Erdem Başçi: Latest economic outlook and macroeconomic
developments in Turkey
Speech by Mr Erdem Başçi, Governor of the Central Bank of the Republic of Turkey, at the January 2012 Inflation
Report press conference, Istanbul, 31 January 2012.
* * *
Distinguished Guests,
Welcome to the press conference held to convey the main messages of the January
2012 Inflation Report. As required by our new communications policy, we will hold two of the
four inflation report press conferences in Istanbul, all of which used to be held in Ankara
before. I will now present an overview of the first inflation report of 2012, which will be
published on our web-site shortly.
The Report summarizes the economic outlook underlying monetary policy decisions, shares
our evaluations on macroeconomic developments and presents our medium-term inflation
forecasts which have been revised in view of the developments in the last quarter, along with
our monetary policy stance. Moreover, the Report includes eleven boxes which entail
interesting and up-to-date analyses on various topics. For instance, there is an analysis on
the functioning of our recent liquidity management policy and its effects on financial markets.
There is also a box exploring the sources of changes in inflation forecasts in the previous
year, which is a topic included in the first inflation report every year. Another box examines
the base effects that will play a major role in the course of inflation in 2012. Also, there is a
box that scrutinizes the steps taken to solve the debt problem in the euro area, which points
out to the role of structural problems such as the marked divergence in member countries'
competitiveness in hindering stable growth in the euro area. There is also a box exploring the
rebalancing process in domestic and external demand thanks to the policies implemented
last year. Titles of the boxes are shown on the slide. All of these boxes include important
analyses. They will be published on our web-site shortly and I strongly recommend that you
read them.
Considering the ongoing major role of the developments in the global economy on our
policies, I would like to start with the global economic outlook.
Since the publication of the October 2011 Inflation Report, concerns over sovereign debt
sustainability across the euro area have continued to weigh on the global economic outlook
despite the implementation of various policy measures. Growth forecasts were revised
downwards at a global scale particularly in the euro area economies (Chart 1). Thus,
perceptions for a further delay in the normalization of monetary policy in advanced
economies grew stronger. Notwithstanding a relative improvement in the risk appetite as of
the onset of 2012, uncertainties regarding the solution of euro area problems persist.
Coupled with the increased risk of contagion, this feeds into the fragility in global financial
markets, highlighting the significance of a flexible monetary policy framework.
Chart 1.
Revisions to Growth Rate Forecasts in Advanced
and Emerging Economies*
(Percent, GDP-Weighted Average)
* Dashed lines show the forecasts using the expectation figures in
the previous quarter while the dotted lines show the revised
forecasts using the updated expectation figures. Advanced
Economies: U.S.A., EU, and Japan. Emerging Economies: China,
India, Brazil, South Korea, Mexico, Russia, Turkey, Poland,
Indonesia, South Africa, Thailand, Malaysia, Israel, Czech
Republic, Hungary, Colombia, Philippines.
Source: Consensus Forecasts, CBRT.
1. Monetary Policy Developments and Monetary Conditions
The Central Bank of the Republic of Turkey (CBRT) has aimed at engineering the economy
gradually towards a more balanced growth composition against the macro financial risks that
aggravated in the first half of 2011. Accordingly, with the support of other institutions,
necessary measures were taken to bring loan growth rates to reasonable levels.
Furthermore, policies were geared towards preventing exchange rates from moving away
from economic fundamentals excessively on either side (Charts 2 and 3).
Chart 2. Chart 3.
TL and Emerging Market Loan Growth Rate*
Currencies*
(13-Week Moving Average,
Annualized, Percent)
(Against the USD, Value of
01.10.2010 = 1)
* Average of emerging market currencies *Adjusted for the exchange rate effect.
including Brazil, Chile, Czech Republic,
Hungary, Mexico, Poland, South Africa,
Source: CBRT.
Indonesia, South Korea and Colombia,
against USD. Increases denote depreciation
of the currency.
Source: Bloomberg, CBRT.
Data released for 2011 point that the desired rebalancing process in the economy has
already started. Accordingly, the contribution of net exports to growth increased notably, and
the current account balance posted a noteworthy improvement in the second half of the year
(Chart 4).
