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 October 2013 Inflation Report, Ankara,
31 October 2013.
* * *
Distinguished Guests,
Welcome to the press conference held to convey the main messages of the Inflation Report.
I will now present an overview of the report, which will be published on our website soon.
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 ten boxes
entailing interesting and up-to-date analyses on various topics. I strongly recommend that
you read these boxes, which will soon be published on our website.
Now, I would like to convey the main messages of the report. Firstly, I will review the
global economic outlook given its undeniable influence on our policies.
Global monetary policy developments continued to influence financial markets in the third
quarter of the year. Ongoing concerns over global growth led to expectations that the US
Federal Reserve might soon start trimming its bond purchases, while the pullback on
bond purchases was postponed later on, causing the global risk appetite to remain
volatile (Chart 1.1). Emerging economies witnessed capital outflows since the Fed's first
signal for tapering off bond purchases in May (Chart 2). In this period, all financial assets
have been re-priced on a global scale.
As global economic activity remains weak, we expect uncertainties over global monetary
policies to linger for some time. While the US economic recovery is yet to stabilize, financial
volatilities and the recent budget battle have posed risks to the recovery by tightening
financial conditions. Despite some positive signs from the Euro Area economies, both the
high unemployment rate and problems in the credit transmission mechanism have caused
the economic outlook to remain weak. The fact that global monetary policies depend on high
frequency data releases as well as the course of economic recovery, and that those data and
recovery indicators are volatile, cause the uncertainties about global monetary policies to
persist.
1. Monetary policy and monetary conditions
Elevated uncertainties regarding global monetary policies since May led the CBRT to adopt a
cautious monetary policy that took into account both inflation indicators and macro financial
risks fueled by global uncertainties. Accordingly, we continued to implement additional
monetary tightening to contain the negative effects of rising inflation on the pricing behavior.
In August, to enhance the effectiveness of the additional monetary tightening, the Bank
widened the interest rate corridor by raising the overnight lending rate from 7.25 percent to
7.75 percent. In addition, the effective liquidity management helped short-term rates to be
realized close to the upper band of the corridor. Hence, a front-loaded monetary tightening
was implemented in the same period, which compensated for the distortion in inflation
expectations. As of August, we decided to enhance the predictability of the Turkish lira
liquidity policy in order to limit the impacts of global monetary policy uncertainties on the
domestic economy. To this end, we adopted a strategy of reducing interest rate uncertainty
by creating a framework where the relationship between global interest rates and domestic
interest rates has largely weakened and market rates have become more sensitive to
domestic macroeconomic developments as they should be.
In the third quarter, we continued to provide the market with foreign exchange liquidity via
foreign exchange selling auctions, which fed into the growing Turkish lira liquidity deficit in
the market (Chart 3). We cut the share of one-week repo in total funding in this quarter,
which led to an increase in the share of funds from overnight and monthly lending facilities.
Correspondingly, the CBRT's average funding rate and the BIST interbank overnight repo
rate increased (Chart 4).
Moreover, in line with its strategy of enhancing the predictability of liquidity management, we
have been sharing more information about the frequency and timing of the additional
tightening since August. Recently, due to our cautious monetary stance, the Interbank Repo
Market rates have been mostly hovering between 6.75 and 7.75 percent. We are able to
control the interest rates in the money market via various policy instruments through an
efficient liquidity management and affect the money market rates in the favored direction and
to the required extent. Accordingly, I would like to underline that in addition to the average
funding cost, Interbank Repo Market rates shown in the chart should be closely monitored for
a better assessment of the monetary policy stance.
We will gradually raise this predictability of the monetary policy in the period ahead and
ensure that interest rates in the Interbank Money Market to hover around 6.75 percent except
the days on which the EPS is implemented. To enhance predictability in the funding strategy,
we will limit the stock amount of the weekly funding we provide through the quantity auction
method at 4.5 percent, not to exceed TL 10 billion until the year-end. Moreover, issues
regarding the implementation procedures besides the funding amount to be made under this
method as of 2014 will be elaborated on in the Monetary and Exchange Rate Policy for 2014
to be published in December 2014.
