Careful readers might recall that I warned here about the probable poor performance of the central government budget in December. As a matter of fact, in December alone, there was a gigantic 16.1 billion-Turkish Lira deficit mainly due to high capital spending. However, despite this outlier, the central government budget produced a 39.6 billion-lira deficit in 2010 (3.6 percent of gross domestic product), pointing to a better performance than the revised official estimate of 44.2 billion liras (4 percent of GDP) deficit. It can also be seen as a relative success in today’s world full of debt and budget problems.
On the other hand, economy officials have long said they would allocate the strong revenue performance especially to investment expenditures rather than saving it. Therefore, the deterioration in the budget was well-telegraphed and came even later than envisaged. In my opinion, it is related to the aim of the full utilization of 2010 appropriations. In other words, the steep advance in expenditures is a result of a year-end factor and does not imply a permanent acceleration. However, for many analysts this was an excuse for changing the rate cut call by citing the Central Bank’s possible caution after these results. Although I give more weight to the “on hold” decision, I do not see any impact from that factor on the Central Bank verdict, as the Central Bank probably has the knowledge of this spending increase beforehand.
For the outlook of fiscal discipline going forward, I still think the strong economic activity should keep supporting the revenues side of the budget. The official target for the 2011 year-end budget deficit of 2.8 percent implies some narrowing in the budget deficit, which is currently at 3.6 percent. However, this improvement is planned to be backed by higher privatization revenues and lower interest payments. This means neither tightening nor loosening in the fiscal discipline in 2011 compared to 2010.
When doves cry
By the time I wrote today’s article, the markets were anxiously waiting for the Central Bank decision. The Central Bank had cut rates by 50 basis points at last month's meeting and many analysts had been pricing in a further cut initially. However, those expectations have waned over the last weeks as the lira has weakened and a majority of analysts think rates will remain on hold. While expectations of no change in the policy rate have been the main theme lately, a contradicting decision is not totally ruled out. Whatever the decision, the Central Bank should make sure that it will not be perceived as “dovish” this time. Gov. Durmuş Yılmaz also acknowledged this by saying: "I don't want to leave this impression that the Central Bank is aiming at a monetary policy of easing. That is not the case. The target that the bank wants to reach is a tighter monetary policy," during a Euromoney conference in Vienna on Tuesday. Yılmaz also said the Central Bank cut interest rates last month to curb the inflow of hot money into the economy and added that its policies were aimed at reducing domestic demand.
Mind the unemployment gap
As a lagging indicator of economic recovery, the unemployment rate continued to come down to levels not seen since October 2008. According to the latest data available, the unemployment rate declined to 11.2 percent, and in the non-farm sectors to 14.1 percent, from 13 percent and 16.4 percent a year ago. While this sharp decline is related to a crisis-hit base term, seasonally adjusted figures also show that the labor market conditions recovered from their weak performance in the previous months. The leading indicators, like consumer and real sector confidence and industrial production, suggest that the economic activity is to strengthen in the fourth quarter of 2010. Thus the labor market conditions will likely improve going forward. However, this would not be strong enough to cause any wage pressure, bearing in mind the still-high unemployment rate and population growth rate of 1.1 percent. Before the global crisis, the long-term unemployment rate average was around 10 percent. That is to say, there is still room for improvement before the full closure of the unemployment gap.
21 Ocak 2011 Cuma
14 Ocak 2011 Cuma
Central Bank in the center of volatility...
The mood in the financial markets has turned decidedly sour over the last few weeks amid a welter of disappointing economic news from around the world. The U.S. is in the center of this pessimism – first the home sales data and then the non-farm payrolls surprised on the downside and erased hopes for an early recovery in the U.S.
In the EU, weak growth outlook persists, accompanied by debates over the feasibility of a credible post-crisis mechanism. It seems that the volatility in the markets would likely remain high or even get higher due to both global and local developments. Globally, the weak recovery pace in developed markets would likely be of main concern. Locally, the Central Bank of Turkey’s new monetary policy toolbox to fulfill the dual mandate of low inflation and financial stability would add to the short-term uncertainty and thus the general volatility. For instance, currently the market is mostly expecting a 50 basis point cut at the next meeting of the Monetary Policy Committee, or MPC, on Jan. 20. However, it doesn’t seem to be a done deal, bearing in mind the currency depreciation recently.
As I’ve mentioned here before, policy rates currently appear to be a function of the short-term fund flows, thus the fluctuations in the level of currency should also be considered. The portfolio inflows have slowed down in December and there seems to be a global risk aversion tendency, which is pushing the currency rates higher in Turkey, beyond some very important technical resistance levels. If this tendency is to be preserved till the next Monetary Policy Committee meeting, then the Central Bank may opt to wait a bit longer before cutting rates further. If really it is the case, the Central Bank may preserve this tool for the times when the portfolio inflows intensify and lead to sharp currency appreciation.
On the other ingredient of policy mix, namely the reserve requirement ratio, the Central Bank relies on this old-fashioned tool to slow down the credit growth, which is considered to be highly correlated with the current account deficit. While the consensus expectation for the deficit points to 6.2 percent of GDP in 2010, the Central Bank says that the credit growth should be limited to 25 percent in order to attain a current account deficit level of 5.4 percent of GDP in 2011. The current trend of credit growth is at 40 percent and it would definitely necessitate more reserve requirement rises in order to attain such a slowdown. So I expect the Central Bank to hike the reserve requirement of foreign exchange liabilities this month (more on short-term liabilities again), but also consider more rises on Turkish Lira liabilities in the following months.