Chart 4.
Current Account Balance
(Seasonally Adjusted, Billion USD)
Despite the attainment of favorable outcomes regarding macro financial risks, soaring
inflation in the last quarter required a revision of the monetary policy stance. The ongoing
deterioration in the global risk appetite as of August led to an excessive depreciation in the
Turkish lira posing risks on the inflation outlook. In addition, sizeable price adjustments in
administered products in October led the short-term inflation to increase above forecasts. In
order to not to allow inflation expectations to deteriorate, the CBRT delivered an important
tightening in monetary policy since October. Accordingly, the interest rate corridor was
widened upwards and the amount of the Turkish lira funding through one-week repo auctions
was adjusted and the average funding cost was raised significantly (Chart 5).
Chart 5.
CBRT Policies
CBRT Policy Rates and Overnight Repo CBRT Funding and Average Interest
Rates Rate
Source: CBRT. Source: CBRT.
The Monetary Policy Committee believes that the tight monetary policy stance should be
maintained for a while to ensure that the inflation outlook is consistent with the medium term
targets. Moreover, due to the ongoing uncertainties regarding the global economy, we are of
the opinion that maintaining a flexible monetary policy will be appropriate.
The downward slope of the current yield curve signifies a tight monetary policy stance (Chart
6). Additionally, loan interest rates have recorded a notable increase since October (Chart 7).
As a consequence, loan growth rate declined to more reasonable levels towards the
yearend (Chart 3).
Yield Curve* Consumer and TL Business Loan
Rates*(Percent)
Calculated by the return on bonds quoted on the *Flow data.
ISE
**4-week moving average.
Bonds and Bills Market using the Extended
Nelson-Siegel (ENS) method.
Source: CBRT.
Source: ISE, CBRT.
Overall, the last quarter of 2011 was marked by ongoing tightening in monetary and financial
conditions and a pronounced deceleration in loans.
2. Macroeconomic Developments and Main Assumptions
Having climbed to 10.45 percent at end-2011, inflation was significantly above the target. As
you all know, the Article 42 of the Central Bank Law stipulates that in the case of a significant
breach of the inflation target, we are required to report to the Government and announce to
the public the reasons behind the breach of the target and the necessary measures to be
taken. I would like to announce that we will publish the Open Letter that will be sent to the
Government today on our web-site at 12 a.m.
Now, I will touch upon the macroeconomic outlook and our assumptions which constitute the
basis for our forecasts. First, I will summarize the recent inflation developments, and then
compare the short term forecasts in the October Inflation Report with the actual inflation data
regarding the fourth quarter of 2011.
There were a few developments in the interreporting period which led inflation to deviate
significantly from October forecasts. More-than-envisaged increases in unprocessed food
prices were an important cause of this deviation. The ongoing depreciation in the Turkish lira
amid the deterioration in the risk appetite was another factor leading to a deviation in
short-term forecasts (Chart 8).
October 2011 Inflation Forecasts and Realizations
* Shaded region indicates the 70 percent confidence interval for the
forecast.
Owing to the lagged effects of the exchange rate pass-through, core inflation indicators
remained at elevated levels during the final quarter (Chart 9). This mainly stemmed from
soaring core goods prices, while the moderate course of the underlying trend of services
inflation indicated a benign outlook in terms of second round effects (Chart 10).
Chart 9. Chart 10.
Core Inflation Indicators Prices of Core Goods and Services
SCA-H and SCA-I
(Seasonally Adjusted, 3-Month Average,
Annual Percent Change)
(Seasonally Adjusted, 3-Month Average,
Annual Percent Change)
Source: TurkStat, CBRT. Source: TurkStat, CBRT.
We see that economic activity remained robust in the second half of 2011, despite a slight
deceleration. Gross Domestic Product (GDP) data pointed that domestic demand proved
stronger in the third quarter of 2011 compared to the outlook presented in the October
Inflation Report (Chart 11). Thus, we revised our output gap forecasts for this period
upwards. Growth composition became much more balanced as we expected (Chart 12).
Despite the weak course of the global economy, exports continued to increase, whereas the
demand for imported goods and services maintained a downward trend. Consequently, the
contribution of net external demand to growth has been positive for the first time after a
protracted period.
