Durmuş Yilmaz: Press conference for the presentation of the Inflation
Report
Press conference by Mr Durmuş Yilmaz, Governor of the Central Bank of the Republic of
Turkey, at the presentation of the Inflation Report, Ankara, 29 April 2010.
* * *
Distinguished Guests and Members of the Press,
Welcome to the press conference held to convey the main messages of the April 2010
Inflation Report, one of the most important communication tools of the inflation-targeting
regime of the Central Bank.
The report typically summarizes the economic framework addressed in monetary policy
decisions, elaborates global and domestic macroeconomic developments and presents the
medium-term inflation forecasts, which have been revised in view of previous quarter
developments, along with the monetary policy stance.
Before moving on to the Central Bank's assessments on the inflation outlook and economic
activity, which I will share with you in detail shortly, I would like to summarize the current
global conditions. The recovery in global economic activity and the normalization of the
international financial system have continued during the first quarter of 2010 (Figure 1).
However, distressing levels of government debt, lingering problems across credit markets,
and high levels of unemployment rates, all suggest that completely resolving problems
across developed economies is not likely over the near term (Figure 2). Although the
recovery across developing economies seems to be stronger, ongoing problems across
developed economies - with their prominent role in global trade - still create downside risks
for developing economies. Moreover, constraints related to external finance remains as a
potential factor that might delay the recovery in many developing economies.
Notwithstanding the lingering uncertainties regarding medium-term growth, developing
economies faced inflationary pressures stemming from a relatively rapid rebound in
economic activity, base effects, and ongoing increases in commodity prices. In this regard,
inflation dynamics in developed and developing countries have started to decouple since the
first quarter of 2010 (Figure 3). This decoupling is more pronounced in core inflation
(Figure 4).
1. Inflation developments
The inflation outlook in Turkey changed in line with the developments I have just mentioned
pertaining to developing countries. However, in addition to these factors, the rise in inflation
can largely be attributed to the high-rates price increases linked to the January tax hikes in
fuel, alcoholic beverages and tobacco products. Moreover, the rate of change in unprocessed
food prices also led the rise in inflation in Turkey to be relatively more pronounced.
Therefore, annual consumer inflation continued to rise and pushed inflation up by around
3 percentage points to 9.56 percent during the first quarter of 2010, compared to figures of
end-2009 (Figure 5).
An analysis of the subcategories with respect to the rise in inflation indicates that
unprocessed food prices displayed the highest quarterly increase in the index history in the
first quarter of 2010, as was the case in the last quarter of 2009 (Figure 6). This increase is
mainly attributable to the hikes in meat prices. Structural reasons led domestic supply to fall
resulting in a remarkable increase in livestock prices. This hike, in turn, had significant effects
on both processed and unprocessed food prices (Figure 7).
Thus, the contribution of meat and meat products to annual inflation reached 1.67 points by
March. This reflects a situation mainly exclusive to Turkey. As a matter of fact, as illustrated
in the slide, meat prices went up by 35 percent in Turkey within the last year, while no
significant change was observed in meat prices in other countries (Figures 8 and 9).
Along with the surge in meat prices, vegetable prices increased to relatively high levels and
led the trend of increase in food prices to become more pronounced. As a consequence, in
the first quarter, food group inflation realized above our projections presented in the January
Inflation Report.
Meanwhile, energy prices registered a significant increase in the first quarter of 2010 due to
the January tax adjustments and the low base effect generated by plummeting prices in the
same period of 2009 (Figure 10). We estimate that owing to the base effect, annual inflation
in the energy group will continue to rise in the second quarter of 2010 as well. Accordingly,
due to tax adjustments and price hikes in food, energy and tobacco, the contribution of food,
energy and tobacco products to annual inflation has reached 6.7 percentage points by the
end of the first quarter (Figure 11).
The impact of soaring food and energy prices on catering and transport services became
more significant in the first quarter of 2010 (Figure 12). Consequently, annual services
inflation, which has been declining since the third quarter of 2008, increased by
1.9 percentage points in the first quarter of 2010. Seasonally adjusted data also indicate that
price increases in the services group accelerated compared to the previous quarter
(Figure 13).
The low base of the previous year caused by the tax cuts in durable goods and the inventory
destocking process have been major factors accounting for the increase in core inflation
indicators (Figure 14). Reverberations of the rise in cost factors and the limited rebound in
demand are also seen in the seasonally adjusted data (Figure 15).
