Durmuş Yilmaz: Press conference for the presentation of the inflation
report
Speech by Mr Durmuş Yilmaz, Governor of the Central Bank of the Republic of Turkey, at
the press conference for the presentation of the inflation report, Central Bank of the Republic
of Turkey, Ankara, 31 January 2008.
* * *
Distinguished Guests and Press Members,
Welcome to the press conference for the presentation of the Inflation Report that is one of
the most important communication tools of the formal inflation targeting regime that we
implement.
In this conference, I would like to give you a short summary of our evaluations and the
Central Bank's inflation forecasts which appear in the Inflation Report that will be posted on
our website shortly today.
1. An assessment of the year 2007
I would like to start by a general assessment of inflation developments in the year 2007.
The monetary tightening exercised since mid-2006, has been successful in leading to a
significant reduction in the underlying inflation. Especially the 3.6 percentage points fall in the
services inflation, which confirmed the marked disinflation trend during 2007, was
remarkable. The fall in headline inflation, however, was more limited, owing mainly to factors
beyond the control of monetary policy, such as developments in energy, food, and
administered prices. Accordingly, inflation realized as 8.39 percent at the end of 2007,
breaching the upper bound of the uncertainty band of 6 percent. On the other hand, annual
CPI inflation excluding food, energy and tobacco products was at 4.8 percent (Figure1).
Figure 1: Annual CPI Inflation and the Target Path
12
11
Annual Inflation
CPI excl. Food, Energy and Tobacco
Target Path
Uncertainty Band
109876543210
1205 0206 0406 0606 0806 1006 1206 0207 0407 0607 0807 1007 1207
Source: TURKSTAT, CBRT.
The course of food prices has been main factor slowing down the disinflation process. A
prolonged shortage of rainfall in Turkey since Autumn 2006 has resulted in low crop yields in
2007, which in turn translated to an adverse supply shock. Global developments, such as
increasing bio-fuel production, strong global demand for food and consequent rises in
agricultural commodity prices, further added to the domestic food inflation through the
external trade channel. These factors had an impact not only on unprocessed food such as
fresh fruit and vegetables, but also on processed food such as grain and dairy products.
Accordingly, annual food inflation maintained its high levels, with an end-year figure of 12
percent. Hence, food prices became the main factor impeding the disinflation process in
2007, with a marked contribution of about 3.4 percent on headline inflation. The contribution
of food prices to the headline inflation in 2007 was significantly higher than it had been in the
past three years (Figure 2).
Figure 2: Contribution to End-Year CPI Inflation
(Percentage Share)
Average of 2004-2006 2007
Food*
Others
24%
30%
Food*
41%
Others
49%
Energy
17%
Tobacco**
Tobacco** 10%
10%
Energy
* Food: Food and Non-Alcoholic Beverages
** Tobacco: Tobacco products and Alcoholic Beverages
Source: TURKSTAT, CBRT.
Another major factor slowing down the disinflation process in 2007 was the adverse
developments in energy and administered prices. The crude oil price in December 2007 was
nearly 50 percent above the levels registered at the end of 2006. This development, together
with the changes in special consumption tax on fuel products, led to a significant rise in
prices of fuel-oil products in 2007. Meanwhile, another energy item, housing water prices,
which is administered by municipalities, edged up in the last quarter of 2007, partly owing to
the drought conditions. Overall, 1.6 points of the headline inflation resulted from the energy
price hikes, where the contribution of administered component outweighs that of the oil price
(Table 1). While food, energy and tobacco products displayed significant increases in 2007,
the fast pace of disinflation in services and core goods excluding food, energy and tobacco in
2007, confirms that supply side shocks were mainly responsible for the breach of the
uncertainty band (Figure 3).
Figure 3: Subcomponents of CPI
(Annual Percentage Change)
20
2006 2007
18
16
14
12
1086420
Energy Food* Tobacco** Goods Excl. Services
Food, Energy
and Tobacco
Source: TURKSTAT, CBRT.
Table 1: Contribution to Annual CPI Inflation (Percentage Points)
Goods Excl.
Food, Energy
Energy Food* Tobacco** Tobacco Services
2007 1.57 3.42 0.87 0.24 2.28
2006 1.51 3.09 0.28 1.43 3.33
* Food: Food and non-alcoholic beverages
** Tobacco: Tobacco products and Alcoholic beverages.
Source: TURKSTAT, CBRT.
