Durmuş Yılmaz: Recent economic and financial developments in Turkey
Speech by Mr Durmuş Yılmaz, Governor of the Central Bank of the Republic of Turkey, at
the press conference for the presentation of the Inflation Report, Ankara, 26 January 2010.
* * *
Distinguished Guests and Members of the Press,
Welcome to the press conference held to convey the main messages of the January 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 global crisis, which erupted in developed markets and then spread
across the world during the last quarter of 2008, has continued to affect the economic
outlook, albeit less forcefully, during the last quarter of 2009. During this period, data
releases regarding the global financial system and economic activity displayed an ongoing
recovery (Figure 1). However, budget deficits - especially in developed economies -
continue to rise, problems across credit markets linger, and employment remains in a
precarious state, all suggesting that it would take a long time for the global economy to
completely recover (Figure 2). Moreover, ongoing uncertainties regarding the exit strategies
from unconventional fiscal and monetary stimulus continue to pose risks on the durability of
the recovery process.
1. Inflation developments
Distinguished Members of the Press,
During the final quarter of 2009, factors affecting inflation evolved in line with the outlook
presented in the October Inflation Report. Both domestic and external demand displayed a
gradual recovery, yet resource utilization remained at low levels. However, an unexpected
surge in unprocessed food prices caused the inflation rate to realize one-percentage point
higher than forecasted in the October Inflation Report. In other words, the deviation from the
end-2009 inflation forecast presented in the October Inflation Report could be explained
almost entirely by the increase in unprocessed food prices. Consequently, in the last quarter
of 2009, annual inflation climbed to 6.53 percent, remaining within the uncertainty band,
albeit slightly below the target set (Figure 3).
While the contribution of food and energy items to annual inflation increased in the last
quarter of 2009, no significant change was observed in the contribution of the categories
excluding food and energy (Figure 4). Meanwhile, rising oil and other commodity prices as
well as the withdrawal of tax cuts within the fiscal stimulus package were other factors
leading to an increase in annual headline inflation in this period. Although these
developments caused the prices of core goods to increase more in the fourth quarter than in
previous years, the price hikes adjusted for tax effects remained below those of previous
years (Figure 5).
Processed food prices followed a course in line with the outlook presented in the October
Inflation Report, whereas unprocessed food prices surged more than expected (Figure 6).
Thus, food prices, which increased due to processed food prices in 2008, maintained an
upward trend in 2009 due to the surge in unprocessed food prices. As I have already
mentioned, these high-rated increases in unprocessed food prices explain substantially both
the rise in inflation in the last quarter and the deviation from the end-2009 inflation forecast.
In Turkey, annual inflation in unprocessed food prices displays remarkable fluctuations and
this creates a significant forecast uncertainty. To illustrate this, following the lowest rate of
third quarter change of the past five years in 2009, this group also displayed the highest rate
of increase over the last six years due to price hikes in fruits-vegetables and meat in the
fourth quarter of 2009 (Figure 7). Here, I would like to remind that, in the third chapter of
Inflation Report that will be posted on our website shortly you can find the Central Bank's
detailed assessments regarding volatility in unprocessed food inflation, including comparative
analyses between Turkey and other countries.
Distinguished Members of the Press,
Let me underline that the rise in annual inflation observed in the last quarter of 2009 can be
attributed to several temporary factors, rather than a deterioration in the general price setting
behavior. In fact, core inflation indicators in the last quarter pointed to an underlying inflation
trend of around 4 to 5 percent and remained consistent with medium-term targets. Although
annual inflation in core measures increased modestly with the expiry of tax incentives on
durable goods, seasonally and tax adjusted data indicate that the underlying trend of inflation
did not deteriorate (Figure 8). Furthermore, the inflation diffusion index, calculated by using
the difference between the share of items with increasing prices and the share of items with
falling prices in the CPI, hovered around historically low levels (Figure 9). These
observations indicate that the increase in inflation in the last quarter of 2009 is mainly due to
temporary developments, and to factors beyond the immediate control of monetary policy,
rather than the main components of inflation.
Parallel to these developments, inflation expectations for 12 months ahead that followed a
downward course throughout the year increased slightly in the last quarter; whereas inflation
expectations for 24 months ahead remained relatively flat (Figure 10). While expectations
displayed a modest increase in January on the back of higher-than-expected inflation due to
the surge in food prices in the last quarter of 2009 and on the back of tax adjustments that
started to be implemented in early January, it is observed that the change in expectations
remained more limited as maturities extended (Figure 11).