Under this outlook with a gradual increase in predictability, I would like to remind you that our
monetary policy will remain cautious until the inflation outlook becomes consistent with the
medium-term projections.
In the third quarter, interest rates were down from the previous reporting period across all
maturities, with a larger decrease in the shorter end, while the yield curve trended upwards
(Chart 5). This is due to the slightly improved global risk sentiment and Turkey's falling
country risk premium as well as the CBRT's monetary policy strategy to reduce interest rate
uncertainty which had a greater impact on short-term rates. Meanwhile, 2-year real rates
declined on falling nominal rates and rising inflation expectations (Chart 6).
Loan rates that trended down in the first half of 2013 started to go up by the third quarter
(Chart 7). This quarter-long uptrend reflects global financial developments and the CBRT's
July and August tightening of overnight lending rates via the interest rate corridor. Moreover,
deposit rates, currency swap rates, the CBRT's average funding rate as well as bill and bond
rates issued by banks, which all represent the Turkish lira funding costs of banks, increased
as well in the same period (Chart 8).
After a more robust first half compared to the average of past years, loan growth has come
down to levels similar to the average of those years as of August (Chart 9). Rising loan rates
due to recent financial fluctuations and our cautious monetary stance have contributed to this
slowdown. Yet, the annual rate of loan growth still recorded a striking 25 percent in the third
quarter (Chart 10). We envisage the cautious monetary stance, recent macroprudential
measures and weak capital inflows to bring the loan growth rates gradually to more plausible
levels in the forthcoming period.
The current policy framework has a favorable impact on the current account balance. After
hitting an all-time high at the end of 2011, the current account deficit saw a major correction
in 2012. Although there has been some deterioration in the 12-month cumulative current
account deficit since early 2013, this is largely due to the gold market dynamics, which is a
temporary factor. In terms of the current account balance excluding gold, the correction that
started in 2012 has continued into 2013, albeit more slowly (Chart 11).
We expect real exchange rate and credit developments to support the economic rebalancing
over the upcoming period. The real effective exchange rate depreciated after the recent
nominal exchange rate developments and largely retreated from the levels that can be called
excessively overvalued (Chart 12). We expect the current account balance to correct further
in the forthcoming period amid expectations for a more acceptable rate of loan growth, a
moderate final domestic demand growth and developments in the real exchange rate. This
will cushion the Turkish economy against the potentially high levels of global uncertainty in
the upcoming period by strengthening its financial stability and supporting the re-balancing
process.
In sum, uncertainty continued to reign over financial markets in the third quarter of 2013 and
financial conditions tightened (Chart 13). The tightening of the index is mostly due to weak
capital inflows, rising loan rates and higher market rates.
2. Macroeconomic developments and 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.
Annual consumer inflation fell by 7.9 percent in the third quarter of 2013, slightly
overshooting the July Inflation Report forecasts (Chart 14). This overshooting was mainly
attributed to a weaker Turkish lira and higher unprocessed food prices. As a result, the main
inflation indicators increased as well (Chart 15).
The higher-than-projected inflation in the previous quarter was largely induced by the
additional depreciation in the Turkish lira (Charts 14 and 15). I think it shall be useful to
inform you about how the exchange rate assumptions are made in the Inflation Report.
Traditionally, the Inflation Report takes the exchange rate realizations during the reporting
month as given for the current quarter, and adopts a framework where exchange rates
respond endogenously to the monetary stance and other economic developments
Accordingly, the exchange rate estimations are based on the July average in the
afterwards.
July Inflation Report. The Turkish lira depreciated following the July Inflation Report, and this
depreciation caused inflation to be higher than projected in the third quarter. This additional
depreciation put an upward pressure of about 0.4 points on the end-2013 inflation forecast.
Exchange rate developments affect core inflation via prices of core goods (Chart 16).
Services inflation went up in the third quarter as well, but remained relatively more stable.
Accordingly, core inflation indicators displayed an upward trend (Chart 17).