Permanent bears
In November, the current account deficit hit a record $5.9 billion. Also, the 12-month cumulative deficit increased to $44.9 billion, from $40.8 billion in the previous month. I expect that the deficit will continue to expand, reaching $46.6 billion in 2010 (6.2 percent of GDP). In my opinion, for an energy-hungry country the deficit is structural and Turkey is no stranger to large current account deficits. However, although I have been following the Turkish economy for many years, I still do not understand the real cause of concern of some market pundits. Is it the deficit, its financing or the quality of financing? This time they put forward the dominance of short-term portfolio inflows in the financing of the current account deficit as a cause of concern. But I remember very well that the same pundits were worried in 2008 as well when the financing was coming from long-term items such as foreign direct investment and long-term loans. Now I understand that there is no way to dispel all worries of some pundits because they are permanent bears.
Early signs of pre-election spending?
Early indicator of the budget performance, The Treasury’s cash-based budget produced a bulky 11.2 billion-lira non-interest deficit in December. The surge in the non-interest expenditures was the key reason behind the weak performance. However, this was not uncommon, as every December points to similar expansion in expenditures. Besides, based on these cash figures, the central government budget deficit to GDP ratio would be slightly above 3 percent in 2010, much below the revised official estimate at 4 percent in the Medium Term Fiscal Program.
In the EU, weak growth outlook persists, accompanied by debates over the feasibility of a credible post-crisis mechanism. It seems that the volatility in the markets would likely remain high or even get higher due to both global and local developments. Globally, the weak recovery pace in developed markets would likely be of main concern. Locally, the Central Bank of Turkey’s new monetary policy toolbox to fulfill the dual mandate of low inflation and financial stability would add to the short-term uncertainty and thus the general volatility. For instance, currently the market is mostly expecting a 50 basis point cut at the next meeting of the Monetary Policy Committee, or MPC, on Jan. 20. However, it doesn’t seem to be a done deal, bearing in mind the currency depreciation recently.
As I’ve mentioned here before, policy rates currently appear to be a function of the short-term fund flows, thus the fluctuations in the level of currency should also be considered. The portfolio inflows have slowed down in December and there seems to be a global risk aversion tendency, which is pushing the currency rates higher in Turkey, beyond some very important technical resistance levels. If this tendency is to be preserved till the next Monetary Policy Committee meeting, then the Central Bank may opt to wait a bit longer before cutting rates further. If really it is the case, the Central Bank may preserve this tool for the times when the portfolio inflows intensify and lead to sharp currency appreciation.
On the other ingredient of policy mix, namely the reserve requirement ratio, the Central Bank relies on this old-fashioned tool to slow down the credit growth, which is considered to be highly correlated with the current account deficit. While the consensus expectation for the deficit points to 6.2 percent of GDP in 2010, the Central Bank says that the credit growth should be limited to 25 percent in order to attain a current account deficit level of 5.4 percent of GDP in 2011. The current trend of credit growth is at 40 percent and it would definitely necessitate more reserve requirement rises in order to attain such a slowdown. So I expect the Central Bank to hike the reserve requirement of foreign exchange liabilities this month (more on short-term liabilities again), but also consider more rises on Turkish Lira liabilities in the following months.
Permanent bears
In November, the current account deficit hit a record $5.9 billion. Also, the 12-month cumulative deficit increased to $44.9 billion, from $40.8 billion in the previous month. I expect that the deficit will continue to expand, reaching $46.6 billion in 2010 (6.2 percent of GDP). In my opinion, for an energy-hungry country the deficit is structural and Turkey is no stranger to large current account deficits. However, although I have been following the Turkish economy for many years, I still do not understand the real cause of concern of some market pundits. Is it the deficit, its financing or the quality of financing? This time they put forward the dominance of short-term portfolio inflows in the financing of the current account deficit as a cause of concern. But I remember very well that the same pundits were worried in 2008 as well when the financing was coming from long-term items such as foreign direct investment and long-term loans. Now I understand that there is no way to dispel all worries of some pundits because they are permanent bears.
Early signs of pre-election spending?
Early indicator of the budget performance, The Treasury’s cash-based budget produced a bulky 11.2 billion-lira non-interest deficit in December. The surge in the non-interest expenditures was the key reason behind the weak performance. However, this was not uncommon, as every December points to similar expansion in expenditures. Besides, based on these cash figures, the central government budget deficit to GDP ratio would be slightly above 3 percent in 2010, much below the revised official estimate at 4 percent in the Medium Term Fiscal Program.
7 Ocak 2011 Cuma
What happens if everyone expects the same thing in an economy?...
When I look at several macro scenarios for the Turkish economy in 2011being depicted by different financial institutions, I barely notice any difference. It looks as if optimism is finally the predominant attitude toward the economy, thanks to self-confidence-boosting developments in the Turkish economy during and after the global crisis. The averages of forecasts are also similar to my forecasts, which I presented here on Dec. 17, 2010.