Distinguished Guests,
Elevated prices of crude oil, agricultural products and other commodities exert inflationary
pressures all over the world. Recently, both the developed and emerging economies have
been facing a rise in inflation. Inflation in Turkey followed a more favorable trend in 2007
compared to other emerging economies under inflation targeting, notwithstanding the
administrative price hikes in November, which added by about 1-percentage point to the
Turkish CPI inflation. During the past year, inflation in Turkey declined to 8.4 percent from
9.7 percent, while the average of inflation in emerging market economies under inflation
targeting rose from 3.4 percent to 5.1 percent (Figures 4&5). Among the mentioned
economies, only 4 countries experienced a decline in inflation in 2007, including Turkey,
which recorded the highest rate of decline. In other words, Turkey was the country with the
largest rate of decline in inflation, in comparison with other economies in this group.
Figure 4: Commodity Prices
Commodity Prices Metal Prices
420
620
Energy Prices (right axis) Agriculture prices (right axis)
380
580
540
340
500
300
460
5
420
260
380
220
340
300 180
17-01-200611-05-200605-09-200628-12-200625-04-200717-08-200711.12.2007
Source: Goldman Sachs.
Figure 5: International Developments in Inflation:
Inflation in the USA, Euro Zone, and Emerging Economies Implementing Inflation
Targeting
b. Inflation Gap Between Turkey and Other Emerging
a. Inflation Rates*
Economies under Inflation Targeting *
9
USA
Euro Zone
6
8
Infl. Targeting
7
5
6
4
5
3
4
3
2
2
1
1205 0206 0406 0606 0806 1006 1206 0207 0407 0607 0807 1007 1207
1205 0206 0406 0606 0806 1006 1206 0207 0407 0607 0807 1007 1207
*The sample of emerging economies under inflation targeting covers Brazil, Czech Republic, Colombia, Philippines, South Africa, Israel, Hungary,
Mexico, Peru, Poland, Romania, Chile, Slovakia and Thailand.
Source: Web sites of related countries' central banks.
2. Monetary policy reaction and outcomes
Distinguished Press Members,
The monetary tightening exercised since June 2006 has had a manifest impact on private
sector demand for the last one and a half year (Figures 6&7). In the first three quarters of
2007, the Gross National Product (GNP) increased by merely 4 percent, remaining at a level
lower than previous years. Sorting out the underlying dynamics of growth developments is
critical in shaping monetary policy decisions. It should be emphasized that while the limited
GDP growth compared to previous years can be attributed essentially to the impact of
monetary tightening; the marked contraction in the agricultural sector also had a significant
influence, especially on the reduced growth rate in the third quarter. In other words, the
slowdown in growth resulted partially from the supply shock. As I have emphasized at the
beginning of my speech, the contraction in the agricultural sector did not only affect the
growth unfavorably, but it also pushed inflation up for a temporary period in 2007.
Figure 6: Private Final Consumption
(Real, quarterly, seasonally adjusted)
26000
Monetary Tightening
25000
24000
23000
22000
21000
20000
2005-I 2006-I 2007-I
2005-II 2006-II 2007-II
2005-III 2006-III 2007-III
2005-IV 2006-IV
Source: TURKSTAT, CBRT.
Figure 7: Contributions to Annual GDP Growth
(Percentage Points)
20 Final Domestic Demand
Net Exports
15
GDP
10
5
0
-5
2005-I 2006-I 2007-I
2005-II 2006-II 2007-II
2005-III 2006-III 2007-III
2005-IV 2006-IV
Source: TURKSTAT, CBRT.
Despite the unfavorable developments in food prices, almost a year after monetary
tightening, core inflation indicators displayed a significant deceleration starting from the
second quarter of 2007. The effects of tightening were clearly visible on the prices of durable
goods and services consistent with the slowdown in the economic activity in the related
sectors. The weaker demand, coupled with a strong domestic currency, helped durables
inflation to come down significantly (Figure 8). In this respect, services inflation also eased
remarkably, declining by 3.6 percentage points throughout 2007. The improvement in
services inflation spread across all sub-items. Especially, the fall in rent inflation, the stickiest
component of services inflation, was significant (Figure 9).
Figure 8: Durable Goods Prices
(Annual Percentage Change)
18
15
129630
-3
Durables (Excl.Gold)
-6
Furniture
-9 Electrical&Non-Electrical Appl.
Automobile
-12
0106 0406 0706 1006 0107 0407 0707 1007
Source: TURKSTAT, CBRT.
Figure 9: Services Group Sub-Items
(Annual Percentage Change)
20
2006
2007
16
12
8
4
0
Transport Rent Other Services
Services RestaurantsHotels
Source: TURKSTAT, CB.