In the last quarter of 2009, inflation displayed an upward trend on a global basis as well.
Inflation rates that had plummeted all over the world due to downward pressures arising from
demand and cost conditions since the second half of 2008, started to trend up in August
2009, particularly due to the low base of 2008 in commodity prices (Figure 12 and 13).
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 as of 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. The cumulative interest rate cuts between November 2008 and November 2009
reached 1,025 basis points, bringing Turkey's policy rate closer to the average of emerging
markets implementing inflation targeting regimes (Figure 14 and 15).
Taking into account the favorable developments in the credit markets and the moderate
recovery in economic activity in the last quarter of 2009, the Monetary Policy Committee
(MPC) slowed the pace of rate cuts, and finally decided to keep rates unchanged at the last
two meetings. However, it was also noted that lingering problems across the global economy
were still a concern and that uncertainties regarding the strength and durability of the
recovery remain. Considering these factors, the MPC reiterated that it would be necessary to
keep policy rates at low levels for a long period of time.
At its January meeting, the MPC indicated that tax adjustments and base effects would
cause inflation to rise significantly in the first two months of 2010 and afterwards remain
above the target for some time. Noting that the underlying trend implied by core inflation
indicators would remain at levels consistent with medium-term targets, the Committee
emphasized that, given the levels of resource utilization, the state of labor markets, and
global economic conditions, general pricing behavior would not be affected adversely by the
temporary rise in inflation, and therefore, inflation would display a declining trend once the
transitory factors taper off.
Market yields have been broadly shaped by the monetary policy stance during the last
quarter of 2009. This is particularly important as it demonstrates the increased effectiveness
of monetary policy. Market interest rates slightly increased in October with rising perceptions
that the policy rate cut cycle is coming to an end. However, continuing improvement in risk
perceptions towards the end of the year recently paved the way for market interest rates to
once again ease to historically low levels (Figure 16).
During the crisis, real market interest rates went down progressively on the back of rate cuts
and declined to all time lows. Although the limited increase in market interest rates
reverberated on medium-term real interest rates in the last quarter of the year, real interest
rates currently hover around historically low levels (Figure 17). Likewise, tightness in credit
markets continues to ease on account of monetary policy practices and reduced credit risk
perceptions (Figure 18).
3. Inflation and monetary policy outlook
Distinguished Members of the Press, Distinguished Guests,
After summarizing inflation and monetary policy developments in the final quarter of 2009, in
this part of my speech, I would like to share with you the evaluation of the inflation outlook
and monetary policy of the Central Bank of Turkey in the upcoming period. Firstly, I will
briefly describe the economic framework underlying these 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 last quarter of 2009, perceptions grew that the crisis was over and recovery started,
which helped the upward tendency in global risk appetite to continue. This development,
coupled with the ample and low-cost liquidity injected to the market in line with expansionary
fiscal and monetary policies on a worldwide scale, underpinned optimism in global financial
markets and led to continued demand for risky assets. Accordingly, risk premium indicators
in most developing countries remained lower than pre-crisis levels (Figure 19).
As you will recall, on several occasions we have mentioned that Turkey's sovereign credit
rating in the post-crisis period was not commensurate with the actual credit risk level in the
market. Actually, in the last quarter of the year, consistent with our discourse and projections,
the medium and long-term forecasts for Turkey have been revised to positive; several
investment institutions have increased Turkey's share in their portfolio, and, more
importantly, the leading credit rating agencies have upgraded Turkey's sovereign rating
(Figure 20).
The improvement in global risk perceptions in the last quarter led to the appreciation of local
currencies of many developing countries. A similar trend was observed in Turkey too and the
relatively stable course of the Turkish lira continued in the last quarter (Figure 21).
Distinguished Members of the Press,
The third quarter gross domestic product (GDP) release was in line with the outlook
presented in the October Inflation Report. While the impact of the fiscal stimulus package on
domestic demand weakened, the gradual recovery in external demand continued. Within this
framework, the GDP decreased by 3.3 percent in the third quarter of 2009 compared to the
same quarter last year (Figure 22). In seasonally adjusted terms, the quarterly upward trend
continued in the third quarter, albeit slower compared to the second quarter during which the
impact of the fiscal stimulus package was substantial (Figure 23).
