Durmuş Yilmaz: Recent economic and financial developments in Turkey
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, Ankara, 26 October 2010.
* * *
Distinguished Guests and Members of the Press,
Welcome to the press conference held to convey the main messages of the October 2010
Inflation Report.
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 of inflation outlook and economic
activity, which I will share with you in detail shortly, I would like to summarize the current
global conditions that continue to be determinant of the domestic economic outlook.
Data released in the third quarter indicate that the recovery will be quite slow and gradual
albeit a second contraction in global economic activity is not very probable. The marked
decoupling between the developed and developing countries in terms of growth dynamics
persisted through the second quarter; where global growth continued to be driven by
developing countries (Figure 1). Meanwhile, the persisting negative outlook in the labor
markets of developed countries confirms the slow pace of rebound in these economies on
one hand; and leads us to believe that the improvement in employment conditions will take a
long time, on the other (Figure 2).
Parallel to the weak outlook in economic activity, core inflation indicators in developed
countries maintain their historically low levels in the third quarter of 2010 (Figure 3).
In line with the outlook I have summarized, the probability that many developed economies,
which are already pursuing exceptionally loose monetary policies, would adopt a second
phase of monetary easing has increased. This has strengthened the investors' inclination
towards risky assets and therefore has boosted capital inflows to emerging markets, leading
to currency appreciation in these countries accompanied by marked increases in commodity
prices.
Ample global liquidity and accelerated capital flows that are driven by the increasing search
for yield have affected many emerging markets, including Turkey. Favorable developments
specific to Turkey have further exacerbated these effects. In particular, a better-than
expected recovery in economic activity, indications of a possible upgrade from credit rating
agencies, an ease of political uncertainty with the completion of the referendum process, and
the signal given by the updated Medium Term Program (MTP) that the fiscal discipline would
be maintained, have all contributed to Turkey's relatively better performance. Turkey's risk
premium indicators performed better than many countries and continued to remain below
pre-crisis levels (Figure 4). Consequently, interest rates have declined, the stock market
soared, and the Turkish lira strengthened (Figure 5).
1. Inflation developments
Dear Members of the Press,
Having summarized the current global conditions, I would now like to share my evaluation of
inflation developments in Turkey that occurred in the last quarter.
In the third quarter of 2010, consumer prices and the annual inflation rate went up to 1.15
percent and 9.24 percent, respectively (Figure 6). This rise in inflation can be attributed to the
sharp increases in unprocessed food prices. Meanwhile, the decline in annual services
inflation and the positive outlook in prices of staple goods continued; and the main trend of
inflation maintained its course consistently with the medium term targets. Thus, rates of
quarterly change in all sub-categories remained well below the average figures of past years
with the exception of food prices (Figure 7).
In the third quarter, food prices recorded a sharp increase driven by unprocessed food
prices. Thus, the contribution of food prices to annual inflation reached 4.2 percentage points
(Figure 8). Unprocessed food prices, which saw sharp slumps in the second quarter, showed
substantial increases in the third quarter, bringing annual unprocessed food prices inflation to
the historically highest level of 28.74 percent (Figure 9). While fresh fruits and vegetables
prices became determinant; the persisting surge in meat prices became another factor
influencing the rise in the group prices. At this point, I would like to underline that the
fluctuating course in unprocessed food prices increases the volatility of consumer inflation
and thus creates significant forecast uncertainty.
In the third quarter, while energy prices followed a horizontal course due to the developments
in oil prices, the inflation trend in core goods excluding food, energy, alcoholic beverages,
tobacco and gold maintained its low level. Meanwhile, the decline in annual services inflation
became more marked than expected. Services prices excluding food and transportation, the
sensitivity of which is relatively higher against demand, recorded its lowest level (Figure 10).
The steady downward tendency in core inflation indicators continued in the third quarter due
to this beyond expected slowdown in services prices (Figure 11). The reverberations of the
strong course of the Turkish lira on core goods prices were also influential in this
development. In this respect, the underlying inflation implied by the core indicators continued
to slow down and followed a course consistent with the medium term targets. Accordingly,
the gap between Turkish core inflation indicators and those of other developing economies
continued to narrow in the third quarter (Figure 12).