Final Domestic Demand Exports and Imports of Goods and
Services
(Seasonally Adjusted, 2008Q1=100)
(Seasonally Adjusted, 1998 Prices,
Billion TL)
Source: TurkStat, CBRT. * Estimate.
Source: TurkStat, CBRT.
Indicators regarding the last quarter of 2011 point that final domestic demand remains flat
and the rebalancing process in the economy is going on as envisaged. Owing to the
monetary tightening, the growth rate of final domestic demand is expected to remain
moderate in the forthcoming period, as suggested by the recent loan and orders data (Chart
13). Accordingly, our inflation forecasts are based on the assumption that domestic demand
will decelerate further during early 2012.
Chart 13. Chart 14.
Growth Rates of Business and 3-Month Ahead Expectations for
Consumer Loans Orders
(13-Week Average, Adjusted for Exchange (Up-Down, Seasonally Adjusted, Percent)
Rate Effect, Annual Percent Change)
Source: CBRT. Source: CBRT.
As I mentioned at the beginning, global growth forecasts have been revised significantly
downwards since the publication of the October Inflation Report mainly owing to the euro
area. Thus, projections for export-weighted global growth index for Turkey also pointed to a
lower pace of growth for external demand (Chart 15). Hence, we based our inflation
forecasts on an outlook of weaker external demand compared to the previous period.
Export-Weighted Global Economic Activity
Index* (2009Q1=100)
* For methodology, see Inflation Report 2010-II,
Box 2.1 "Foreign Demand Index for Turkey".
Source: CBRT, Bloomberg, Consensus Forecasts 2011 October
and 2012 January Bulletins.
In sum, we revised our output gap forecasts upwards for the second half of 2011 considering
the stronger-than-expected economic activity in the third quarter. Meanwhile, due to the
deterioration in the global growth outlook, we estimate that aggregate demand conditions will
provide a stronger support to disinflation in the medium term compared to the previous
reporting period.
We also revised our assumptions for commodity and oil prices slightly upwards. Considering
the recent developments and futures prices, we revised our assumptions for oil prices
upwards from USD 100 to USD 110 per barrel for 2012 and to USD 105 for 2013.
Accordingly, our assumptions for import prices were also subject to a slight upward revision
(Chart 16). In addition, we preserved our assumptions for the annual rate of increase in food
prices at 7.5 percent throughout the forecast horizon.
Chart 16.
Revisions in the Assumptions for Oil and Imports Prices
Oil Prices (USD/Barrel) Import Prices (2003=100)
Source: Bloomberg, CBRT. Source: CBRT, TurkStat.
3. Inflation and Monetary Policy Outlook
Now, I would like to present our inflation and output gap forecasts based on the outlook I
have described so far. When forming our forecasts, we assumed that the tight monetary
policy stance will be sustained for a while; and consequently, annualized loan growth rate will
hover around 15 percent and the Turkish lira will display a mild appreciation trend.
Accordingly, inflation is expected to be, with 70 percent probability, between 5.1 and
7.9 percent with a mid-point of 6.5 percent at the end of 2012, and between 3.3 and
6.9 percent with a mid-point of 5.1 percent at the end of 2013. We expect inflation to stabilize
around 5 percent in the medium term (Chart 17).
Chart 17.
Inflation and Output Gap Forecasts
* Shaded region indicates the 70 percent confidence interval for the
forecast.
Overall, although demand and cost conditions have not changed notably since the
publication of the October Report, we revised our inflation forecasts for end-2012 upwards
due to higher initial point (the initial point referring to the latest inflation data before the
forecast period) resulting from higher-than-expected inflation during the past three months.
As elaborated on in the Report as well, cumulative increases in the exchange rate and
commodity prices coupled with soaring unprocessed food prices and the developments in
administered prices pushed inflation to high levels in 2011. We estimate that inflation will
remain flat in the first quarter and exhibit a gradual downtrend starting from the second
quarter (Chart 17). Our tight monetary policy stance since October prevents a deterioration in
the price setting behavior by keeping inflation expectations under control. Thus, we expect
that inflation will follow a downward trend as the accumulated effects of the temporary price
movements on annual inflation gradually fade away. Thus, we estimate that inflation will
display a notable decline particularly in the last quarter of 2012.