On the spending side, inventory change became the demand component that made the
largest contribution to quarterly growth (Figure 24). Nevertheless, private consumption
demand slowed down slightly after the tax cuts were phased out (Figure 25). Meanwhile,
although private sector investments displayed a quarterly rise after a long time, investment
expenditures are not expected to display a significant acceleration in the short term given the
current uncertainty about demand and low capacity utilization rates, and it is obvious that it
would take some time for investments to return to the pre-crisis level.
Data pertaining to the last quarter of 2009 indicate that the moderate recovery in aggregate
demand continues (Figure 26). Although inventory de-stocking, which started with the
sudden contraction in demand in the last quarter of 2008 and remained strong throughout the
first half of 2009, grew significantly weaker, demand for consumer goods continued to
support disinflation (Figure 27).
The significant decline in external demand has been one of the main factors driving the sharp
contraction in economic activity during the last quarter of 2008 and the first quarter of 2009.
As inventory de-stocking decelerated in the third quarter of 2009, the pick-up in aggregate
demand led to acceleration in demand for imported goods and the contribution of net exports
to quarterly growth became negative (Figure 24). External demand conditions will continue to
play a critical role regarding the pace of the recovery in economic activity in the forthcoming
period as well. As of December, no significant upward revision in growth forecasts for
developed countries - as compared to the forecasts in October Inflation Report - is deemed
necessary. Within this framework, even if the recently issued data affirm that moderate
recovery in exports continues, given the current level of exports and the expected pace of
global economic recovery, external demand is not expected to reach its pre-crisis levels for a
long period of time (Figure 28).
The weak course of external demand would restrain economic activity and employment
growth through its impact on industrial production. Indicators such as capacity utilization
rates and per capita hours worked across industries suggest that resource utilization remains
low throughout the economy. Nevertheless, indicators of the labor market started to recover
in the third quarter of 2009. Although the upward trend in unemployment rates reversed in
seasonally adjusted terms, the unemployment rate is still quite high compared to the
precrisis level (Figure 29). The mentioned recovery in unemployment rates as of the third
quarter of 2009 was mainly driven by the pick-up in non-farm employment (Figure 30).
Assuming that the ample slack would continue to be a drag on investment and employment,
recent signs of improvement in employment data is not expected to turn into a significant
recovery, suggesting that the unemployment rate will likely remain elevated for an extended
period. Therefore, unit labor costs and domestic demand would continue to support
disinflation.
Distinguished Guests,
As I have mentioned earlier in my speech, the tightness in credit conditions have been
moderating since the publication of the July Inflation Report, owing to the improvement in
global liquidity conditions and risk perceptions. Easing financial conditions and declining loan
rates have been strengthening the expansionary impact of monetary policy. The October
Inflation Report had stated that the credit channel would begin to support domestic economic
activity during the fourth quarter of the year. In fact, credit demand started to recover in this
period, especially with commercial loans picking up significantly. However, the effectiveness
of the credit channel in supporting economic activity is still partly restrained owing to the
ongoing tightness in lending standards for small- and medium-sized enterprises.
It is expected that the credit channel would continue to support domestic activity, and the
impact of cumulative rate cuts would become more prevalent over the medium term.
However, the rising domestic borrowing requirement of the public sector, ongoing problems
in the global economy, and elevated levels of unemployment would continue to restrain credit
expansion.
Overall, recent data releases have shown that economic activity is on a gradual recovery
path. Even if the gradual recovery in economic activity is expected to continue in the period
ahead, resource utilization is anticipated to remain below the long-term average for some
time. In this context, our medium-term forecasts suggest that the output gap - albeit closing
faster than envisaged in the October Report - will remain disinflationary until the beginning of
2012.
Distinguished Members of the Press,
Although the course of economic activity has been broadly in line with the outlook presented
in the October Inflation Report, there have been some developments that necessitated an
upward revision in short-term inflation forecasts. As I believe that interpreting these
developments accurately is very important, I would like to further elaborate on these
developments.
The tax measures implemented in January on fuel, alcohol, and tobacco products, to
increase budget revenues, will add around 1.5 percentage points to 2010 consumer inflation.
Forecasts presented in the October Inflation Report assumed that prices of these products
would increase in line with target inflation in 2010, and thus the total contribution of these
items was envisaged to be 0.5 percentage points. Accordingly, tax measures in January
have shifted the inflation forecast path by around 1 percentage point through 2010. I would
like to underline that this impact will be seen immediately in January 2010 and disappear
following January 2011.