Now, I would like to talk about developments in economic activity and the short-term outlook,
on which the inflation forecasts are based. Economic activity was more favorable in the
second quarter of 2013 compared to the outlook set in the July Inflation Report. The
stronger-than-expected economic activity was mostly driven by changes in inventories.
Private consumption demand saw a dramatic recovery, while final domestic demand
remained almost flat due to slowing public demand (Chart 18). On the other hand, imports
grew strongly, while exports increased only modestly due to weak global demand.
Indicators for the third quarter of 2013 suggest that economic activity will grow more
moderately than in the second quarter. In the July-August period, production of consumer
goods was down from the previous quarter, while imports of consumer goods continued to
rise. On the investment side, indicators show a weaker outlook compared to consumption
demand. While exports were flat, imports saw a remarkable decline. Therefore, we expect
the negative contribution of net exports to growth to decrease in the third quarter. Meanwhile,
the export-weighted global growth index remains virtually unchanged from the previous
reporting period (Chart 19).
Final domestic demand is likely to continue to recover modestly in the second half of the
year. Thus, we revised output gap forecasts slightly upwards for 2013. However, downside
risks to recovery increased following the latest financial developments. Accordingly, we
revised output gap forecasts downwards for 2014. We expect domestic demand
developments to support the downtrend in inflation and the improvement in current account
deficit in the months to come.
To sum up, a co-analysis of domestic and foreign demand reveals that forecasts are based
on an outlook in which the contribution of aggregate demand conditions to the end-2013
inflation has slightly increased compared to the previous reporting period. This revision drove
the end-2013 inflation forecast up by 0.1 points.
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.
Import prices remained below the assumptions of the July Inflation Report in the third
quarter. On the other hand, oil prices materialized slightly above the assumptions (Chart 20).
In line with the average futures prices in the first three weeks of October, the average
assumption for 2013, which was set as USD 107 in July, was revised upwards to USD 109.
This revision added 0.1 percentage points to the end-2013 inflation forecast.
We preserved our assumption for the annual rate of increase in food prices as 7 percent. In
other words, it was assumed that the recent unfavorable course of unprocessed food prices
would be temporary.
Before moving on to forecasts, I will talk about our assumptions regarding public finance.
Medium-term projections are based on the assumption that no additional tax adjustments will
be introduced to tobacco and energy products the rest of the year. Meanwhile, we assumed
other tax adjustments and administered prices would be consistent with the inflation targets
and automatic pricing mechanisms. Thus, there has been no change in the end-2013
inflation forecast stemming from the fiscal policy.
Regarding the fiscal policy stance, recently-revised MTP projections are taken as given.
Accordingly, we assumed that fiscal discipline would be preserved and the ratio of primary
expenditures to GDP would gradually decline starting next year.
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.
Medium-term forecasts perceive an outlook where a gradual increase in the predictability of
the monetary policy is continued. In addition, we envisage that the cautious stance of the
monetary policy is preserved and the liquidity policy remains tight and the annual growth rate
of credit will fall to 15 percent reference value by mid-2014 owing also to recent
macroprudential measures.
Accordingly, inflation is expected to be, with 70 percent probability, between 6.3 percent and
7.3 percent (with a mid-point of 6.8 percent) at end-2013 and between 3.8 percent and
6.8 percent (with a mid-point of 5.3 percent) at end-2014 (Chart 21).
As a result, we revised inflation forecasts for 2013 and 2014 upwards by 0.6 and
0.3 percentage points, respectively, in the inter-reporting period. 0.4 percentage points of the
revision in 2013 was led by exchange rate developments, while 0.1 percentage points
stemmed from the rise in average oil price assumption. Moreover, the output gap forecast,
which was revised upwards owing to the better-than-expected growth outlook for 2013
compared to the figures presented in the July Inflation Report, added 0.1 percentage points
to the year-end inflation forecast. Developments in the exchange rate and oil prices were
also influential on the revision in the inflation forecast for 2014. When evaluated together with
output gap forecasts, we expect these cost-side factors to push the inflation rate in 2014 up
by 0.3 percentage points.