Parallel to these developments, medium-term inflation expectations, which started to
increase in the last quarter of 2009, maintained this trend in the first quarter of 2010
(Figure 16). While expectations displayed an increase in all maturities, the difference
between expectations and targets became wider (Figure 17). However, the increase in
medium-term expectations remained relatively limited.
2. Monetary policy response
After commenting briefly on inflation developments, I would now like to cover the policies
pursued by the Central Bank during the last quarter.
Anticipating that inflation would decrease sharply following the last quarter of 2008, the
Central Bank of Turkey (CBT) focused on alleviating the potentially harsh impact of the
global financial crisis on the domestic economy. In this respect, the CBT has delivered
sizeable cuts in policy rates, while providing liquidity support to facilitate the smooth
operation of credit markets. Accordingly, policy rates were cut by 1025 basis points between
November 2008 and November 2009. Considering the favorable developments in credit
markets and the moderate recovery in economic activity, the Monetary Policy Committee (the
Committee) has kept policy rates constant since December 2009 (Table 1).
Following the policy rate cuts implemented by the CBT since November 2008, market rates
have plummeted to historic lows since the second quarter of 2009 (Figure 18). The stable
course of market rates had implications on medium-term real rates in this period (Figure 19).
Lower policy rates and stabilizing liquidity measures continued to be effective on money and
credit markets during the first quarter of 2010. In this context, while consumer loan rates
remained at historic lows, commercial loan rates continued to decline in the first quarter as
well (Figure 20). With the easing of financial conditions, the expansionary impact of CBT's
monetary policy has become more pronounced in this period.
As I have just mentioned, the pronounced elevation in inflation since the last quarter of 2009
had adverse effects on inflation expectations. Therefore, taking account of the adverse
effects of the high inflation levels on expectations, albeit temporary, the Central Bank
signaled the transition to a more cautious stance as of March. Meanwhile, considering that
the problems in the global economy have not been completely eliminated despite recent
improvements, I would like to remind you that as we have already pointed out, policy rates
may need to be kept at current levels for a while and may need to follow a low course for an
extended period.
In the first quarter of 2010, central banks mostly implemented exit strategies from
expansionary monetary policies and therefore the global monetary policy outlook became
partially tighter. In the said quarter, a limited number of central banks tightened their
monetary policy stance by increasing policy rates, while most of them kept their rates
unchanged at low levels. In the meantime, these central banks started to terminate the
expansionary monetary policy implementations, which are conducted with the use of
unconventional policy tools. Accordingly, while drawing attention to the risks regarding
pricing behaviors and taking account of the normalization in both money and credit markets;
we decided to gradually withdraw some of the measures taken in the foreign exchange and
Turkish lira markets during the crisis. Owing to the importance that we attach to transparency
and predictability, I would like to remind you that we informed the public about the general
framework of our exit strategy in our Press Release of 14 April 2010, before putting the
strategy into practice.
3. Inflation and monetary policy outlook
Now, I would like to share with you the monetary and financial conditions, as well as the
economic outlook underlying our forecasts. Then, I will outline the Central Bank's inflation
forecasts presented in the Inflation Report that will be posted on our website shortly.
In the first quarter of 2010, as perceptions regarding recovery in the global economy became
more pronounced, the trend of increase in risk appetite in global financial markets continued.
Accordingly, as had been the case since the second half of 2009, emerging markets
attracted more capital through increased portfolio movements. On the other hand, risk
premium indicators in most developing countries remained below those of pre-crisis levels. In
this period, Turkey's risk premium indicators continued their positive trend and did not
differentiate from the general trend except for short periods when developments specific to
our country were pronounced (Figure 21).
The improvement in global risk perceptions in the first quarter led the currency of many
developing countries to appreciate. In terms of changes in currency values, the Turkish lira
did not significantly differ from currencies of other emerging markets in this period and the
relatively stable course of the Turkish lira in the crisis period continued throughout the
postcrisis process as well (Figure 22).
National income data of the last quarter of 2009 were consistent with the outlook we
presented in the January Inflation Report. In this period, while the mild recovery in private
sector demand continued, public sector consumption expenditures increased more than
envisaged due to temporary factors. Meanwhile, persisting problems in the global economy
restricted foreign demand, whereas stock accumulation started, albeit slowly, along with the
improvement in domestic demand. In this regard, while the Gross Domestic Product
increased by 6 percent on an annual basis in the last quarter of 2009, it decreased by
4.7 percent across the year (Figure 23). Seasonally adjusted data indicate continuance of the
recovery process in national income as of the second quarter of 2009 (Figure 24).