Medium-term inflation expectations, which displayed a downward trend from the second
quarter in the framework of these developments, registered a limited decline in the third
quarter (Figure 13). Core inflation indicators that steadily went down despite the rise in
consumer inflation prevented deterioration of the medium-term expectations in this period.
While recent inflation expectations showed a limited quarter-on-quarter decline, it appears
that despite longer maturities, expectations are not differed from their previous quarter level
so far (Figure 14). Nevertheless, 12 and 24 month-forward expectations are slightly higher
than the figures implied by inflation targets for the ends of 2011 and 2012.
2. Monetary policy response
Dear Members of the Press, Dear Guests,
After commenting briefly on inflation developments, I would like to cover the policies pursued
by the Central Bank during the last quarter.
Although domestic demand was relatively stronger during the third quarter of 2010,
aggregate demand conditions continued to support disinflation due to weak external demand,
bringing core inflation to historically low levels. Therefore, the Monetary Policy Committee
maintained its stance of keeping policy rates constant for some time, and to keep them at low
levels for a long period.
Observing the surge in capital inflows as the last quarter of the year began, in anticipation
that the combination of strong domestic demand and weak external demand will continue, I
would like to remind you that rapid credit growth coupled with the risks regarding the current
account deficit and financial stability necessitates caution. In this respect, considering the
favorable developments in credit markets and the ongoing recovery in economic activity, the
CBT has, to a large extent, completed the process of reversing the temporary liquidity
measures implemented during the crisis period. Accordingly, overfunding of the markets was
halted and the required reserve ratios were increased. Moreover, to facilitate the use of
alternative macroprudential policy tools, the remuneration of required reserves was
terminated and the operational framework of liquidity management was changed. Finally, in
order to be more flexible against the variability of capital flows, a new method for foreign
exchange purchase auctions was designed and put into effect on 4 October 2010. To this
end, a total of USD 1.76 billion was purchased in the first three weeks, USD 1.2 billion of
which was additional purchase.
Within the framework of these developments, while the yield curve has shifted down across
all maturities during the third quarter, the decline was more significant for longer-term
interest. Although surging capital inflows towards emerging markets have been effective,
factors specific to Turkey have also contributed to the downward shift in the yield curve, as I
mentioned at the beginning of my speech. Lower-than-expected core inflation has
contributed to the downside movement in the short term, while the drop in longer-term
interest rates mostly reflects perceptions that the improvement in the relative
creditworthiness of Turkey would become permanent (Figure 15).
Dear Guests,
Along with decreasing nominal interest rates, real interest rates have continued to hover at
historically low levels during the third quarter. Moreover, Turkey's real interest rates do not
differ significantly from those of other emerging markets (Figure 16).
Meanwhile, with the removal of extra tightness in financial conditions that emerged during the
crisis, the effectiveness of the monetary policy on credit market enhanced; thus, the low level
of real market rates were better reflected in credit interest rates (Figure 17). Moreover, the
lending appetite of banks has improved and expectations for further loosening of lending
conditions in the upcoming period have arisen. Accordingly, under the current conditions,
where commercial loans tend to increase and this increase is spreading across more
sectors, the spread between the interest rates of commercial loans and deposits are
hovering at historically low levels, pointing to less tightness in credit supply (Figure 18).
3. Inflation and monetary policy outlook
Dear Guests,
After summarizing our monetary policy stance and its impacts on the financial markets, I
would now like to share with you the financial outlook and our assumptions underlying our
forecasts.
National income data released pertaining to the second quarter of 2010 are broadly
consistent with the outlook presented in the July Inflation Report. While the relatively stable
recovery in domestic demand continues, exports of goods and services have accelerated. In
this context, the Gross Domestic Product (GDP) increased by 10.3 percent compared to the
same period last year, (Figure 19). Following the slowdown in the first quarter, the quarterly
growth rate of national income began to reaccelerate on the back of high rate increases in
exports and public construction sectors compared to the previous quarter, while private
growth pursued a relatively more moderate course (Figure 20). Hence, while the GDP
reached its pre-crisis level by the second quarter, the GDP excluding public expenditures
hovers below the pre-crisis level.
