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 January 2015 Inflation Report, Ankara,
27 January 2015.
* * *
Accompanying charts can be found at the end of the speech.
Distinguished Guests,
Welcome to the briefing held to convey the main messages of the Inflation Report of January
2015.
We have been pursuing a cautious monetary policy stance for a year. We have witnessed
some favorable outcomes of this approach. The downward trend in inflation will accelerate
starting from this month. Therefore, we began cutting policy rates in January. Provided we
maintain our cautious approach throughout these policy rate reductions, the end-2015
inflation will likely be the lowest we have seen in the last 45 years. 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 seven boxes
entailing interesting and up-to-date analyses on various topics. The report presents boxes
that analyze the effects of oil prices on consumer prices and the reflection of international
grain prices on domestic prices. Moreover, there are studies elaborating on the role of base
effects on consumer inflation in 2015, the debt dollarization of companies in Turkey and their
growth performance, the macroeconomic effects of international energy prices and the
reverberations of remuneration of required reserves. Titles of the boxes are shown on the
slide. All of these analyses shed light on noteworthy issues in the Turkish economy. I
strongly recommend that you read these boxes, which will soon be published on our website.
I would like to commence my speech by reviewing the global economic outlook given its
undeniable influence on our policies. In the fourth quarter of 2014, due to the persisting
divergence among global monetary policies besides uncertainties regarding the
normalization process, we saw aggravated volatility in financial markets. This led the portfolio
flows towards emerging economies to fluctuate and the volatilities of exchange rates in these
countries to increase (Chart 1). The persisting deterioration in global economic activity
accompanied by mainly supply-side factors has recently pulled down oil prices sharply.
These developments caused considerable fluctuations especially in energy-exporting
emerging countries. Overall, the risk premia of emerging economies followed a volatile
course due to the monetary policy uncertainties, the slowdown in economic activity and the
course of oil prices (Chart 2).
Effects of this volatility in global markets emerged in the Turkish economy as fluctuations of
risk premium indicators and exchange rates. The fall in commodity prices, chiefly in oil, is
expected to improve the economy especially in terms of inflation and external balance.
Additionally, the tight monetary policy stance stands out as a factor that limits the negative
effects of global volatilities on Turkey in this period.
Annual growth recorded some deceleration following the first quarter of 2014. This was
mainly led by receding agricultural output amid unfavorable climatic conditions as well as the
slowdown of export growth resulting from geopolitical risks. Indicators regarding the last
quarter show that annual growth remained moderate due to weak foreign demand. In 2015,
we expect the growth rate to increase gradually with the increased contribution of domestic
demand.
The positive effects of the tight monetary policy stance and macroprudential measures
continued in the last quarter of 2014 leading the core inflation trends to approach the target.
Moreover, plummeting oil prices supported the disinflation process and inflation expectations
have recently seen a noticeable improvement. Due to the fading cumulative effects of the
exchange rate, the reverting of food inflation to past years' averages as well as the falling oil
prices, we project a notable decline in inflation in 2015. Accordingly, inflation is estimated to
approach the levels consistent with the target in mid-2015.
1. Monetary policy and financial conditions
The Central Bank of the Republic of Turkey (the CBRT) maintained its tight stance in the last
quarter of 2014 and in consideration of global volatilities, supported the tight monetary policy
with a tight liquidity policy. As you can see on the slide, the BIST overnight repo rates have
remained close to the upper bound of the interest rate corridor since October in line with the
liquidity policy (Chart 3). The CBRT funding has been made mainly through one-week repo
auctions since early 2014 (Chart 4). Thus, the CBRT average funding rate hovered around
the 1-week repo rate in this period.
As we all know, core inflation trends are following a downward trend. Considering the fall in
oil prices and improved expectations that result in favorable developments in the inflation
outlook besides this downward trend in the core inflation trend, we decided on a measured
cut in the 1-week repo rate from 8.25 percent to 7.75 percent in January. On the other hand,
given the elevated volatility in global markets, we kept overnight rates unchanged and
announced through the MPC Decision that we would adopt a cautious stance to render the
decline in inflation permanent. In this context, we emphasized that we would closely monitor
inflation expectations, the pricing behavior and other factors affecting inflation and maintain
the tight monetary policy stance by keeping the yield curve flat until the there is a significant
improvement in the inflation outlook. Owing to this stance, the spread between 5-year market
rates and the BIST Interbank Overnight Repo Rates continues to take negative values
(Chart 5). Along with these developments, the yield curve has remained almost flat (Chart 6).