Let me summarize the macro outlook:
1) GDP growth is likely to be at least 5 percent, probably in the broad range of 5.5 percent to 6.5 percent. 2) Headline CPI inflation will remain within the 6 percent to 7 percent range, after hitting the 4 percent to 5 percent range in the first quarter. 3) Current account deficit is likely to expand to $50-$55 billion range, depending on growth forecast, from an estimated $45 billion in 2010. 4) The fall in unemployment is likely to continue but with reduced momentum. The yearly average unemployment rate will remain around 11 percent, better than 2010 but significantly above pre-crisis levels. 5) Budget deficit and non-interest balances are likely to improve further despite the general elections likely to be held in June. 6) There is a big chance the Turkish economy could be upgraded to investment grade in 2011. Such a rating would improve Turkey’s risk profile, bolstering long-term loans and foreign direct investment.
However, the convergence of views does not make me more comfortable. I still wonder whether this big consensus is really healthy. Actually, it means every market player is on the same side and this limits market fluctuations. It is definitely good for financial stability, but it also makes positions more exposed to macro data surprises in both directions.
On the other hand, there is certainly less consensus about financial indicators, especially the Central Bank policy rate path – although most analysts expect further rate cuts in the short-term. In that context, the first edition of quarterly inflation report from the Central Bank, due Jan. 25, will help shape a base scenario for the direction of rates in the medium-term on the policy horizon.
Yet another threshold from ratings agencies...
Could a rating upgrade be a Central Bank mission? Ratings agency Fitch thinks so. A Fitch Turkey analyst said Monday that Turkey's Central Bank faces a challenge to reduce inflation, prevent overheating and limit the current account deficit, and its success in managing this will feed into its rating assessment.
It is not an easy task. Though the headline consumer price index, or CPI, closed last year at 6.4 percent, below the year-end target of 6.5 percent, and I expect it to fall further to around 4 percent at the end of February – mainly due to favorable base effects generated by last year’s administrative (tax) price increases. However, from then on, the real challenge will be to keep the CPI below or around the 2011 target of 5.5 percent. In that context, the key variables are oil, unprocessed food prices and Turkish Lira depreciation (or appreciation). The first two are exogenous, but the last one will be tied to the monetary stance of the central bank. The easier the stance, the bigger the upward pressure on depreciation. Consequently, it is good for the current account, but not for inflation.
What is good for the country may not be good for the banks...
On the other side of the ledger, easy money could fuel a lending boom. In 2010, total growth in bank lending reached 30 percent. Moreover, the ratio of change in credit volume to GDP jumped by 11 percent. The Central Bank sees the difference between the system’s credit and deposit growth as a proxy to the private sector savings gap.
According to its calculations, all else (public sector savings gap, FDI and portfolio investments) being equal, a rise of 5 percentage points in the credit growth rate will increase the current account deficit by 2.1 points in any given year. Therefore, another strong growth spurt, as many bank CEOs aimed for in their 2011 plan, would make the CBT’s plan ineffective. That was the main motive behind the Central Bank’s warning to all banks to curb credit expansion to a level (at most 25 percent) consistent with macroeconomic targets of the Medium Term Program.
Let me summarize the macro outlook:
1) GDP growth is likely to be at least 5 percent, probably in the broad range of 5.5 percent to 6.5 percent. 2) Headline CPI inflation will remain within the 6 percent to 7 percent range, after hitting the 4 percent to 5 percent range in the first quarter. 3) Current account deficit is likely to expand to $50-$55 billion range, depending on growth forecast, from an estimated $45 billion in 2010. 4) The fall in unemployment is likely to continue but with reduced momentum. The yearly average unemployment rate will remain around 11 percent, better than 2010 but significantly above pre-crisis levels. 5) Budget deficit and non-interest balances are likely to improve further despite the general elections likely to be held in June. 6) There is a big chance the Turkish economy could be upgraded to investment grade in 2011. Such a rating would improve Turkey’s risk profile, bolstering long-term loans and foreign direct investment.
However, the convergence of views does not make me more comfortable. I still wonder whether this big consensus is really healthy. Actually, it means every market player is on the same side and this limits market fluctuations. It is definitely good for financial stability, but it also makes positions more exposed to macro data surprises in both directions.
On the other hand, there is certainly less consensus about financial indicators, especially the Central Bank policy rate path – although most analysts expect further rate cuts in the short-term. In that context, the first edition of quarterly inflation report from the Central Bank, due Jan. 25, will help shape a base scenario for the direction of rates in the medium-term on the policy horizon.
Yet another threshold from ratings agencies...
Could a rating upgrade be a Central Bank mission? Ratings agency Fitch thinks so. A Fitch Turkey analyst said Monday that Turkey's Central Bank faces a challenge to reduce inflation, prevent overheating and limit the current account deficit, and its success in managing this will feed into its rating assessment.
It is not an easy task. Though the headline consumer price index, or CPI, closed last year at 6.4 percent, below the year-end target of 6.5 percent, and I expect it to fall further to around 4 percent at the end of February – mainly due to favorable base effects generated by last year’s administrative (tax) price increases. However, from then on, the real challenge will be to keep the CPI below or around the 2011 target of 5.5 percent. In that context, the key variables are oil, unprocessed food prices and Turkish Lira depreciation (or appreciation). The first two are exogenous, but the last one will be tied to the monetary stance of the central bank. The easier the stance, the bigger the upward pressure on depreciation. Consequently, it is good for the current account, but not for inflation.
What is good for the country may not be good for the banks...