Recent data suggest that the recovery in domestic demand is slightly stronger than expected
and that a more moderate growth process was assumed in the second half of the year.
Indicators pertaining to private sector demand indicate that private sector consumption and
investments continued to rise rapidly in the third quarter in annual terms (Figure 21).
Consumption and investment expenditures are likely to accelerate in the final quarter of the
year with the support of the counter-cyclical stance of monetary and fiscal policies as well as
strengthening capital inflows.
The steady rise in credits confirms continuing recovery in economic activity (Figure 22).
Another noteworthy point about this period is that credit expansion continues to extend
across a greater part of our economy in terms of both sectors and scale. Low interest rates
and easing credit risk indicators suggest that credit growth will be strong, and therefore, the
credit channel should continue to underpin domestic demand over the forthcoming period.
As supply-side constraints have widely subsided, we believe that credit realizations rather
reflect the dynamics pertaining to credit demand. The Loans Tendency Survey suggests that
the borrowing motivation of firms tends to change in the post-crisis period. Firms used to
demand credits to facilitate debt rollover or to finance their working capital during the crisis.
However, as the effects of the crisis tapered off, loans for rolling over debts decreased while
loans for investment purposes increased (Figure 23). Actually, GDP data for the first half of
the year and other indicators of economic activity suggest that demand for investment loans
is on the rise and this outlook is consistent with the recovery in credit demand for investment
purposes.
Despite the relatively robust course of domestic demand, external demand remains subdued
in line with the signals for a sluggish recovery in global economy. In other words, lingering
problems in the global economy further accentuate decoupling between the pace of recovery
in domestic and external demand. In this framework, the negative contribution of net exports
in growth is predicted to increase. Moreover, forecasts for global economic activity, which
have been revised in the last three months, indicate that there has been no significant
improvement in the growth outlook of our trade partners (Figure 24). Therefore, revised
forecasts were based on the assumption that external demand conditions would not display a
significant change compared to the previous Report.
Dear Guests,
Continued recovery in economic activity fuelled by rapid growth in domestic demand
underpins the improvement in employment conditions. Although the rapid recovery observed
in non-farm employment since the second quarter of 2009 halted in the third quarter of 2010,
leading indicators suggest that this is only temporary (Figure 25). Nevertheless, we expect
unemployment rates to remain high for quite some time compared to the pre-crisis period
due to the relative slowdown employment growth and high labor force participation rates
(Figure 26). Therefore, we envisage no significant pressure on unit labor costs in the
upcoming period.
In light of these assessments, our revised inflation forecasts are based on a framework in
which domestic demand is stronger compared to the previous period, external demand
continues to restrain domestic economic activity, and thus aggregate demand conditions
continue to support disinflation, albeit to a lesser degree.
As for fiscal policy, MTP (Medium-Term Program) projections revised in October constitute
the basis of our forecasts. In this respect, we envisage a temporary acceleration in public
expenditures for the rest of the year, to be followed by a gradual decline in the ratio of
primary expenditures to national income starting from 2011. We also assume that any fiscal
space that may arise due to stronger-than-expected economic activity would partially be
used to reduce government debt stock, congruent to the counter-cyclical fiscal policy
approach. It was envisaged that the ratio of debt stock to GDP would continue to decline and
no significant change would be observed in the risk premium throughout the forecast horizon.
Moreover, our forecasts are based on the assumption that tax adjustments would be
consistent with the inflation targets and automatic pricing mechanisms.
Distinguished members of the press,
Important developments since the July Inflation Report warranted a revision of the
assumptions, which our forecasts are based on. I would like to provide some detailed
information on these factors to ensure that our forecasts are better understood.