Data regarding the first quarter of 2010 indicate that the rebound in Domestic Demand is
gradually becoming stable and broad-based. The influence of policy rate cuts besides the
hikes in public expenditures are getting more pronounced and a relatively more robust
activity in sectors sensitive to domestic demand is being witnessed. In this respect, the
analysis of the recovery process in industrial production indicates that besides the sectors
stimulated by fiscal incentives and their intermediate input suppliers as well as the
nondurable goods sector and sectors with strong links to the construction sector have been on
the rebound (Figure 25).
There is no significant improvement in external demand. The global growth outlook continues
to dampen economic activity, particularly in sectors that are relatively more sensitive to
foreign demand. Following the recent crisis, manufacturing firms that mostly serve external
markets have been operating at lower capacity than local market oriented firms (Figure 26).
Thus, in line with our previous forecasts, domestic demand has remained more robust than
foreign demand. Yet, aggregate demand uncertainty continues to be a major concern, as
inventory buildups have remained limited. Against this background, the gradual recovery in
domestic demand is expected to continue into the first quarter (Figure 27). However, I would
also like to emphasize that the achievement of a two-digit annual growth rate is highly
probable in the first quarter of 2010 due to the low base of the same period last year.
The weak course of external demand continues to restrain economic activity and
employment growth through its impact on industrial production. As a matter of fact, despite
the recent partial recovery, indicators such as per capita hours worked across industries and
capacity utilization rates of firms oriented towards export markets suggest that resource
utilization remains low throughout the economy (Figure 26).
The recovery in the labor market that started in the third quarter of 2009 continued into the
fourth quarter, albeit at a slower pace. Unemployment declined in seasonally adjusted terms,
but still remains elevated (Figure 28). Given that ample slack would continue to be a drag on
investment and employment, signs of improvement in employment data during the second
half of 2009 are not expected to turn into a robust recovery, suggesting that the
unemployment rate will likely remain elevated for an extended period. Therefore, unit labor
costs would continue to support disinflation (Figure 29).
Overall, recent data releases suggest that the economic recovery has become more robust.
Domestic demand would continue to recover, while the weak outlook for global growth would
dampen economic activity and employment in the tradable sector for sometime. Accordingly,
we predict that aggregate demand conditions would not restrain inflation for a while. In this
context, our revised medium-term forecasts are based on a disinflationary output gap - albeit
narrower than envisaged in the previous Report.
As I mentioned earlier in my speech, the tightness in credit conditions tend to attenuate with
the effect of easing global liquidity conditions and improving risk appetites. The healthy state
of the Turkish banking system is conducive for a rapid recovery in credit volumes. In fact,
credit markets have been increasingly supportive of domestic activity in the recent period.
Accordingly, the first quarter of 2010 was marked by the increasingly benign outlook for
credit markets (Figure 30). Consumer loans have continued to recover while commercial
loans have accelerated. Credit extended to small- and medium-sized enterprises has also
begun to recover after a long period of stagnation, indicating the support of easy monetary
conditions on economic activity (Figure 31).
Assuming that external finance conditions continue to ease steadily and that the fiscal stance
does not crowd out domestic funding, we expect that credit volumes would continue to
expand in the forthcoming period. However, expectations that unemployment rates will
remain at high levels for a long period, and ongoing problems in the global economy are still
potential factors that might restrain credit expansion.
Although economic activity in the first quarter of 2010 has been broadly in line with the
outlook presented in the January Inflation Report, there have been some developments,
which necessitated an upward revision of the inflation forecast for 2010. As I believe that
interpreting these developments accurately is very important, I would like to further elaborate
on these developments.
First of all, the revisions to the Gross Domestic Product (GDP) series, and somewhat
stronger than expected domestic demand have led to an upward revision in the output gap
estimates, which have pushed the inflation forecast for end-2010 up by 0.4 percentage points
(Table 2).
Considering recent developments, our oil price assumptions stated in the past Report have
been revised slightly upwards (Figure 32). In this context, the previous assumption of oil
prices are revised up from 80 USD per barrel to 85 USD for 2010, and from 85 USD to
90 USD for 2011 and thereafter (Table 2). Besides, in April, commodity prices surged to their
highest levels for 2010 on the back of ongoing favorable growth expectations (Figure 33).
