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.
31 Aralık 2010 Cuma
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.
3 Aralık 2010 Cuma
Now it is your turn...
Summary: While the slowdown in the global economy and in Turkey expected for the second half of the year remained limited in Q3, there seems to be a revival in Q4. This should keep pushing up the consensus growth forecast for 2010. However, the growth estimates for 2011 is at reasonable levels. That limits the room for surprises from either side and inflation appears to be a more important theme for markets next year, as it is more exposed to surprises. The inflation forecasts for next year are quite high, preparing an appropriate ground for positive surprises.
We will see the third quarter growth performance in Turkey when the GDP figures are released on next Friday. After the data, the consensus for the overall year is likely to keep being upgraded from 7.0% print of the last survey. I believe this is quite important, considering the fact that the uninterrupted increase in the growth forecasts this year has become the key driver of the markets. The tight relation between the forward-looking expectations and the market performance would most likely be valid in the upcoming years, as well. The average GDP estimate has come all the way up to 7.0% in the last Central Bank expectation survey from the initial 3.3% in the beginning of the year, exploring the big potential for a positive surprise when the expectations are set irrationally low. In essence, there is still upside potential for the consensus. However, it is time to focus on 2011 expectations as we approach the new year.
Regarding the next year’s growth prospects, two important aspects would determine the outcome. Starting with the favorable one, the leading indicators suggest that the economic activity has picked up in the last quarter of the year and this momentum is highly likely to be preserved in the next year. Technically speaking, the seasonally adjusted industrial output that has recovered to pre-crisis levels would sustain quite strong year-on-year growth rates. Moreover, as suggested by the PMIs, the economic activity has been gaining steam globally which is an assuring factor for the sustainability of the revival at home. Nevertheless, this support from the global backdrop would be valid only if the heightened worries regarding the European debt crisis and the Fed’s launch of the second phase of the quantitative easing program, do not jeopardize the business and consumer confidence. Coming to the dismal aspect of growth dynamics for the year ahead, the GDP growth is set to reach 8% this year and this robust performance would form an unfavorable base year effect for 2011. In that context, the 4.8% average forecast for next year’s GDP is neither low nor high, limiting the surprise from either side.
Therefore, even though the GDP forecast continue playing an important role, the inflation forecasts are likely to replace as the more dominant market driver in 2011. Until then, the data disclosures regarding the growth outlook would continue to be attractive for markets. As we said before, all the leading indicators (capacity use, reel sector confidence index, Turkish PMI and consumer confidence) suggest acceleration of economic activity in the last quarter of this year. For a quick flash back, in the first half of the year both the leading indicators and the hard data for output had implied a strong growth performance, which was then replaced by a slower performance due to the European debt problems. Rather than suffering a contraction, output remained flat during May-September period. The other country groups also displayed a similar performance, with their seasonally adjusted industrial production lacking any visible improvement in that period. However, this standstill position shall change from October onwards. As is known, the hard data is two-month backward-looking and we expect to see the activity gaining ground in October. This remains to be confirmed when the October industrial output figure is disclosed on December 8th. On year-on-year comparisons, the industrial output is to enjoy 10% growth in the first month of the last quarter, after expanding by 10% in the third quarter and 13.5% in the first 9 months of the year. At first look, this seems to indicate a similar performance to the third quarter. However, in reality, my estimate implies a seasonally adjusted 2.4% m/m increase and suggests acceleration. The 6.1% consensus for the industrial output is below my forecast. The second important data of the week is the Q3 GDP due December 10th. My forecast is 6.2% y/y expansion. If our call turns out to be true, this would urge the markets to upgrade their 7% forecast for the overall 2010. Otherwise, Q4 GDP growth would need to come at a subdued 1.5% or lower in order to be consistent with 7% growth for the year. If industrial output expands as rapidly as we expect in October, the odds of such a weak performance would get even lower.
If the data disclosures mentioned here come in line with our forecasts, the Central Bank would narrow the output gap forecast when they release the Inflation Report in January. By itself, this outlook would normally urge for earlier rate hikes. At that point, the inflation pattern would play an important role to prevent the markets revising their rate hike forecasts to an earlier date than the last quarter of the year, as the recent polls suggest.
