12 Mar-13 Dec-13
* Shaded region indicates the 70 percent confidence interval for the forecast.
An analysis of inflation developments in terms of sub-categories reveals that the rapid
decline in inflation was mainly driven by the waning base effects from unprocessed food,
energy and tobacco prices and the favorable course of services prices (Chart 6). Meanwhile,
the rapid increase in import prices and the depreciation of the Turkish lira caused prices of
core goods to accelerate. Indeed, the rate of change across all subcategories of the CPI,
except core goods, remained below past year averages during the first quarter (Chart 7).
Chart 6. Chart 7.
Contribution to Annual CPI Inflation CPI by Subcategories
(First Quarter Percent Change)
* Core Goods: Goods excluding food, energy, alcoholic beverages, tobacco and gold.
** Food and Energy: Food and non-alcoholic beverages and energy.
*** Tobacco and Gold: Alcoholic beverages, tobacco and gold.
Source: TurkStat, CBRT.
While inflationary pressures by producer prices grew stronger in the first quarter, aggregate
demand conditions provided less support for disinflation compared to previous quarters.
Meanwhile, core goods inflation posted an increase, albeit remaining low (Chart 8). On the
back of these developments, medium-term inflation expectations registered a limited
increase in the first quarter (Chart 9).
Chart 8. Chart 9.
Core Inflation Indicators H and I 12- and 24-Month Ahead CPI Expectations*
(Annual Percent Change) (Annual Percent Change)
*CBRT Survey of Expectations, second survey period results.
Source: TurkStat, CBRT. Source: CBRT.
Esteemed Guests,
GDP data for the fourth-quarter of 2010 have been in line with the outlook presented in the
January Inflation Report. The third-quarter slowdown turned out to be temporary as expected
and economic activity expanded at a remarkable pace in the last quarter. Domestic demand
became the main determinant of growth in the said period (Chart 10). Thus, the post-crisis
divergence between domestic and external demand growth became more pronounced in this
period, confirming the adoption of the new policy mix (Chart 11).
Chart 10. Chart 11.
Contributions to GDP Growth by Demand Exports and Imports of Goods and Services
Components
(Seasonally Adjusted, 1998 Prices, Billion TL)
(Percentage Points)
Source: TurkStat. * Estimate.
Source: TurkStat, CBRT.
In line with the robust course of economic activity, non-farm employment also maintained its
upward trend; while unemployment rates displayed a notable decline (Chart 12). Leading
indicators signal an ongoing recovery in employment conditions.
Chart 12.
Unemployment Rates
(Seasonally Adjusted, Percent)
* As of January.
Source: TurkStat, CBRT.
Data for the first quarter of 2011 indicate that economic activity, driven by domestic demand,
is more robust than expected. Accordingly, our revised forecasts are based on the
assumption that aggregate demand conditions would provide less support for disinflation
compared to the previous period. However, I would like to underline that given the capacity
utilization rates which are still below pre-crisis levels and unemployment rates above
pre-crisis levels, we assume an outlook where aggregate demand conditions do not impose
a remarkable upward pressure on inflation by the first quarter of 2011.
The absence of signs for overheating in the economy is mainly owed to weak external
demand. In particular, the weak course of economic activity the euro area puts a cap to
growth of external demand. Therefore, our medium-term forecasts are based on the
assumption that external demand will continue to recover gradually and slowly, as was the
case in the previous Report. In fact, global economy forecasts do not imply any significant
changes in external markets in the first quarter. Accordingly, Turkey's export-weighted
growth index remained mainly unchanged from the previous reporting period (Chart 13).
Chart 13.
Export-Weighted Global Economic Activity Index*
* For methodology, see Inflation Report 2010-II, Box 2.1 "Foreign Demand Index for Turkey".
Source: Bloomberg, Consensus Forecasts, CBRT.
Fiscal policy forecasts are based on the Medium Term Program (MTP) projections. Since
primary expenditures remained largely in line with MTP targets in the first quarter, the fiscal
policy outlook remained broadly unchanged. Hence, our forecasts are based on the
assumption primary expenditures and debt to GDP ratios would continue to decline gradually
and the risk premium would remain broadly unchanged over the forecast horizon.