We announced the outline of the monetary and exchange rate policy for 2015 through a
press meeting on 10 December 2014. We also launched new macroprudential policies to
limit macro-financial risks and to support prudential borrowing at this meeting. In this scope,
to encourage the extension of maturities of external borrowing, we raised the required
reserve ratios applied to non-core foreign exchange (FX) short-term liabilities of banks and
financing companies. Additionally, we embarked on the remuneration of TL required reserves
to encourage core liabilities in January 2015. Moreover, we implemented technical
adjustments in reserve option tranches and coefficients to meet the FX liquidity to be
required due to the changes in required reserve ratios. We envisage that the automatic
stabilization feature of the Reserve Option Mechanism (ROM) will gain strength with these
adjustments. Through these policy measures we announced, our final aim is to limit
macrofinancial risks and contribute to balanced growth by supporting prudential borrowing.
The rate of increase in the loans extended to the non-financial sector in the last quarter of the
year maintains a reasonable course owing to the CBRT's tight monetary policy stance and
the macroprudential measures. Supported also by the actions of the Banking Regulations
and Supervision Agency (the BRSA), consumer loans grew slower than past years, while
commercial loans displayed a higher rate of increase (Charts 7 and 8). According to the
current financial conditions and the results of the Loan Tendency Survey, there has not been
any noticeable change in demand and supply conditions in commercial and consumer loans
in the first quarter of 2015. Accordingly, we envisage that credit growth will maintain its
current trend in the upcoming period. These reasonable levels in credit growth are expected
to continue to limit medium-term inflation pressures on the one hand, and support the
improvement in the current accounts balance on the other.
2. Macroeconomic developments and main 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.
In the fourth quarter of 2014, annual consumer inflation posted a quarter-on-quarter decline
by 0.7 points and stood at 8.17 percent remaining below the forecasts of the October
Inflation Report (Charts 9 and 10). Annual inflation decreased across sub-groups in this
period, the most remarkable slowdown being in the energy group, which was led by the
plunge in international oil prices. The food group remained as the largest contributor to
inflation. Core goods registered a slight fall in annual inflation, while the improvement in the
underlying trend, which continued from the second quarter on, halted. Meanwhile, we
witnessed the considerable effect of the fall in oil prices on fuel-related services and saw a
notable improvement in the underlying trend of services.
The tight monetary policy stance coupled with the macroprudential measures continues to
improve the core inflation trend (Chart 11). As of the end of 2014, the core inflation trend has
receded to 5 percent. The leading recent development, which affected inflation dynamics at
most, has been the plunge in oil prices (Chart 12). Amid this decline, annual inflation in the
energy group fell remarkably and stood below zero at the year-end. Favorable cost
developments driven by plummeting oil prices also contribute to the improvement in the core
inflation trend.
Briefly, the last quarter of the year was marked by evident effects of the falling oil prices on
inflation. A remarkable improvement was witnessed in inflation expectations after a long
period and the positive effect of oil prices on the headline inflation spilled over into many
subgroups, chiefly the services group. Besides the international price developments that
contribute to falling inflation, we envisage that the gradual elimination of cumulative
exchange rate effects, the decline in food inflation to past years' averages and our tight
monetary policy stance will support the disinflation process in the upcoming period. Against
this background, we project that consumer inflation will register a notable improvement
particularly in the first quarter, and inflation will recede to levels consistent with the target in
mid-2015.