On the other side of the ledger, easy money could fuel a lending boom. In 2010, total growth in bank lending reached 30 percent. Moreover, the ratio of change in credit volume to GDP jumped by 11 percent. The Central Bank sees the difference between the system’s credit and deposit growth as a proxy to the private sector savings gap.
According to its calculations, all else (public sector savings gap, FDI and portfolio investments) being equal, a rise of 5 percentage points in the credit growth rate will increase the current account deficit by 2.1 points in any given year. Therefore, another strong growth spurt, as many bank CEOs aimed for in their 2011 plan, would make the CBT’s plan ineffective. That was the main motive behind the Central Bank’s warning to all banks to curb credit expansion to a level (at most 25 percent) consistent with macroeconomic targets of the Medium Term Program.
31 Aralık 2010 Cuma
Take away the punch bowl, serve up a policy cocktail...
Central Bank decisions and post-meeting communications have continued to dominate the economic agenda. Although I give the Central Bank the benefit of the doubt and will wait and see the results of recent decisions, it is clear that the policy rate cut accompanying the increased reserve requirement has generated reaction from some analysts who think price stability should be the overriding concern of a central bank. Since the expectations channel is vital for transmitting monetary policy to the real economy, inability to shape expectations as desired could be an obstacle to the effectiveness of the latest efforts. I think the Central Bank of Turkey got this message from market players. In return, the Central Bank is trying to convince decision-makers that the rate cut has nothing to do with the inflation outlook, which is very promising in the short term; it is indeed an element in a policy mix that has two main goals.
According to the Central Bank, the first goal of the current policy mix is reducing the pace of credit growth and the second goal is fostering longer maturity periods for capital inflows. It seems that a lower policy rate is very much related to the second goal of discouraging short-term capital inflows mainly in the form of swap transactions with non-residents. As a supplement to this, the Central Bank also widens the corridor between overnight borrowing and lending rates so as to allow fluctuations in the short-term interest rates when needed. As Central Bank Gov. Durmuş Yılmaz confirmed in a TV interview, this strategy was quite successful in driving away hot money and causing the recent depreciation of the Turkish Lira. I also saw from banks’ rapidly shrinking off-balance sheet transactions that it is actually happening. This is important for improving the quality of the capital account and avoiding exchange rate movements detached from economic fundamentals. However, it could also imply that another rate cut would not be needed if the second goal were accomplished. On the first goal, the Central Bank said higher effective required reserve ratios are anticipated to curb credit growth through the cost and liquidity channels starting from January. This means the composition and the direction of the policy instruments in the forthcoming period will be dependent on credit growth and capital flows data.
The Central Bank sent clear signals about the inflation outlook in the summary notes from its monetary policy meeting as an important part of its communication strategy. First, headline inflation is expected to be close to the end-2010 target of 6.5 percent. Second, inflation will decline in the forthcoming period. Third, the output gap still exists and will help to limit the pass-through from commodity prices to the prices of core goods and services. However, the bank remained cautious by highlighting the sharp increases in agricultural commodity prices (cotton and wheat) and the rapid pace of domestic demand. The bank said the impact of commodity prices on general price-setting behavior should be closely monitored.
Last but certainly not the least, the Central Bank clearly said the net impact of the macro-prudential policy package implemented – and to be implemented – both by itself and at other institutions should be on the tightening side. While this statement makes measuring the policy stance even more difficult, it also increases the importance of the Central Bank’s credibility. So it all depends on do you trust the bank or not?...
The Central Bank has been harshly criticized for not mentioning the importance of fiscal discipline in the fight against the current account deficit while bringing new burdens to the banking system. In the meeting notes, the Central Bank said increasing government savings is essential for containing the risks regarding the current account deficit and applauded the control of budget expenditures during 2010 as envisaged in the country’s medium-term program, while underlining the vitality of maintaining fiscal discipline in the period ahead.
According to the Central Bank, the first goal of the current policy mix is reducing the pace of credit growth and the second goal is fostering longer maturity periods for capital inflows. It seems that a lower policy rate is very much related to the second goal of discouraging short-term capital inflows mainly in the form of swap transactions with non-residents. As a supplement to this, the Central Bank also widens the corridor between overnight borrowing and lending rates so as to allow fluctuations in the short-term interest rates when needed. As Central Bank Gov. Durmuş Yılmaz confirmed in a TV interview, this strategy was quite successful in driving away hot money and causing the recent depreciation of the Turkish Lira. I also saw from banks’ rapidly shrinking off-balance sheet transactions that it is actually happening. This is important for improving the quality of the capital account and avoiding exchange rate movements detached from economic fundamentals. However, it could also imply that another rate cut would not be needed if the second goal were accomplished. On the first goal, the Central Bank said higher effective required reserve ratios are anticipated to curb credit growth through the cost and liquidity channels starting from January. This means the composition and the direction of the policy instruments in the forthcoming period will be dependent on credit growth and capital flows data.
The Central Bank sent clear signals about the inflation outlook in the summary notes from its monetary policy meeting as an important part of its communication strategy. First, headline inflation is expected to be close to the end-2010 target of 6.5 percent. Second, inflation will decline in the forthcoming period. Third, the output gap still exists and will help to limit the pass-through from commodity prices to the prices of core goods and services. However, the bank remained cautious by highlighting the sharp increases in agricultural commodity prices (cotton and wheat) and the rapid pace of domestic demand. The bank said the impact of commodity prices on general price-setting behavior should be closely monitored.