Furthermore, tax adjustments are assumed to be consistent with inflation targets and
automatic pricing mechanisms.
Chart 14.
Revisions to Oil and Import Price Assumptions
Oil Prices (USD/bbl) Import Prices (2003=100)
Source: Bloomberg, CBRT. Source: TurkStat, CBRT.
Particularly due to supply-side developments, oil and other commodity prices remained
considerably above our assumptions presented in the January Inflation Report (Chart 14).
Hence, we revised our assumptions for oil and other commodity prices upwards (Table 2). As
illustrated on the slide, these changes in assumptions led to an upward revision of about
50 basis points for the end-2011 inflation forecast and a slightly upward revision for the
2012 inflation forecast.
Another factor affecting 2011 inflation forecasts has been the tariff hike on fabrics and
apparels. Although major uncertainties exist about how this development will be reflected on
prices, we assumed that this would add to year-end inflation by about 50 basis points while
revising our forecasts.
Despite the recent benign course of food prices, we preserved our assumption regarding
food inflation for end-2011 at 7.5 percent in view of the extreme volatility in unprocessed food
prices and rapid increases in agricultural commodity prices (Table 2).
In sum, due to developments beyond the control of monetary policy, such as soaring energy
prices and renewed tariffs, we revised the mid-point for our end-2011 inflation forecast up by
1 percentage point.
Distinguished Members of the Press,
Within the new policy framework, the question of how and which policy tools will be
employed to change the policy stance is determined by factors affecting financial stability and
price stability. Given the high level of uncertainty arising from global economic conditions, we
believe that it would be more appropriate to remain flexible regarding the exact content of the
policy mix. Therefore, in this Report, the monetary policy stance underlying our inflation
forecasts will continue to be communicated using the term "monetary tightening", and we will
not provide any information about the explicit path for individual instruments.
Against this background, I now would like to share our inflation and output gap forecasts.
Assuming an additional limited monetary tightening during the second half of 2011, which
would bring credit growth to 20-25 percent at the end of 2011, inflation is expected to be,
with 70 percent probability, between 5.6 and 8.2 percent with a mid-point of 6.9 percent at
the end of 2011, and between 3.4 and 7.0 percent with a mid-point of 5.2 percent at the end
of 2012. Inflation is expected to stabilize at around 5 percent in the medium term (Chart 15).
Chart 15.
Inflation and Output Gap Forecasts
* Shaded region indicates the 70 percent confidence interval for the forecast.
Revised forecasts suggest that credits should grow at a measured and vigorous pace to
keep inflation in line with targets over the medium term. To this end, we provide a numerical
range for the annual rate of credit growth in order to be more concrete. I would like to
underline that these growth rates should not be perceived as strict targets for the CBRT. At
this point, I would also like to emphasize that the nominal credit growth consistent with the
medium-term inflation target may vary over the years depending on the course of factors
such as inflation, growth and the composition of the aggregate demand.
As illustrated on the slide, over the next three quarters, inflation may display significant
fluctuations mainly due to base effects driven by food prices. Accordingly, annual food
inflation is expected to rise in the second quarter, decline in the third quarter, and increase
markedly in the last quarter (Chart 15).
Comparison of January 2011 and April 2011 Inflation Report Forecasts
Chart 16. Chart 17.
Output Gap Forecast Inflation Forecast
Source: CBRT. Source: TurkStat, CBRT.
Comparing our current forecasts with those of the previous reporting period, I would like to
reiterate that we revised the initial point of our output gap forecasts upwards due to the
more-than-expected increase in the domestic demand in the last quarter of 2010 (Chart 16).
However, taking into account the stronger-than-expected effects of the monetary tightening
implemented in the first quarter, the output gap is expected to close at a slower pace
compared to the previous period.
In sum, due to developments beyond the monetary policy control such as the significant
surge in oil and other imports prices as well as the renewed tariffs, we have revised our
inflation expectations upwards (Chart 17). In addition, I would like to remind you that we will
not respond to first round effects of rising oil and other commodity prices, but second round
effects will be closely monitored and deterioration in the pricing behavior will not be tolerated.
It should be emphasized that any new data or information regarding the inflation outlook may
lead to a change in the monetary policy stance. Therefore, assumptions regarding the
monetary policy outlook underlying our inflation forecasts should not be perceived as a
commitment on behalf of the CBRT.