The rise in oil prices was another factor that necessitated an upward revision in our
shortterm inflation forecasts. Commodity prices continued along a rising trend during the last
quarter of 2009, with the improving perception regarding the global economic recovery
(Figure 32). Accordingly, oil prices hovered above our assumption of 70 USD per barrel for
the fourth quarter (Figure 33). Therefore, oil price assumptions stated in the previous Report
have been revised in line with futures prices registered during the first half of January. In this
context, the previous assumption of oil prices have been revised up from 75 USD per barrel
to 80 USD for 2010, and from 80 USD to 85 USD for 2011 and thereafter (Table 1). This
revision has added around 0.2 percentage points to the 2010 inflation forecasts. Moreover, in
line with oil prices, imported input prices are also assumed to increase gradually throughout
the forecast horizon in response to the gradual recovery in the world economy.
The October Inflation Report envisaged annual food inflation to be 5.8 percent for 2009 and
6 percent for the years to follow. However, as I have mentioned earlier in my speech,
unprocessed food prices exceeded our forecasts. Therefore, we revised our assumptions for
food inflation up from 6 percent to 7 percent for end-2010 (Table 1) and this added around
0.3 percentage points to the 2010 inflation forecast. Similarly, assumptions for 2011 food
inflation have been raised to 6.5 percent from 6 percent. We maintain our 6 percent annual
food inflation forecast for subsequent years.
Finally, regarding fiscal policy, it is assumed that the consistent framework outlined in the
Medium Term Program (MTP) will be implemented and further enhanced by institutional and
structural measures. In other words, it is assumed that no public price/tax adjustments would
be made to lead to unpredictable volatilities in inflation and administered prices would be set
in line with inflation targets over the next three years. Moreover, it is assumed that the fiscal
stance will remain expansionary - but less so than in 2009 - throughout 2010, and
subsequently fiscal tightening would be gradually adopted starting from 2011. In this respect,
it is envisaged that the rising debt-to-GDP ratios would reverse their course steadily starting
from 2011, and hence the risk premium would not display any significant changes throughout
the forecast horizon.
Distinguished Guests and Members of the Press,
Against this background, assuming policy rates are kept constant for a long period followed
by limited rises thereafter, 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 5.5 and 8.3 percent with a mid-point of 6.9 percent at end-2010; and
between 3.4 and 7.0 percent with a mid-point of 5.2 percent by the end of 2011.
Furthermore, inflation is expected to decline to 4.9 percent by the end of 2012 (Figure 34).
Overall, there has not been any major change in medium-term forecasts and the monetary
policy stance, since economic activity has evolved in line with the outlook presented in the
October Inflation Report. However, all the main variables affecting the short-term forecast
have been subject to an upward revision. In this respect, while short-term forecasts were
revised upwards significantly, there has been no major change regarding medium-term
forecasts.
The revised forecasts indicate that there will be no significant upside pressures on inflation,
even if policy rates remain at low levels for a long period. However, as depicted in the slide,
inflation is likely to display a significant increase over the next two months due to tax hikes
and strong base effects (Figure 34). Moreover, the annual inflation rate may post a limited
increase in the second quarter of 2010, due to the low base effect generated by the
Consumer Price Index in the first half of 2009, when the downside effects of the global crisis
on prices became more pronounced. Accordingly, even if inflation remains above the target
for some time, parallel to the gradual phasing out impact of the tax hikes, inflation is
expected to trend downwards, stabilizing at around 5 percent over the medium term.
As you may have noticed, I have frequently referred to the base effect today. The reason for
this is that the base effect will influence the course of annual inflation throughout 2010 to a
large extent. You will find our detailed explanatory evaluations regarding the base effect and
its effects on 2010 inflation outlook in a box under the third chapter of the Inflation Report to
be posted on our website shortly. I strongly recommend that you read these evaluations
carefully.
The fact that inflation is expected to stay at elevated levels for some time due to tax
adjustments and strong base effects highlights the importance of expectations management.
In this respect, with the awareness of these temporary factors, it is critical that economic
agents focus on the medium-term inflation trend, and therefore, take inflation targets as a
benchmark for their pricing plans and contracts.
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, assumptions
regarding future policy rates underlying the inflation forecast should not be perceived as a
commitment on behalf of the CBT.