Before moving on to the risks regarding the inflation outlook, there is a particular subject I
would like to touch upon. As you might have noticed, I have given an inflation forecast that
exceeds our end-year inflation target of 5 percent. This is because we think that pulling
inflation towards the target by end-2012 would prove to be quite costly. Reducing inflation
from the current level of 10.45 percent to 5-percent-target within 12 months would lead to
unfavorable fluctuations in economic activity; accordingly we think that it is more reasonable
to bring inflation back to the target in one and a half year. Thus, our baseline scenario
envisages inflation to reach the target of 5 percent by mid-2013 (Chart 17). However, the
target might be attained by the end of 2012, should the risk appetite improve markedly in the
forthcoming period and the capital flows towards emerging economies re-accelerate, leading
to a stronger appreciation of the Turkish lira than assumed in our baseline scenario.
At this point, I would like to emphasize 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.
4. Risks and Monetary Policy
In the last part of my speech, I would like to share our assessment of the risks on inflation
outlook. The first of these risks is the possibility of second round effects that might stem from
inflation hovering at high levels in the short term. Three-month accumulated increase in
consumer prices in the final quarter of 2011 was 5.66 percent. This will stay in annual
inflation figure for another three quarters. Therefore, it is highly likely that annual inflation will
stay significantly above the target until the last quarter of the year, even if the underlying
trend in the forthcoming period eases to levels consistent with the target. Although the
monetary tightening delivered by the CBRT since October has reduced the possibility of
second round effects, I would like to emphasize that inflation expectations and pricing
behavior will be monitored closely and necessary measures will be taken to keep
medium-term inflation outlook consistent with the target.
Ongoing uncertainties regarding the global economy call for a continuation of a flexible
approach in monetary policy. The medium term outlook presented in the Report assumes
that problems in the euro area will be resolved gradually and the global outlook will not
deteriorate further. However, the probability that the solution of the problems may take a
more protracted and painful process poses downside risks regarding the global growth and
risk appetite. On the other hand, perceptions regarding the global economic outlook may turn
more favorable than expected, should the measures taken towards the solution are
completed sooner and more decisively than envisaged. Such a situation, coupled with the
ongoing quantitative easing policies pursued by the central banks of advanced economies,
may improve risk appetite and re-accelerate capital flows towards emerging economies.
Overall, ongoing problems in the euro area and uncertainties regarding the effectiveness of
measures aimed at solving these problems suggest that global financial markets will continue
to be volatile in the forthcoming period. These conditions necessitate a flexible approach in
monetary policy, which utilizes multiple instruments. I would like to underline once more that
the CBRT will continue to monitor global developments closely and take the required
measures promptly.
Another risk on the inflation outlook is the uncertainty regarding oil prices. Although weak
global outlook dampens commodity prices, rising problems of oil supply have recently posed
upside risks on energy prices. I would like to reiterate that should such a risk materialize, the
CBRT will not respond to temporary price movements, yet will not tolerate any deterioration
in expectations.
We will continue to monitor fiscal policy developments closely while formulating monetary
policy. In this respect, our baseline forecasts take the Medium Term Program as given and
thus assume that fiscal discipline will be maintained. A revision in the monetary policy stance
may be considered, should the fiscal stance deviate significantly from this framework and
consequently have an adverse effect on the medium-term inflation outlook.
We will continue to focus on price stability in the formulation of the monetary policy while
preserving financial stability as a supplementary objective. To this end, we will carefully
assess the impact of the macroprudential measures taken by the CBRT and other institutions
on the inflation outlook. We are of the opinion that strengthening the structural reform agenda
that would ensure the sustainability of the fiscal discipline and reduce the saving deficit would
support the relative improvement of Turkey's sovereign risk, and thus facilitate price stability
and financial stability in the medium term. This will also provide more flexibility for monetary
policy and contribute to social welfare by keeping interest rates of long-term government
securities at low levels. In this respect, I would like to end my remarks reminding you the
importance of the steps towards implementation of the structural reforms envisaged by the
Medium Term Program.
Thank you very much for your participation.