Last but certainly not the least, the Central Bank clearly said the net impact of the macro-prudential policy package implemented – and to be implemented – both by itself and at other institutions should be on the tightening side. While this statement makes measuring the policy stance even more difficult, it also increases the importance of the Central Bank’s credibility. So it all depends on do you trust the bank or not?...
The Central Bank has been harshly criticized for not mentioning the importance of fiscal discipline in the fight against the current account deficit while bringing new burdens to the banking system. In the meeting notes, the Central Bank said increasing government savings is essential for containing the risks regarding the current account deficit and applauded the control of budget expenditures during 2010 as envisaged in the country’s medium-term program, while underlining the vitality of maintaining fiscal discipline in the period ahead.
24 Aralık 2010 Cuma
Second act of hocus-pocus plan...
On Dec. 17, one day after the Central Bank of Turkey decided to cut rates, an article titled “Turkey’s Financial Conundrum” was published in the Wall Street Journal. Although it displayed opposite views about the decision and refrained from early judgment, the tone of the article was rather cynical as you might also extract from the sentence below:
“The bank’s monetary policy committee on Friday completed the second act of a hocus-pocus plan to simultaneously slow booming credit growth and curb the inflows of hot money that’s threatened to destabilize Turkey’s rapid recovery. Policymakers in Ankara have gambled that cutting rates to dissuade speculative investors is less risky than firing a domestic consumer boom that some fear could see the economy overheat. It’s too early to judge whether the complicated policy shift will have the desired effect: reducing hot money flows and cooling runaway lending rates. But the policy push has split the market. Some have praised the [Central Bank]’s boldness, acknowledging that rate-setters are in a tough spot trying to square competing objectives. Others are less sanguine, warning that the abrupt shift in policy calls the bank’s credibility into question.”
In an environment of uncertainty and unconventional approaches to monetary policy globally, as well as general elections and a Central Bank governor change locally in 2011, one could easily understand why there are different views and second thoughts about the same decision. Exactly for that reason, in my previous article, I underlined the importance of the Central Bank’s credibility in the eyes of market players since measuring how much increase in required reserve ratios would be enough to offset the interest rate cut is not very straightforward. If you want my honest opinion, the Central Bank has built up huge credibility during the global crisis by starting pre-emptive rate cuts that later on many others followed. So I beg to differ from those who see problems and risks in this policy mix. Clearly, the Central Bank is planning to ride on possible positive surprises from the inflation front. I can imagine how skeptics might react if headline inflation fell rapidly and reached 5 percent or lower at the end of February next year. The first test for this strategy will be held with December inflation, where I expect another fall in year-on-year comparisons. This could mean success for the Central Bank in reaching the 2010 target of 6.5 percent.
Capital war advances in all fronts
In the Monetary and Exchange Rate Policy announcement for 2011, on Dec. 21, the Central Bank said it would continue with the policy to increase the reserve requirement gradually for short-term Turkish Lira liabilities and also may consider changing the reserve requirement of foreign currency liabilities according to maturity composition. This implicitly means that the bank will continue with policy rate cuts in the following meetings to smooth the tightening effect of the reserve requirement increase. Another move from the Central Bank could be to widen the scope of the reserve requirements for foreign exchange liabilities. In that context, the Central Bank said banks’ off-balance sheet activities are going to be monitored closely. This means that the Central Bank may consider applying reserve requirements to FX swaps, which is another source for creating cheap Turkish Lira funding.
New target for Central Bank?
With its recent precautions and mention of possible measures it could take, the Central Bank seems to have adopted an implicit target for the current account deficit, as they expect it in 2011 to approach the level forecasted in the Medium Term Program ($42.2 billion, or 5.4 percent of GDP). However, consensus expectation for 2010 suggests the current account deficit will approach $45 billion this year, thus making such an assertion quite ambitious. Moreover, reaching this target necessitates a significant slowdown in economic activity especially in domestic demand. Therefore, striving for a narrower current account deficit would eventually mean prudent policy making thus confidence-boosting development for the government in an election year.
“The bank’s monetary policy committee on Friday completed the second act of a hocus-pocus plan to simultaneously slow booming credit growth and curb the inflows of hot money that’s threatened to destabilize Turkey’s rapid recovery. Policymakers in Ankara have gambled that cutting rates to dissuade speculative investors is less risky than firing a domestic consumer boom that some fear could see the economy overheat. It’s too early to judge whether the complicated policy shift will have the desired effect: reducing hot money flows and cooling runaway lending rates. But the policy push has split the market. Some have praised the [Central Bank]’s boldness, acknowledging that rate-setters are in a tough spot trying to square competing objectives. Others are less sanguine, warning that the abrupt shift in policy calls the bank’s credibility into question.”
In an environment of uncertainty and unconventional approaches to monetary policy globally, as well as general elections and a Central Bank governor change locally in 2011, one could easily understand why there are different views and second thoughts about the same decision. Exactly for that reason, in my previous article, I underlined the importance of the Central Bank’s credibility in the eyes of market players since measuring how much increase in required reserve ratios would be enough to offset the interest rate cut is not very straightforward. If you want my honest opinion, the Central Bank has built up huge credibility during the global crisis by starting pre-emptive rate cuts that later on many others followed. So I beg to differ from those who see problems and risks in this policy mix. Clearly, the Central Bank is planning to ride on possible positive surprises from the inflation front. I can imagine how skeptics might react if headline inflation fell rapidly and reached 5 percent or lower at the end of February next year. The first test for this strategy will be held with December inflation, where I expect another fall in year-on-year comparisons. This could mean success for the Central Bank in reaching the 2010 target of 6.5 percent.