Worse-than-expected outcomes regarding vegetable prices and the slower-than-expected
downward correction in meat prices in the third quarter necessitated an upward revision in
the assumption for food inflation in the short-term. In this respect, we revised our food
inflation assumption from 7.5 percent to 10.5 percent for end-2010, while keeping our
assumptions for food inflation for 2011 and 2012 at 7 percent (Table 1). The revision in
question pushed our inflation forecast for end-2010 up by 0.8 percentage points.
Although unprocessed food inflation was markedly higher than expected in the third quarter,
the deceleration in core goods and services inflation was more significant than envisaged. In
other words, the core inflation trend, which pins down the initial point of the medium-term
forecasts, has decreased at a faster-than-expected pace. This development necessitated a
downward revision of the inflation forecasts for end-2010 by 0.8 percentage points, while
also favorably affecting medium-term forecasts.
With stronger-than-expected domestic demand data in the last period, the output gap was
revised upwards compared to the previous forecast (Table 1). In other words, we base our
assumptions on an outlook, in which the contribution of aggregate demand conditions to
disinflation in the revised forecast is slightly more limited as opposed to the July Inflation
Report. This development has not affected short-term inflation forecasts, but has had some
upward impact on medium-term forecasts.
Increased expectations that the developed economies would continue to pursue
expansionary monetary policy have led to rapid increases in commodity prices. However,
crude oil prices in the futures markets as of October are still largely aligned with the
assumptions in the July Inflation Report. In this context, our previous assumption of oil prices
are kept unchanged, as you can see on the slide (Table 1). Moreover, based on commodity
prices in the futures market, we assume that import prices will exhibit a gradual upward trend
throughout the forecast horizon (Figure 27).
Now I would like to share with you our inflation and output gap forecasts produced in line with
the framework that I have outlined so far. While producing our forecasts, we assumed that
the measures outlined in our exit strategy would be completed during the rest of the year,
and that policy rates would be kept constant at current levels for some time to be followed by
limited increases starting from the last quarter of 2011, with policy rates staying in single
digits throughout the 3-year forecast horizon. Within this framework, we project that, with
70 percent probability, inflation will be between 7 and 8 percent with a mid-point of
7.5 percent at end-2010, and between 3.9 and 6.9 percent with a mid-point of 5.4 percent by
the end of 2011. Furthermore, inflation is expected to decline to 5.1 percent by the end of
2012 (Figure 28).
Overall, the impact of the upward revision in the food price assumption is offset by
lower-thanexpected non-food inflation, leading to an unchanged inflation forecast at 7.5 percent for
end2010. Similarly, the impacts of factors affecting the medium-term inflation outlook have balanced
each other out, and consequently there has not been a significant revision in the forecasts.
I think comparison of the forecasts by the ones in the previous Report period would help us
to better understand the changes in forecasts. As I have mentioned earlier, considering a
relatively stronger recovery in the domestic demand outlook and the second quarter GDP
data, our output gap estimates have been revised upwards as of the second quarter of 2010
(Figure 29). The impact of the upward revision in the output gap was largely offset by the
downward revision in the underlying inflation trend. Consequently, there has not been a
significant change in medium-term inflation forecasts and the monetary policy outlook
compared to the previous Report (Figure 30).
In sum, assuming that policy rates would stay constant for sometime and remain at low levels
for a long period, our revised forecasts suggest that aggregate demand conditions would
continue to support disinflation for a while. Under current conditions, inflation is expected to
follow a marked downward trend over the next two quarters and decline to levels consistent with
medium-term targets as of mid-2011, as the adverse impact of the temporary price movements
taper off. Considering that the increases in unprocessed food and tobacco prices - which are
beyond the control of monetary policy account for 5 percentage points of current annual
inflation, it is clear that there is sizeable room for disinflation from this channel (Figure 31).
Factors that are beyond the control of monetary policy, such as fluctuations in unprocessed
food prices and tax adjustments related to tobacco products, created significant forecast
uncertainty by increasing the volatility of consumer inflation. This, in turn, has created a
challenge for us to understand the underlying inflation correctly and to manage expectations.