The significant deceleration in the core inflation indicators set the ground for a relatively less
restrictive monetary policy. Hence, we decided to start the measured easing cycle in
September 2007 with a 25 basis-points cut, while continuing with 50 basis-points in the
consecutive three meetings. At this point, I have to underscore that monetary policy
remained restrictive even after these rate cuts. Nevertheless, we underlined the need to
remain cautious against the risks related to potential second round effects of food and
energy prices as manifested in the sticky inflation expectations; and reduced the pace of rate
cuts in January 2008. Consequently, policy rates were lowered by 200 basis points in the
period between September 2007 and January 2008 (Table 2).
Table 2: Monetary Policy Decisions in 2007 and 2008
MPC Meeting Dates Interest Rate Decisions Interest Rates
16 January 2007 No Change 17.50
15 February 2007 No Change 17.50
15 March 2007 No Change 17.50
18 April 2007 No Change 17.50
14 May 2007 No Change 17.50
14 June 2007 No Change 17.50
12 July 2007 No Change 17.50
14 August 2007 No Change 17.50
13 September 2007 -0.25 17.25
16 October 2007 -0.50 16.75
14 November 2007 -0.50 16.25
13 December 2007 -0.50 15.75
17 January 2008 -0.25 15.50
Source: CBRT.
Both the 12-month and 24-month ahead inflation expectations exhibited a declining pattern
throughout 2007 (Figure 10). However, the improvement in expectations, especially in the
last quarter, was rather limited, owing to backward looking behavior, and possibly due to
preannounced hikes in administered energy prices. Nevertheless, it is worthwhile to mention
that the administrative price hikes in November had little effect on medium-term inflation
expectations, despite the upward revision in the year-end inflation expectations. This
observation shows that inflation target, to a significant extent, continue to serve as an anchor
and that economic agents expect the disinflation process to continue in the medium term.
Nevertheless, the fact that currently medium-term inflation expectations are significantly
above our medium term target of 4 percent necessitates a cautious policy stance1.
Figure 10: Medium-Term Inflation Expectations*
9
12-Month 24-Month
8
7
6
5
4
0105 0305 0505 0705 0905 1105 0106 0306 0506 0706 0906 1106 0107 0307 0507 0707 0907 1107 0108
Expectations regarding the period after 24 months have been published since May 2006.
Source: CBRT.
3. Inflation and monetary policy outlook
Distinguished Guests and Press Members,
After summarizing inflation and monetary policy developments in 2007, in this part of my
speech, I would like to share our evaluations on inflation and the monetary policy outlook.
First of all, I would like to summarize several factors that might enable the disinflation
process to continue in the upcoming period:
Annual percentage change in CPI excluding food, energy and tobacco imply an inflation
trend of 4.8 percent (Figure 11)2. In other words, underlying inflation in the past year was not
far away from the medium-term targets. Therefore, under the assumption that oil and food
inflation will follow a more benign path in 2008 than 2007, we expect some contribution to
disinflation from the base effects.
Figure 11: Response of Inflation to Monetary Tightening
18 11
10
17
9
16
8
15
7
14
6
13
5
Policy Rates
12
4
H (right axis)
11
3
H exc. Processed Food (right axis)
10 2
1205 0206 0406 0606 0806 1006 1206 0207 0407 0607 0807 1007 1207
H: Unprocessed food, energy, alcohol beverages-tobacco, and gold excluded CPI.
Source: TURKSTAT, CBRT.
We believe that existing supply and demand conditions continue to support disinflation. The
sharp slowdown in the second half of 2006 created an ample slack in the economy (Graph
12). Although domestic demand showed some signs of recovery in the second half of the
year 2007, the pace of economic activity does not appear to be fast enough to eliminate the
output gap. Moreover, the uncertainty created by the ongoing difficulties in the mature credit
markets is expected to hold back the domestic consumer and investment spending in the
forthcoming period. Accordingly, our medium term projections are constructed under the
assumption that demand and capacity conditions contribute to the disinflation process
throughout 2008.
Figure 12: Output Gap
6
4
2
0
-2
-4
Monetary Tightening
-6
-8
-10
00-I 01-I 02-I 03-I 04-I 05-I 06-I 07-I
00-III 01-III 02-III 03-III 04-III 05-III 06-III 07-III
Monetary conditions continue to support the disinflation process. Despite the recent rate
cuts, monetary policy can still be considered to be in the restrictive territory. Underlying rate
of monetary expansion remains modest, consistent with a relatively restrictive monetary
stance. Although medium term interest rates followed a downward trend in the past quarter,
2-year-real rates at this point fluctuate between 9 and 10 percent, implying a
nonaccommodative monetary stance. Moreover, the currency remains strong, curbing
inflationary pressures and easing the impact of rising commodity prices on domestic
production costs. (Figure 13).