3. Risks and monetary policy
In the last part of my speech, I would like to mention risks regarding inflation outlook in the
upcoming period and prospective monetary policy strategies to be implemented should these
risks materialize.
We envision that the impact of the ongoing monetary tightening on loans and domestic
demand will be more apparent starting from the second quarter. However, the extent and the
timing of the impact may vary depending on developments beyond the control of monetary
policy. I would like to underline that as the Central Bank, we will closely monitor the lagged
effects of our policy measures on price stability and financial stability, and will take additional
measures if deemed necessary.
In assessing risk factors and related monetary policy measures under current circumstances,
we adopt a framework where both price stability and financial stability are taken into account.
Therefore, risk factors are not only assessed with respect to their impact on the level but also
on the composition of the aggregate demand. This is because the level of aggregate demand
is related to price stability, while its composition relates directly to financial stability.
Therefore, we evaluate risk factors regarding the global economy against this backdrop.
Although downside risks regarding the global economy have decreased compared to the
previous reporting period, they still remain significant. Problems in credit, real estate and
labor markets in many advanced economies are yet to be completely solved. Moreover,
uncertainties regarding debt sustainability and the impact of a possible fiscal consolidation
persist. Meanwhile, rapid increases in oil prices may restrain global recovery. All these
factors continue to feed downside risks regarding the pace of global growth. The possibility of
prolonged period of slow global growth not only poses downside risks regarding external
demand, but also keeps prospects for strong capital flows to Turkey vigorous. Should such a
scenario materialize, a policy mix of low policy rate, high reserve requirement ratios and a
wide interest rate corridor may be implemented for a long period. Moreover, an outcome
whereby problems in advanced economies intensify, leading to contraction in domestic
economic activity, may require an easing in all policy instruments. In other words, we may
consider joint cuts in policy rates and reserve requirement ratios.
Although downside risks to global economy remain notable, upside risks are also becoming
more significant. Major uncertainties exist regarding the lagged impacts of the exceptionally
loose monetary policies implemented by advanced economies on global economic activity
and inflation. If the global economy faces a faster-than-expected recovery in the upcoming
period, inflationary pressures may arise sooner than envisaged in the advanced economies.
Materialization of such a scenario would mean a tightening by using policy rates as well as
reserve requirements against higher global policy rates and demand-pull inflationary
pressure.
As I have previously emphasized, the outlook for oil and other commodity prices remains
uncertain. Should the increases in commodity prices persist and impose risks on achieving
medium-term inflation targets, additional tightening may be implemented sooner than implied
by the baseline scenario. However, given that higher oil prices will also worsen the current
account balance, a possible policy response will consider macro financial risks as well.
Therefore, the exact content of the adopted policy mix may vary depending on the outlook for
external demand, capital flows and the credit growth.
Esteemed Guests,
We will continue to monitor fiscal policy developments closely while formulating our monetary
policy strategy. Our inflation forecasts assume that the ratio of fiscal expenditures to GDP will
evolve as projected in the MTP. A revision in the monetary policy stance may be considered
should the fiscal stance deviate significantly from this framework, and consequently has an
adverse effect on the medium-term inflation outlook. Increasing government saving, thus
sustaining fiscal discipline, under current circumstances is essential to control the current
account deficit driven by the divergence between domestic and external demand. Therefore
saving the extra tax revenues driven by the stronger-than-expected economic activity would
not only reduce financial stability risks, but also enhance the effectiveness of the new policy
mix.
Monetary policy in the period ahead will continue to focus on building price stability on a
permanent basis. To this end, the impact of the macroprudential measures taken by CBRT
and other institutions on the inflation outlook will also be assessed carefully. Fulfilling the
commitment to maintain fiscal discipline and strengthening the structural reform agenda in
the medium term would contribute to the improvement of Turkey's sovereign risk, and thus,
enhance macroeconomic stability and the price stability. Maintaining fiscal discipline will also
provide more room for monetary policy maneuver and support the social welfare by keeping
interest rates permanently at low levels. I would like conclude my remarks by reiterating that
implementation of the structural reforms envisaged by the MTP and the European Union
accession process remains to be of the utmost importance.
Thank you for your attention.