Therefore, while producing medium-term forecasts, in line with oil prices, imported input
costs are also assumed to increase gradually throughout the forecast horizon in response to
the recovery in the world economy. This revision has shifted the 2010 inflation forecast up by
0.15 percentage points.
The January Inflation Report envisaged food inflation to be 7 percent at end-2010,
6.5 percent for 2011 and 6 percent for the following years (Table 2). However, worse than
expected outcomes regarding unprocessed food prices and ongoing supply-side structural
problems led to an upward revision in the assumption for food inflation from 7 percent to
9 percent for 2010, which added 0.55 percentage points to end-2010 inflation forecast
(Table 2). Similarly, assumptions for 2011 food inflation have been raised to 7 percent from
6.5 percent, and 7 percent from 6 percent for the following years (Table 2). At this point, I
would like to highlight that the recent measures regarding meat prices posed a downside risk
especially for our assumption on food prices in 2010.
In the previous Report, the impact of the tax measures implemented in January on fuel,
alcohol, and tobacco products on 2010 inflation were estimated to be around 1.5 percentage
points. However, the realization was 1.9 percent, partly reflecting the change in the weighting
scheme of the CPI, and thus shifting the inflation forecast path by around 0.4 percentage
points throughout 2010. Here I would like to particularly underline once more that the impact
of the tax hikes would disappear at the beginning of 2011.
Regarding fiscal policy, it is assumed that, in line with the Medium Term Program, the fiscal
stance will remain expansionary - but less so than in 2009 - throughout 2010, and that fiscal
consolidation would gradually ensue starting from 2011 as guided by the fiscal rule set out in
the Medium Term Program. In this respect, as implied by the fiscal rule, it is assumed that
the fiscal space created by the stronger than expected economic activity leading to better
than expected performance in budget revenues since the second half of 2009, would be
used mostly to reduce the government debt stock; therefore, the goals set out in the MTP be
implemented through institutional and structural improvements in 2011 and onwards. In other
words, it is assumed that tax adjustments would be consistent with the inflation targets and
automatic pricing mechanisms throughout the forecast horizon. Accordingly, it is envisaged
that the rising debt-to-GDP ratios would gradually reverse course starting in 2011, and hence
the risk premium would not display any significant changes throughout the forecast horizon.
Against this background, assuming that liquidity measures are normalized gradually over the
short term and that policy rates are kept constant at current levels for some time followed by
limited increases starting in the last quarter of 2010, with policy rates staying at single digits
throughout the three-year forecast horizon, the medium-term forecasts suggest that, with
70 percent probability, inflation will be between 7.2 and 9.6 percent with a mid-point of
8.4 percent at end-2010, and between 3.6 and 7.2 percent with a mid-point of 5.4 percent by
the end of 2011. Furthermore, inflation is expected to decline to 5.0 percent by the end of
2012 (Figure 34).
Despite the upward revision in the output gap, it is expected that the economic recovery
would be gradual. However, owing to the effects of tax hikes, increases in food and energy
prices, and base effects, the inflation rate is hovering significantly above the target, which is
having an adverse impact on inflation expectations, and leading to risks regarding pricing
behavior. Therefore, the revised forecasts are based on the assumption of gradually
withdrawing the excessive amount of liquidity provided to the market, and increasing policy
rates at a measured pace starting in the last quarter of 2010. However, based on the
prediction that resource utilization will likely remain at low levels for sometime, the baseline
scenario envisages that the increases in interest rates would be limited with policy rates
remaining at single-digit levels throughout the forecast horizon.
As shown in the slide, inflation will follow a volatile path throughout 2010 owing to the base
effects driven by the temporary tax cuts and unprocessed food price fluctuations that
occurred during 2009 (Figure 34). The temporary tax cuts implemented in March 2009, which
were withdrawn partly in June and fully in October, would cause headline inflation to increase
during March and April, and to decrease during June, July and October of 2010. Accordingly,
inflation is expected to increase slightly during the second quarter and then fluctuate at
around 10 percent in the third quarter (Figure 34).
Inflation is expected to drop significantly in the last quarter of 2010 and the first quarter of
2011 (Figure 34). The fall in the last quarter of 2010 would reflect the base effects caused by
the indirect tax hikes and the sharp increases in food prices that occurred during the last
quarter of 2009. Similarly, the impact of the tax hikes, which added around 1.9 percentage
points to headline inflation in the first quarter of 2010, would largely disappear during January
and February of 2011. Accordingly, inflation would fall to 8.4 percent at end-2010, and
display a significant drop during the first quarter of 2011, converging to levels consistent with
the targets (Table 3). Afterwards, with the transmission of the lagged impact of the envisaged
monetary tightening, inflation is expected to further decline and stabilize at around 5 percent
over the medium term.