Figure 13: Real Interest Rate and Real Exchange Rate*
200 14
190 13
180 12
170 11
160 10
150 9
Real Exchange Rate (Left Axis)
140 8
2-year Real Interest Rates
130 7
120 6
0106 0306 0506 0706 0906 1106 0107 0307 0507 0707 0907 1107
*Real interest rates are computed by using the Expectations Survey and 2-year nominal rate estimated
with Extended Nelson-Siegel method. Real exchange rate is CPI based (an increase means an
appreciation).
Source: CBRT.
Credit data also confirm that monetary conditions are still non-accommodative. Annual
growth rates in the automobile and housing loans are at much lower levels compared to the
periods of vigorous domestic demand (Figure 14). Following the significant slowdown in the
second half of 2006, consumer credits showed signs of recovery after the first quarter of
2007 (Table 3). However, we expect the cautious monetary policy stance and the tightening
in global credit conditions are likely to restrain credit expansion in the forthcoming period.
Figure 14: Selected Sub-items of Consumer Loans
(Annual Percentage Change)
450 570
Housing
400
470
Automobiles (right axis)
350
300 370
250
270
200
150 170
100
70
50
0 -30
07/05 10/05 01/06 04/06 07/06 10/06 01/07 04/07 07/07 10/07 01/08
Table 3: Consumer Loans and Claims From Credit Cards
(Quarterly Real Percentage Change)
2006-II 2006-III 2006-IV 2007-I 2007-II 2007-III 2007-IV
Consumer Loans 20,0 1,5 3,6 2,6 9,0 10,0 6,6
Housing 22,8 0,9 2,2 2,7 7,5 10,2 5,4
Automobile 5,1 -6,4 -5,0 -8,9 -3,4 -2,0 -1,4
Other 24,3 6,0 8,9 6,6 14,5 12,8 9,9
Credit Cards 6,8 2,1 2,1 -1,6 7,7 2,4 3,2
Source: CBRT.
External demand conditions are also expected to contribute to disinflation in 2008. Recent
data on global economic activity suggest that world economic growth is likely to moderate in
the forthcoming period, increasing the downside risks on external demand. Accordingly, our
medium term outlook is constructed under a baseline scenario of gradual slowdown in
external demand.
Esteemed Press Members,
Overall, we expect aggregate demand conditions to support the downward trend in the
underlying inflation, i.e., inflation excluding items beyond the control of monetary policy such
as energy, food and tobacco prices. Hence, barring new supply shocks, headline inflation
should continue to move towards the target. The speed of the convergence to the target,
however, will depend mainly on the course of food and energy prices.
Distinguished Guests,
Our forecast in the 2007 October Inflation Report incorporated two main assumptions: The
assumption for oil price was set as 70 USD per barrel. Observing the high base created by
the unusually elevated food prices in 2006, we assumed food inflation to correct towards the
values consistent with medium term inflation in 2007. However, food and energy inflation
turned out to be more persistent than we had envisaged, as the prices of oil and agricultural
commodities continued to rise throughout 2007. These developments not only led to an
undershooting of our inflation projections for end-year 2007, but also necessitated an upward
revision in our medium term
forecasts.
In this framework, we revised our assumption for oil prices from USD 70 to USD 85 per
barrel in 2008. Higher oil price assumption added about 0.5 percentage points to the
end2008 inflation forecasts. Moreover, the first round impacts of the recent hikes in end-user
electricity and natural gas prices on end-2008 inflation are expected to be around 0.6
percentage points, which is higher than what we assumed in the previous Inflation Report.
Meanwhile, considering the lagged impacts of last year's drought and elevated prices of
agricultural commodities in global markets, we now envisage that the price increases in
processed food will persist for a while and the inflation in this item will stay at relatively high
levels throughout 2008, albeit a slight decline.
Upside revisions on the assumptions for food and energy inflation imply that it may take
longer to bring headline inflation to 4 percent than envisaged in our previous Inflation Report.
Therefore, in the absence of a significant correction in food inflation, headline inflation will
most probably exceed the target level of 4 percent at the end of 2008.
Figure 15: Forecasts for Inflation and Output Gap
Forecast Range* Medium-term Target
Uncertainty Band for 2008 Output Gap
12
Percent
1086420
-2
-4
-6
2007- 2008- 2009-
2008-I 2009-I
2008-II 2009-II
2007-III 2008-III 2009-III
*The shaded region indicates the 70 percent confidence interval for forecast.