Capital war advances in all fronts
In the Monetary and Exchange Rate Policy announcement for 2011, on Dec. 21, the Central Bank said it would continue with the policy to increase the reserve requirement gradually for short-term Turkish Lira liabilities and also may consider changing the reserve requirement of foreign currency liabilities according to maturity composition. This implicitly means that the bank will continue with policy rate cuts in the following meetings to smooth the tightening effect of the reserve requirement increase. Another move from the Central Bank could be to widen the scope of the reserve requirements for foreign exchange liabilities. In that context, the Central Bank said banks’ off-balance sheet activities are going to be monitored closely. This means that the Central Bank may consider applying reserve requirements to FX swaps, which is another source for creating cheap Turkish Lira funding.
New target for Central Bank?
With its recent precautions and mention of possible measures it could take, the Central Bank seems to have adopted an implicit target for the current account deficit, as they expect it in 2011 to approach the level forecasted in the Medium Term Program ($42.2 billion, or 5.4 percent of GDP). However, consensus expectation for 2010 suggests the current account deficit will approach $45 billion this year, thus making such an assertion quite ambitious. Moreover, reaching this target necessitates a significant slowdown in economic activity especially in domestic demand. Therefore, striving for a narrower current account deficit would eventually mean prudent policy making thus confidence-boosting development for the government in an election year.
20 Aralık 2010 Pazartesi
In Central Bank We Trust...
The Central Bank is finally taking action against the expanding current account deficit, which is perceived as the most significant threat against the financial stability, a phenomenon that is as important for the Bank as sustaining the price stability. Ahead of the Monetary Policy Meeting on December 16 and the 2011 Monetary and Foreign Exchange Rate Policy due December 21, the Central Bank used all the communication channels to give the message that the monetary policy stance may change. To justify this shift in the monetary policy the Bank says that the additional monetary easing in developed countries magnifies the risks of boosting capital inflows and further widening current account deficit. The Bank states that the current account deficit may grow through two channels; an acceleration of credit, domestic demand and demand for imported goods, due to an increased availability of ample low-cost borrowing opportunities, or an acceleration of demand for imported goods due to the current real appreciation trend of TRY reaching levels that are inconsistent with economic fundamentals. The Bank describes the new monetary policy framework in this environment as tightening via macroprudential instruments to prevent acceleration in credit, while reducing short-term interest rates in a controlled fashion to curb the appreciation trend in the exchange rate. The Bank believes this is the ideal policy mix. Now, we have an idea about the general terms of the new policy framework. However, there are question marks as to how much the Bank would cut the policy rate and raise the reserve requirements. I will try to answer these questions. The level of the real interest rate would mark the lower boundary for the policy rate, while CBRT Deputy Governor Basci gave the first clues regarding the macroprudential tools in his presentation held at the last weekend. The foremost objective of these measures is to provide incentives for the extension of maturities in all types of funding the Banks obtain from sources other than the Central Bank, while containing the money and the credit growth. Below I mention the first possible steps and my assessments regarding them in parentheses.
The financial stability measures to extend maturity: The purpose of the new measures will be to provide incentives to longer maturities for depositors as well as for international investors.
- Short-term deposit rates will settle at levels significantly below the longer term deposit rates. (This can be achieved by setting higher required reserve ratios for short term deposits, as well as by the policy rate cuts.)
- The CBT will take the necessary steps so that the average level of the short-term swap rates will form below long-term swap rate averages, while the volatility of short-term swap rates will materialize above those of the long-term rates. (While the swap rates would normally trade below the money market rates, by cutting the O/N borrowing rate to 1.5% and by letting the O/N repo rates to temporarily deviate from the policy rate the Central Bank already prepared the ground for this environment)
Financial stability measures to contain money and credit growth are as follows:
- The fall in long term interest rates is expected to be much more limited than that in short term interest rates. (The long term interest rates are what really matters for the credit rates. Therefore, if the Central Bank, by successfully managing the expectations, achieves to prevent the long term rates to decline as much as the policy rate cut, this may limit the credit growth.)
- The required reserve ratios will be increased primarily and especially for short term liabilities in gradual manner. (Given the fact the average maturity of deposits is 1-month, setting a different required reserve ratio for that segment may be an effective policy. In the meantime, the Bank now expands the funding channels of banks that are subject to required reserve to include the repo transactions)
- For containing the widening of the current account deficit, other public authorities in Turkey should also provide incentives for the extension of maturities in all types of funding while moderately and gradually tightening their macroprudential instruments. (Here, the Bank calls other institutions such as Finance Ministry and BRSA to use taxes and other instruments for the same purpose)
- The Central Bank will continue to tighten and loosen the short term funding amount at the policy rate as required by the circumstances. (The outstanding funding the Central Bank provides for the banking system hovers at TRY20bn and the level of O/N rates are affected by the changes in the funding size)
Some of these measures have been in use for some time, while some others are put into force at the Central Bank’s last MPC meeting and the remaining items (the new rules planned to motivate long term corporate bonds and eurobonds) on the list would be introduced depending on the ability of the economy officials to collaborate and synchronize.