Although inflation is estimated to fluctuate in the short term due to the base effect on energy
prices, we expect it to remain on a downward track. As the effects of the hike in tobacco
prices in January 2013 on annual inflation taper off, we expect inflation to plunge in early
2014, and come down to levels consistent with the target by the last quarter of 2014.
In addition to these forecasts, alternative scenarios on the inflation outlook and the global
economy are discussed 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.
Chart 1 Chart 2.
Global Risk Appetite
Portfolio Flows to Emerging Economies
(12-Week Moving Average, Billion USD)
Source: Bloomberg, Credit Suisse. Source: EPFR.
Chart 3 Chart 4.
CBRT Funding# (2-Week Average, Billion TL) Policy Rate and Liquidity Policies (Percent)
# Other CBRT funding includes primary dealer repo transactions, repo transactions at the BIST Repo and the Reverse
Repo Market and lending depo facility at the Interbank Money Market.
* 18 basis points were added to BIST Interbank Overnight Repo Rate. For BIST Interbank Repo Market overnight rates
see: http://borsaistanbul.com/veriler/verileralt/tahvil-ve-bono-piyasasi-verileri/piyasa-verileri
Source: BIST, CBRT.
Chart 5. Chart 6.
Yield Curve* 2-Year Real Interest Rates for Turkey*
(Percent) (Percent)
* Calculated as the 2-year discounted bond returns derived
from the
*Calculated from the compounded returns on bonds
quoted at the BIST Bonds and Bills Market by using ENS yield curve, minus the 24-month ahead inflation
method. expectations from the CBRT Survey of Expectations.
Source: BIST, CBRT. Source: BIST, CBRT.
Chart 7. Chart 8.
TL Loan Rates Funding Costs of Banks
(Percent) (Percent)
Source: CBRT. Source: PDP, CBRT.
Chart 9. Chart 10.
Growth Rate of Loans Annual Growth Rate of Loans
(Adjusted for Exchange Rate, 13-Week Average, (Percent)
Annualized, Percent)
Source: CBRT. Source: CBRT.
Chart 11. Chart 12.
Current Account Balance (CAB)* Real Effective Exchange Rate
(12-Month Cumulative, Billion USD)
(CPI based, 2003=100)
* Third quarter data includes July-August realization and The dotted lines show the 2 percent annual trend starting
September forecast. from June 2003=100 and June 2003=90.
Source: CBRT, TURKSTAT. Source: CBRT.
Chart 13.
Financial Conditions Index *
*For further details on financial conditions index, see CBT Research Notes in
Economics No.12/31.
Source: CBRT.
Chart 14. Chart 15.
July 2013 Inflation Forecasts and Realizations Inflation Forecast and Realizations Excluding
(Percent) Unprocessed Food, Tobacco and Alcoholic
Beverages (Percent)
* Shaded region indicates the 70 percent confidence interval * Shaded region indicates the 70 percent confidence interval
for the forecast. for the forecast.
Source: TurkStat, CBRT. Source: TurkStat, CBRT.
Chart 16. Chart 17.
Core Goods and Services Prices Core Inflation Indicators SCA-H and SCA-I
(Annual Percent Change) (Annual Percent Change)
Source: TurkStat. Source: TurkStat.
Chart 1.2.5. Chart 1.2.6.
GDP and Final Domestic Demand Export-Weighted Global Economic Activity Index*
(Seasonally adjusted, Billion TL, 1998 prices) (2008Q2=100)
Source: TurkStat, CBRT. * For methodology, see Inflation Report 2010-II, Box 2.1
"Foreign Demand Index for Turkey".
Source: Bloomberg, Consensus Forecasts, CBRT.
Chart 20.
Oil and Import Price Assumptions
Oil Prices (USD/bbl) Import Prices (USD, 2010=100)
* Shaded area indicates the forecast period.
* Shaded area indicates the forecast period.
Source: Bloomberg, CBRT.
Source: TurkStat, CBRT.
Chart 21.
Inflation and Output Gap Forecasts
* Shaded region indicates the 70 percent confidence interval for the forecast.