Now, I would like to give a brief account of developments in economic activity and the
shortterm outlook on which the inflation forecasts are based. According to the GDP data of the
third quarter of 2014, economic activity was relatively weaker compared to the outlook
presented in the October Inflation Report. In the third quarter, the GDP rose by 1.7 percent
on an annual basis, while growth remained limited compared to the previous quarter with
0.4 percent (Chart 13). Analysis of national income components on the production side
indicates that the contraction in agricultural value-added led by adverse weather conditions is
an important factor in the low growth of the national income (Chart 14). Data on the
expenditures side reveal that in the third quarter, final domestic demand compensated for the
fall in the first half and stood slightly above its level in the last quarter of 2013 (Chart 13).
Following an interval of two quarters, private consumption expenditures recorded a robust
recovery. In addition, the languishing trend in private investments, which lasted for a long
time, reversed due to the increase in machinery and equipment investments. These two
factors supported quarterly growth. However, the relatively weak course of exports limited
the growth in this period.
We expect industrial production, which fell below its previous-quarter average during
October-November 2014, to decrease on a quarterly basis in the fourth quarter in line with
the decline in December's PMI and BTS survey indicators. Yet, data for the fourth quarter of
2014 point to a quarter-on-quarter pickup in consumer demand, a moderate course in
machinery-equipment investments and some recovery in construction investments. Hence,
we believe that domestic demand will remain on a modest upward track in the final quarter.
External demand, on the other hand, remains weak due to Europe's slowing economy and
geopolitical tensions in neighboring countries. The weak external demand puts pressure on
export growth, but the fact that export growth exceeds import growth supports the
rebalancing of the economy (Chart 15). Moreover, falling oil prices contribute positively to the
current account balance by reducing import expenditures (Chart 16).
We expect domestic demand to recover moderately and external demand to remain weak in
2015. Depending on weather and precipitation conditions, the projected correction in the
agricultural value-added will be a factor to support growth. However, there are external
demand-driven downside risks to growth. Thus, in 2015, demand conditions will contribute to
the disinflation process. Although we expect the growth composition to change in favor of
domestic final demand, we believe that the current account deficit will continue to improve on
the back of the macroprudential measures and the improved terms of trade.
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.
In the fourth quarter of 2014, oil and import prices remained well below the projections of the
October Inflation Report (Chart 17). Accordingly, we revised our medium-term assumptions
of oil and import prices significantly downwards. In view of the direct and indirect effects of
these developments, we revised the end-2015 inflation forecast down by 0.6 percentage
points compared to the previous reporting period. In food prices, we left the end-2015
inflation forecast unchanged at 9 percent.
Our medium-term projections are based on the assumption that tax adjustments and
administered prices are consistent with inflation targets and automatic pricing mechanisms.
The medium-term fiscal policy stance is based on the Medium Term Program projections
covering the 2015-2017 period. Accordingly, we assume that a tight fiscal stance will be
implemented and the primary expenditures to the GDP ratio will decrease gradually.
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.
Our medium-term forecasts are based on a framework that we will adopt a cautious
approach to make the improvement in inflation outlook permanent and maintain the tight
monetary policy stance by keeping the yield curve flat. Moreover, we assess that the annual
loan growth rate will stabilize around the recent reasonable levels, also thanks to the
macroprudential measures. Accordingly, we expect inflation to be, with 70 percent
probability, between 4.1 percent and 6.9 percent (with a mid-point of 5.5 percent) at
end2015 and between 3.2 percent and 6.8 percent (with a mid-point of 5 percent) at end-2016.
We project inflation to stabilize around 5 percent in the medium term (Chart 18).
In sum, we revised our end-2015 inflation forecast down by 0.6 points to 5.5 percent from
6.1 percent in the October Inflation Report. This revision is driven by falling oil prices. The
projected noticeable decline in inflation compared to 2014 is largely due to falling oil prices
as well as our projections that cumulative exchange rate effects will continue to taper off and
food price inflation will recede to past years' averages. The course of inflation in 2015 will be
determined by base effects. We expect base effects to pull annual inflation down until August
and push it up the rest of the year. Thus, we project that annual inflation will remain on a
downward track until the third quarter and increase slightly to 5.5 percent due to base effects
in the fourth quarter (Chart 18).
In addition to these forecasts, we discuss alternative scenarios on the inflation outlook and
the global economy 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.
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