Within the framework that I have drawn up so far, we forecast inflation, with 70 percent
probability, to be between 4.1 percent and 6.9 percent (midpoint 5.5) at the end of 2008, and
between 1.8 percent and 5.5 percent (midpoint 3.7) at the end of 2009 (Figure 15). The
forecasts are based on the scenario in which policy rates display a limited decline in 2008.
Main message of the forecast is that continuation of the gradual easing cycle that started in
2007 September will remain conditional on favorable data and developments. In that sense,
the current policy stance envisages a more moderate decline in policy interest rates than
indicated in the previous Inflation Report.
I would like to emphasize once more that any new data or information on the inflation outlook
may lead to a revision in the future policy stance of the Central Bank. Therefore, the policy
path that was indicated above should not be perceived as a commitment on behalf of the
CBRT.
4. Risks and monetary policy
Distinguished Guests,
I would like to dedicate the last part of my speech to the upside and downside risks to the
inflation and monetary policy outlook in the upcoming period.
The main upside risk factor for the current medium term inflation outlook pertains to the
potential second round effects of the accumulated supply shocks, which may also create a
higher than expected inflation inertia, as currently manifested in the medium term inflation
expectations. So far, the second round impact of food prices has been limited and confined
to selected sub-components of the overall index such as restaurants and catering services.
The potential second round impact of elevated food and energy prices, however, on overall
economy should not be overlooked. Therefore, the CBRT will keep a close eye on the price
setting behavior along with various core inflation measures. In the upcoming period, the
Central Bank will tolerate the first-round impacts on inflation resulting from food, energy and
one-off adjustments in administered prices, yet remain responsive to the second round
effects such as possible deterioration in general pricing behavior.
The Central Bank closely monitors the developments in global markets. The potential impact
of ongoing difficulties in the US credit markets, on the financial markets and the real
economy, continue to create uncertainty about the course of the global economy. Our
baseline scenario assumes a soft landing in developed economies, with no major portfolio
shock on the Turkish financial markets. However, the probability of a sharper than expected
slowdown should not be ruled out. While the possibility of a sharper-than envisaged
slowdown in global economic activity, through its potential impact on the exchange rates,
may constitute an upside risk for the short term inflation outlook, it also poses downside risks
for inflation in the medium term through a possible weakening in external demand and
domestic credit.
It should be underlined that fiscal discipline of the past several years, by reducing the
longterm risk premium, has been the key force allowing the achievement of robust output growth
during a remarkable disinflation period. In that sense, I believe it is useful to emphasize once
more that maintaining the prudent fiscal policy during an episode of worsening risk appetite is
even more critical for preserving the resilience of the economy.
Our medium term projections are based on the assumption that government expenditure
targets will be met in 2008. Moreover, we assume that any extra need to readjust the primary
budget balance will be implemented primarily through expenditure cuts rather than hikes in
indirect taxes. Therefore the medium-term outlook that I mentioned above does not envisage
major shocks arising from administered price adjustments, except the hikes in electricity and
natural gas in January 2008. It should be kept in mind that any deviation from this
assumption may alter the inflation and monetary outlook.
The recent increase in end-user energy prices may continue to exert some temporary
upward pressure on headline inflation in the coming months. However, these adjustments
will also support lower inflation in the medium term as they contribute to a prudent fiscal
stance and facilitate an expansion of the domestic energy production. Hence the central
bank's policy will not to react to these price adjustments, except to contain second-round
effects.
Developments in food prices are still considered as an important risk to the short-term
inflation outlook, as food items constitute more than one fourth of the CPI basket. The course
of food inflation is highly dependent on domestic weather conditions as well as global
developments. In the medium term, there is a significant chance of a downward correction in
unprocessed food inflation, especially given the base effect created by the last two years'
elevated food prices. On the other hand, it is also possible that global developments and
increasing demand for certain food items may continue to push up the food prices.
Therefore, food prices continue to pose risks to the inflation outlook on both sides.
So far, Turkish economy has been resilient to reappraisal of risks in global financial markets.
The support of fiscal policy and structural reforms are critical in shielding the economy
against possible further deterioration in global sentiment. In this respect, the European Union
accession process and the implementation of structural reforms envisaged in the economic
program remain crucial. Finally, I would like to conclude my speech by mentioning that
advances in structural reforms enhancing the quality of fiscal discipline and raising
productivity are monitored closely with regard to their implications on macroeconomic and
price stability.
Thank you.