On the other hand, the Central Bank believes that the significant drop in Turkey’s risk premium, the sharp decline in inflation expected in the following months (I anticipate CPI falling below 5% by February) and the likely acceleration in the portfolio inflows would give enough space for rate cuts. I assume that the real interest rate adjusted by the risk premium would determine the size of the rate cuts, which would be “measured” according to the Central Bank’s rhetoric. Even if the policy rate remains unchanged, real interest would rise if the risk premium and/or inflation expectations ease, the implication being a tighter monetary policy. The current risk premium of Turkey (that is 170 bps as measured by the EMBI+ Turkey) gives room for 150 bps rate cut in order to bring the monetary policy back to the loosest stance observed in the first half of the year (when the real interest rate was a negative 2.7%). This gives us the maximum amount of rate cut that is possible. As other criteria, the Central Banks says that the net impact of the measured policy rate cuts and tighter macroprudential tools to be contractionary. However, measuring how much increase in required reserve ratios would be enough to offset the interest rate cut is not very straightforward and the Central Bank’s credibility would play an important role. I believe that the Central Bank has been very credible for the markets over the recent period and I do not expect any problem on this side.
The financial stability measures to extend maturity: The purpose of the new measures will be to provide incentives to longer maturities for depositors as well as for international investors.
- Short-term deposit rates will settle at levels significantly below the longer term deposit rates. (This can be achieved by setting higher required reserve ratios for short term deposits, as well as by the policy rate cuts.)
- The CBT will take the necessary steps so that the average level of the short-term swap rates will form below long-term swap rate averages, while the volatility of short-term swap rates will materialize above those of the long-term rates. (While the swap rates would normally trade below the money market rates, by cutting the O/N borrowing rate to 1.5% and by letting the O/N repo rates to temporarily deviate from the policy rate the Central Bank already prepared the ground for this environment)
Financial stability measures to contain money and credit growth are as follows:
- The fall in long term interest rates is expected to be much more limited than that in short term interest rates. (The long term interest rates are what really matters for the credit rates. Therefore, if the Central Bank, by successfully managing the expectations, achieves to prevent the long term rates to decline as much as the policy rate cut, this may limit the credit growth.)
- The required reserve ratios will be increased primarily and especially for short term liabilities in gradual manner. (Given the fact the average maturity of deposits is 1-month, setting a different required reserve ratio for that segment may be an effective policy. In the meantime, the Bank now expands the funding channels of banks that are subject to required reserve to include the repo transactions)
- For containing the widening of the current account deficit, other public authorities in Turkey should also provide incentives for the extension of maturities in all types of funding while moderately and gradually tightening their macroprudential instruments. (Here, the Bank calls other institutions such as Finance Ministry and BRSA to use taxes and other instruments for the same purpose)
- The Central Bank will continue to tighten and loosen the short term funding amount at the policy rate as required by the circumstances. (The outstanding funding the Central Bank provides for the banking system hovers at TRY20bn and the level of O/N rates are affected by the changes in the funding size)
Some of these measures have been in use for some time, while some others are put into force at the Central Bank’s last MPC meeting and the remaining items (the new rules planned to motivate long term corporate bonds and eurobonds) on the list would be introduced depending on the ability of the economy officials to collaborate and synchronize.
On the other hand, the Central Bank believes that the significant drop in Turkey’s risk premium, the sharp decline in inflation expected in the following months (I anticipate CPI falling below 5% by February) and the likely acceleration in the portfolio inflows would give enough space for rate cuts. I assume that the real interest rate adjusted by the risk premium would determine the size of the rate cuts, which would be “measured” according to the Central Bank’s rhetoric. Even if the policy rate remains unchanged, real interest would rise if the risk premium and/or inflation expectations ease, the implication being a tighter monetary policy. The current risk premium of Turkey (that is 170 bps as measured by the EMBI+ Turkey) gives room for 150 bps rate cut in order to bring the monetary policy back to the loosest stance observed in the first half of the year (when the real interest rate was a negative 2.7%). This gives us the maximum amount of rate cut that is possible. As other criteria, the Central Banks says that the net impact of the measured policy rate cuts and tighter macroprudential tools to be contractionary. However, measuring how much increase in required reserve ratios would be enough to offset the interest rate cut is not very straightforward and the Central Bank’s credibility would play an important role. I believe that the Central Bank has been very credible for the markets over the recent period and I do not expect any problem on this side.
13 Aralık 2010 Pazartesi
Turkish Economic Outlook 2011
Summary: There has been a distinctly superb performance in 2010, as the economic activity has achieved a sharp rebound, making up for the much severer collapse than other countries during the crisis. However, the Q3 GDP figures suggest that the output has returned to the pre-crisis levels and the recovery pace would likely enter into a slower trajectory in 2011.
Under this broad picture;
1) Growth: I envisage that the economy would post a slower 5.0% growth next year, after expanding by a robust 8.0% this year.
2) Employment and Unemployment Rate: I anticipate unemployment rate falling to 11.9% on average this year, down from 14.0% in 2009. On the other hand, the downtrend in unemployment rate is likely to slow next year in tandem with a softer economic growth. Due to the high rate of growth in population at 1.5% and to the migration of labor force from agricultural sector to the other sectors, I believe that only a limited 0.5 pp drop in unemployment rate to 11.4% can accompany the economic growth that we estimate for next year.