4. Risks
Distinguished Members of the Press,
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 outlook for the domestic economy and the risks thereto has been largely shaped by
global developments in line with the intensification of the global crisis as of the last quarter of
2008. Given the important role of trade and global financial channels in the contraction of
domestic economic activity during 2009, we believe that global developments would continue
to be the main determinant of the outlook for domestic activity and inflation in the forthcoming
period. Accordingly, in this part of my speech, I will cover both the possible trends of global
and domestic economic activity, as well as their impact on the domestic inflation outlook
jointly.
Rising budget deficits and ongoing problems in credit and real estate markets continue to
pose downside risks for global activity, especially for developed economies. Although the
probability of another disruption in global economic activity has been decreasing, it is still an
important source of downside risk on domestic economic activity and inflation. Should global
conditions deteriorate again, and consequently delay domestic recovery, the CBT would
consider further monetary easing.
Despite the prevailing downside risks on global and domestic economic activity, upside risks
have also been emerging since the second half of 2009. The extent of recovery in global
economic activity in the second half of 2009 reminds us of some of the upside risks in
economic activity as well. Moreover, it should be noted that the impact of the unprecedented
expansionary policy measures that have been taken since the last quarter of 2008 would
become visible with a lag. Similarly, it should be considered that the 1025 basis points of
cumulative easing in CBT policy rates between November 2008 and November 2009 would
also be fully conveyed with a lag. In this respect, should the recovery in domestic economic
activity turn out to be faster than expected, the limited monetary policy tightening implied in
the baseline scenario could be implemented earlier than envisaged.
The fact that inflation will rise in the forthcoming period due to base effects and public price
adjustments, poses an important risk factor through its potential impact on inflation
expectations. Several adverse factors such as food and oil price increases, base effects and
administered price hikes have brought about upward movements in inflation since the last
quarter of 2009. Although these factors are temporary, they are likely to cause headline
inflation to stay at elevated levels for some time. It is crucial that economic agents fully
understand the temporary nature of these developments while forming their medium- and
longer-term expectations. Under the assumption that resource utilization would remain low,
labor market conditions would have an adverse impact on consumption expenditure, and
fiscal policy would generate a gradual depressing effect on the economy, these temporary
factors as well as other one-time cost push pressures would not lead to a significant
deterioration in general pricing behavior. Currently, the annual rate of increase of services
prices and core inflation are consistent with medium-term inflation targets, and no serious
risk of pass-through is observed. Therefore, it is foreseen that policy rates would be
maintained at low levels for a long period. However, I would like to underline that should any
unforeseen developments lead to a deterioration in general price setting behavior, the CBT
will not hesitate to tighten monetary policy sooner than envisioned under the baseline
scenario drawn up in this Report.
Increasing budget deficits on a worldwide scale, especially in developed economies,
continue to pose upside risks on inflation expectations and thus on longer term global
interest rates. Countries with relatively sounder banking systems and prudent fiscal policies
would be more resilient against these risks. In this respect, the CBT will continue to monitor
fiscal policy developments closely while formulating monetary policy. Should the goals set
out in the Medium Term Program be implemented through institutional and structural
measures, rather than tax and administered price hikes, it would be possible to keep policy
rates at single digits throughout the forecast horizon.
The probable course of oil and other commodity prices still remains as another important risk
factor. Short-term ample liquidity driven by countercyclical policies that are adopted by public
authorities on a global scale can give way to speculative movements in commodity prices.
Fast growth trends in countries like China and India, and the rising share of these economies
in global commodity demand, exacerbate these speculative motives. Therefore, oil and other
commodity prices may continue to rise, even in a scenario of a gradual global economic
recovery. At this point, it is worth noting that weak domestic demand conditions would limit
the pass-through stemming from upside cost-push shocks. Therefore, the CBT will not react
to the first round effects of short-term volatility in commodity prices, especially when
domestic resource utilization remains at depressed levels. However, if an uptrend in
commodity prices coincides with a strong and durable rebound in global economic activity
that would in turn have adverse effects on inflation expectations, then the CBT will tighten
monetary policy appropriately to keep inflation in line with medium-term inflation targets.
Since the last quarter of 2008, the CBT, without endangering its main objective of price
stability, has focused on containing the adverse effects of the global crisis on domestic
economy, and this task has to a large extent been achieved. Monetary policy will continue to
focus on permanent price stability in the period ahead. Strengthening the commitment to
fiscal discipline and the structural reform agenda would support the relative improvement in
Turkey's sovereign risk, and thus facilitate macroeconomic and price stability. In this respect,
before concluding my remarks, I would like to underline 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. Thank you for
your attention.