durmus yilmaz : central bank monetary and exchange rate policies and economic outlook speech by mr durmus yilmaz, governor of the central bank of the republic of turkey, at a meeting organised by the aegean industrialists and businessmen association, izmir, 8 june 2006. * * * distinguished guests, ladies and gentlemen, it is, indeed, a great pleasure for me to address another information meeting – yet another one in a series held since 2003 – organized in cooperation with dunya newspaper with a view to informing the business world. today ’ s meeting is the first meeting of 2006. i would like to take this opportunity to thank the aegean industrialists and businessmen association for their organization. considering recent inflation figures, i am sure you are all expecting me to inform you of developments in the economy, especially those regarding inflation. however, before moving on to topical subjects, at this very first meeting of 2006, i would like to briefly touch on what the transformation process the turkish economy has been undergoing since 2001 means to us. i also want to give you a framework of the macroeconomic outlook. my speech will cover the developments in inflation, the central bank ’ s interest rate and exchange rate policies, the developments in financial markets, growth, employment and the current account deficit. as i have mentioned earlier, the turkish economy has been undergoing a structural transformation process. this dynamic process, which started in 2001 and has reached a certain point today – though it still has a long way to go – is the process that will reveal the potential of our economy and determine its place in the world. since that time only five years have passed. this is a short span of time for an economy that needs structural changes and whose policies are formulated towards to this end, in order to implement reforms, achieve results and ensure the sustainability of such results. yet, the achievements attained in macroeconomic aggregates have been even beyond the program forecasts. cpi inflation declined to single digit figures after 35 years, from 68. 5 percent as of end - 2001. while inflation was in decline, high growth rates were achieved. annual growth in gnp, which was realized as 3. 9 percent on average between 1970 - 2001, became 7. 8 percent between 2002 - 2005. the ratio of public net debt stock to gnp, which had led to concerns about the sustainability of public debt, decreased to 55. 8 percent as of 2005, from 90. 5 percent. with the contribution of all these favorable

in inflation in the first quarter of the year was an expected development, which has been stated in the bank ’ s reports since january. in april and may, the increase in inflation was above the expected level due to unforeseen developments in seasonal pricing behaviors. compared to march, consumer prices increased by 1. 34 percent and 1. 88 percent in april and may, respectively. as of may, annual inflation became 9. 86 percent, which is obviously above the target path. in may, the direct effects of exchange rate movements on inflation started to be observed through the channels of fuel oil, gold and durable goods. during this period, the upward pressure exerted by the depreciation in the new turkish lira on inflation reached 0. 5 points. adding the exogenous movements in gold and oil prices, the total impact amounts to 0. 65 point. in other words, some of the direct effects of exchange rate movements on prices became evident in may. however, these effects are expected to be high in june, too. in the light of evaluations made in this respect, annual inflation figures may increase a little more for a temporary period of time in the upcoming months, due to the recent exchange rate movements observed after the fluctuations in financial markets. we foresee that these developments will mostly affect the short term, and the disinflation process will not be interrupted as long as the monetary and fiscal discipline continues in the medium - term. nevertheless, we have experienced many times that short - term developments might affect longer - term variables via expectations, due to past habits and the short - term perspective in turkey. as a matter of fact, we observe that short - term developments seem likely to affect the medium - term inflation expectations and pricing behaviors recently. in order to prevent the said short - term developments from creating permanent impacts on pricing behaviors and to maintain consistency between the mediumterm inflation trend and the targets, we have held an extra meeting and increased short - term borrowing interest rates to 15 percent from 13. 25 percent. in this respect, the outlook we take as a basis is the one in which a relative slowdown is observed in domestic demand, the increase in unit costs stops and inflation enters a downward trend again in the coming months. in light of information currently available, it can be said that inflation will be above the point target in end - 2006. in this framework, we have adopted a policy perspective in which inflation will come close to the target towards the end