3) Current Account Deficit and External Financing: I expect the deficit to expand slightly to $50.5bn (5.8% of GDP) from an estimated $44.9bn (5.9% of GDP) this year. Recall that Turkey had experienced such large deficits before. However, back then, the long term capital flows was the key financing tool, whereas today portfolio inflows constitute the major source. I believe that unless Turkey’s growth prospects are impaired and the government deviates from the fiscal framework depicted in the Medium Term Program, there is a great deal of chance that Turkey would be upgraded to the investment grade category next year. Such a rating move would improve Turkey’s risk profile, bolstering long term loans and foreign direct investment to the country. In that sense, I am less worried about the towering current account deficit.
4) Inflation: In line with the slowdown in GDP, the inflation outlook shall remain benign. Note that core inflation has been surfacing at a record low 2.5% over the last two months, despite the headline CPI is boosted by tax adjustments and food prices. However, with the partial correction in food prices in November, the annual CPI receded to 7.3%. The CPI is set to keep heading south in the upcoming months, easing even below 5% by February. Such a gigantic fall is linked to the high base year effect and the decline is set to be replaced by a slight uptrend later in the year, bringing the CPI to 6.0% by the end of 2011.
The key assumption that feeds our baseline scenario is that the global economy continues to recover and the risk appetite, which is important for the fund flows, does not get hurt due to additional uncertainty surrounding the global economy. Amidst the ongoing concerns regarding the European debt crisis and the fears that it may spread to bigger members, the delay of the fiscal consolidation in the U.S. may significantly hinder the internal and external rebalancing acts that are needed for a strong, balanced and sustained world recovery (*). This sluggishness has so far thwarted a strong and balanced post-crisis recovery and created uncertainty regarding its sustainability.
(*) Internal rebalancing: When private demand collapsed, fiscal stimulus helped alleviate the fall in output. But fiscal stimulus has to eventually give way to fiscal consolidation, and private demand must be strong enough to take the lead and sustain growth. External rebalancing: Many advanced economies, most notably the United States, which relied excessively on domestic demand, must now rely more on net exports. Many emerging market economies, most notably China, which relied excessively on net exports, must now rely more on domestic demand. “ World Economic Outlook, October 2010, foreword by Economic Counsellor Oliver Blanchard.
Under this broad picture;
1) Growth: I envisage that the economy would post a slower 5.0% growth next year, after expanding by a robust 8.0% this year.
2) Employment and Unemployment Rate: I anticipate unemployment rate falling to 11.9% on average this year, down from 14.0% in 2009. On the other hand, the downtrend in unemployment rate is likely to slow next year in tandem with a softer economic growth. Due to the high rate of growth in population at 1.5% and to the migration of labor force from agricultural sector to the other sectors, I believe that only a limited 0.5 pp drop in unemployment rate to 11.4% can accompany the economic growth that we estimate for next year.
3) Current Account Deficit and External Financing: I expect the deficit to expand slightly to $50.5bn (5.8% of GDP) from an estimated $44.9bn (5.9% of GDP) this year. Recall that Turkey had experienced such large deficits before. However, back then, the long term capital flows was the key financing tool, whereas today portfolio inflows constitute the major source. I believe that unless Turkey’s growth prospects are impaired and the government deviates from the fiscal framework depicted in the Medium Term Program, there is a great deal of chance that Turkey would be upgraded to the investment grade category next year. Such a rating move would improve Turkey’s risk profile, bolstering long term loans and foreign direct investment to the country. In that sense, I am less worried about the towering current account deficit.
4) Inflation: In line with the slowdown in GDP, the inflation outlook shall remain benign. Note that core inflation has been surfacing at a record low 2.5% over the last two months, despite the headline CPI is boosted by tax adjustments and food prices. However, with the partial correction in food prices in November, the annual CPI receded to 7.3%. The CPI is set to keep heading south in the upcoming months, easing even below 5% by February. Such a gigantic fall is linked to the high base year effect and the decline is set to be replaced by a slight uptrend later in the year, bringing the CPI to 6.0% by the end of 2011.
The key assumption that feeds our baseline scenario is that the global economy continues to recover and the risk appetite, which is important for the fund flows, does not get hurt due to additional uncertainty surrounding the global economy. Amidst the ongoing concerns regarding the European debt crisis and the fears that it may spread to bigger members, the delay of the fiscal consolidation in the U.S. may significantly hinder the internal and external rebalancing acts that are needed for a strong, balanced and sustained world recovery (*). This sluggishness has so far thwarted a strong and balanced post-crisis recovery and created uncertainty regarding its sustainability.
(*) Internal rebalancing: When private demand collapsed, fiscal stimulus helped alleviate the fall in output. But fiscal stimulus has to eventually give way to fiscal consolidation, and private demand must be strong enough to take the lead and sustain growth. External rebalancing: Many advanced economies, most notably the United States, which relied excessively on domestic demand, must now rely more on net exports. Many emerging market economies, most notably China, which relied excessively on net exports, must now rely more on domestic demand. “ World Economic Outlook, October 2010, foreword by Economic Counsellor Oliver Blanchard.
Kaydol:
Kayıtlar (Atom)