In this context, I believe that it would be useful in terms of transparency and predictability, to
share with the public the assumptions we make relating to the said groups while making
forecasts and our inflation expectations excluding these groups. Accordingly, we assume that
annual inflation in unprocessed food products will be 17 percent for end-2010 and 9 percent
for the following two years. Meanwhile, the annual rate of increase in the tobacco and
alcoholic beverages group index is expected to be 24 percent at end-2010 and to hover
around levels consistent with inflation targets in subsequent years. Within this scope, we
expect the inflation indicator excluding unprocessed food and tobacco and alcoholic
beverages to follow a volatile trend in the first half of 2011 due to the base effect and to gain
stability slightly above 4 percent in the medium term (Figure 32).
At this point, I would like to underline 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
particularly like to highlight that assumptions regarding future stance of monetary policy
underlying the inflation forecasts should not be perceived as a commitment on behalf of the
CBT.
4. Risks
In the last part of my speech, I would like to elaborate the risks regarding the inflation outlook
in the upcoming period and prospective monetary policy strategies to be implemented should
these risks materialize.
Developments regarding global economic activity would continue to be the main factor
shaping inflation dynamics and the monetary policy outlook. Recently, leading indicators of
economic activity continue to slow down, underscoring downside risks especially regarding
the US economy. Furthermore, ongoing problems in credit, real estate, and labor markets
across developed economies and uncertainties regarding the impact of fiscal consolidations
suggest that the downside risks regarding the pace of global growth are likely to persist for
some time. Should the global economy face a longer-than-anticipated period of anemic
growth, the monetary tightening envisaged to start in the final quarter of 2011 under the
baseline scenario might be postponed. Moreover, an outcome whereby global economic
problems intensify and contribute to a contraction of domestic economic activity, may trigger
a new easing cycle. By contrast, monetary tightening may be implemented at an earlier
stage, should the recovery in economic activity turn out to be faster than expected.
The weakness in the global economic outlook not only delays recovery in external demand
but also leads to continuing expansionary monetary policies across developed economies,
which in turn fuel domestic demand through an acceleration of capital inflows to emerging
markets. Should capital inflows continue, the divergence in the growth rates between
domestic and external demand is likely to intensify in the forthcoming period. Additional
policy instruments, other than the short-term policy rates, would be needed to curb risks
emanating from this channel. In this respect, should the disparity between domestic demand
and external demand continue and be accompanied by rapid credit expansion and
deterioration of the current account balance, all to lead to financial stability concerns, it would
be necessary to utilize other monetary policy instruments such as reserve requirement ratios
and liquidity management facilities more effectively.
Food and commodity price inflation has accelerated recently. The aggregate demand is not
yet at a level to exert inflationary pressures. Along with this, the strength of the Turkish lira
limits the pass-through from food and commodity inflation to core goods and services
inflation. However, the potential second-round effects continue to pose a risk, if increases in
food and commodity prices persist. Should such a risk materialize and lead to a deterioration
in price setting behavior, which in turn hampers the attainment of medium-term inflation
targets, a tightening earlier than the one envisaged in the baseline scenario would be
considered.
Dear Guests,
The CBT will continue to monitor fiscal policy developments closely while formulating
monetary policy. Increasing public savings and maintaining the fiscal discipline are essential
to control the current account deficit driven by the disparity between domestic and external
demand. The medium-term perspective included in the revised Medium Term Program
(MTP) is seen as an important step in this direction. Accordingly, our revised forecasts take
the projections of public expenditures in the MTP as given, while tax adjustments are
assumed to be consistent with inflation targets and automatic pricing mechanisms. Should
the fiscal stance deviate significantly from this framework in a way to have adverse effects on
the medium-term inflation outlook, a revision in the monetary policy stance may be
considered.
Monetary policy will continue to focus on achieving lasting price stability in the period ahead.
Strengthening the commitment to fiscal discipline and the structural reform agenda would
support the improvement of Turkey's sovereign risk, and thus facilitate macroeconomic and
price stability. In this respect, on closing my remarks, I would like to remind you once more
that timely implementation of the structural reforms envisaged by the MTP and the European
Union accession process remain to be of utmost importance. Thank you for your
participation.