The projection that inflation would remain at elevated levels - albeit temporarily - over the
forthcoming period, highlights the importance of expectations management. As of April,
medium-term inflation expectations are significantly above the revised inflation forecasts
(Table 3). In this respect, it is critical that economic agents, with an awareness of temporary
factors, focus on medium-term inflation trends, and therefore, take the inflation targets as a
benchmark for their pricing plans and contracts.
At this point, I would like to emphasize once more that any new data or information regarding
the inflation outlook may lead to a change in the monetary policy stance. Therefore, I would
like to particularly highlight that assumptions regarding future policy rates underlying the
inflation forecast should not be perceived as a commitment on behalf of the CBT.
4. Risks
In the last part of my presentation, I would like to talk about the risks with respect to the
inflation outlook in the upcoming period and provide some information pertaining to the
probable monetary policy strategy should these risks materialize.
The fact that inflation will remain elevated for some time warrants the close monitoring of
price setting behavior. The combination of several unfavorable developments, such as
unprocessed food and oil price increases, administered price hikes and base effects has led
to a significant increase in inflation since the last quarter of 2009. Although these factors are
temporary, they cause headline inflation to significantly exceed the inflation target, leading to
an adverse impact on inflation expectations. Apart from items that are directly affected by
cost push effects, current pricing behavior does not reveal any deterioration to the extent that
might endanger the achievement of medium-term targets. However, I would like to remind
you that monetary tightening may be implemented sooner than envisaged in the baseline
scenario, should inflation expectations continue to rise and lead to a deterioration in general
price setting behavior.
Although downside risks regarding global economic activity have been decreasing, they
remain a concern. Rising budget deficits and ongoing problems in credit, real estate and
labor markets across developed economies continue to pose downside risks for the recovery
in global activity. Should the global conditions deteriorate again, and consequently delay
domestic recovery, the policy rate may remain constant for a longer period than envisaged
under the baseline scenario.
Uncertainties regarding the lagged effects of the strong monetary stimulus pose upside risks
on both domestic and global economic activity. Given that the recovery in domestic demand
has been relatively robust, a faster than envisaged recovery in external demand could lead to
a rapid narrowing in the idle capacity, which, coupled with cost push pressures, may delay
the attainment of the medium-term inflation targets. In this respect, should the recovery in
economic activity turn out to be faster than expected, the monetary tightening implied in the
baseline scenario may be implemented sooner than envisaged.
Prospects regarding the pace of growth in developing economies, especially in China and
India, have been posing upside risks regarding oil and other commodity prices. The
increasing share of these economies in world demand has been creating additional
pressures on commodity prices. I would like to emphasize that if commodity prices rise faster
than expected in the forthcoming period and delay the disinflation, then we, as the Central
Bank, may implement the monetary tightening described in the baseline scenario sooner
than envisaged in order to eliminate the risks of deteriorating price setting behavior.
The Central Bank will continue to monitor fiscal policy developments closely while
formulating monetary policy strategy. Since the second half of 2009, economic activity has
been stronger than envisaged in the Medium Term Program, leading to a better than
expected performance in budget revenues. Using this fiscal room mostly to reduce the
government debt, as implied by the fiscal rule, would enhance demand management and
ease the need for indirect tax hikes, therefore providing more flexibility regarding the conduct
of a stabilizing monetary policy. In this respect, we believe that should the goals set out in the
Medium Term Program be implemented through institutional and structural improvements,
such as enacting and establishing the fiscal rule, it would be possible to keep policy rates at
single-digit levels over the medium term.
Since the last quarter of 2008, the CBT, without conflicting with its primary objective of price
stability, has focused on containing the adverse effects of the global crisis on the domestic
economy, which has, to a large extent, been achieved. Monetary policy will continue to focus
on price stability in the period ahead. Adhering to the commitment for fiscal discipline and
strengthening the structural reform agenda would support the improvement of Turkey's
sovereign risk, and thus facilitate macroeconomic and price stability in the medium term. In
this respect, while reiterating once more that timely implementation of the structural reforms
envisaged by the Medium Term Program and the European Union accession process
remains to be of the utmost importance, I would like to thank you for your participation.