In that context, the key market theme to follow next year is whether the annual CPI would recede to the 5-6% interval from the first months onwards, in line with the Central Bank’s presumptions. It seems that the upward pressure on inflation has been building up, given the industrial output that is poised to return to pre-crisis levels, along with the recovery of the capacity use to long term averages and the ongoing improvement in labor market. This outlook makes the pricing behavior more important than ever. The underlying inflation trend that is best gauged by the core indices and the service sector prices suggest that there is no visible deterioration yet and the benign pattern is still on track. However, after displaying a sluggish performance when coming out of the recession, Turkish economy has now been pulled into an unbalanced growth structure on the back of robust domestic demand and weak external demand. While this outlook warns against threats to financial stability on one hand, it at the same time raises the question marks regarding the policy reaction of the Central Bank. It is true that the inflation is hovering above the official target and is set to overshoot the year-end target. However, acknowledging that the food component contributes some 4.7 pp to the headline CPI and the annual inflation in the unprocessed food component is at a record high 31.3% as of October, there is a large potential of decline in their contributions going forward and that in turn makes any policy reaction unnecessary. Unless the inflationary pressures become widespread and the inflation in non-food and non-energy segments deteriorates, a wait-and-see approach, accompanied with measures to prevent excess credit expansion, is worth to try, despite all the ambiguities regarding its effectiveness.
We will see the third quarter growth performance in Turkey when the GDP figures are released on next Friday. After the data, the consensus for the overall year is likely to keep being upgraded from 7.0% print of the last survey. I believe this is quite important, considering the fact that the uninterrupted increase in the growth forecasts this year has become the key driver of the markets. The tight relation between the forward-looking expectations and the market performance would most likely be valid in the upcoming years, as well. The average GDP estimate has come all the way up to 7.0% in the last Central Bank expectation survey from the initial 3.3% in the beginning of the year, exploring the big potential for a positive surprise when the expectations are set irrationally low. In essence, there is still upside potential for the consensus. However, it is time to focus on 2011 expectations as we approach the new year.
Regarding the next year’s growth prospects, two important aspects would determine the outcome. Starting with the favorable one, the leading indicators suggest that the economic activity has picked up in the last quarter of the year and this momentum is highly likely to be preserved in the next year. Technically speaking, the seasonally adjusted industrial output that has recovered to pre-crisis levels would sustain quite strong year-on-year growth rates. Moreover, as suggested by the PMIs, the economic activity has been gaining steam globally which is an assuring factor for the sustainability of the revival at home. Nevertheless, this support from the global backdrop would be valid only if the heightened worries regarding the European debt crisis and the Fed’s launch of the second phase of the quantitative easing program, do not jeopardize the business and consumer confidence. Coming to the dismal aspect of growth dynamics for the year ahead, the GDP growth is set to reach 8% this year and this robust performance would form an unfavorable base year effect for 2011. In that context, the 4.8% average forecast for next year’s GDP is neither low nor high, limiting the surprise from either side.
Therefore, even though the GDP forecast continue playing an important role, the inflation forecasts are likely to replace as the more dominant market driver in 2011. Until then, the data disclosures regarding the growth outlook would continue to be attractive for markets. As we said before, all the leading indicators (capacity use, reel sector confidence index, Turkish PMI and consumer confidence) suggest acceleration of economic activity in the last quarter of this year. For a quick flash back, in the first half of the year both the leading indicators and the hard data for output had implied a strong growth performance, which was then replaced by a slower performance due to the European debt problems. Rather than suffering a contraction, output remained flat during May-September period. The other country groups also displayed a similar performance, with their seasonally adjusted industrial production lacking any visible improvement in that period. However, this standstill position shall change from October onwards. As is known, the hard data is two-month backward-looking and we expect to see the activity gaining ground in October. This remains to be confirmed when the October industrial output figure is disclosed on December 8th. On year-on-year comparisons, the industrial output is to enjoy 10% growth in the first month of the last quarter, after expanding by 10% in the third quarter and 13.5% in the first 9 months of the year. At first look, this seems to indicate a similar performance to the third quarter. However, in reality, my estimate implies a seasonally adjusted 2.4% m/m increase and suggests acceleration. The 6.1% consensus for the industrial output is below my forecast. The second important data of the week is the Q3 GDP due December 10th. My forecast is 6.2% y/y expansion. If our call turns out to be true, this would urge the markets to upgrade their 7% forecast for the overall 2010. Otherwise, Q4 GDP growth would need to come at a subdued 1.5% or lower in order to be consistent with 7% growth for the year. If industrial output expands as rapidly as we expect in October, the odds of such a weak performance would get even lower.
If the data disclosures mentioned here come in line with our forecasts, the Central Bank would narrow the output gap forecast when they release the Inflation Report in January. By itself, this outlook would normally urge for earlier rate hikes. At that point, the inflation pattern would play an important role to prevent the markets revising their rate hike forecasts to an earlier date than the last quarter of the year, as the recent polls suggest.
In that context, the key market theme to follow next year is whether the annual CPI would recede to the 5-6% interval from the first months onwards, in line with the Central Bank’s presumptions. It seems that the upward pressure on inflation has been building up, given the industrial output that is poised to return to pre-crisis levels, along with the recovery of the capacity use to long term averages and the ongoing improvement in labor market. This outlook makes the pricing behavior more important than ever. The underlying inflation trend that is best gauged by the core indices and the service sector prices suggest that there is no visible deterioration yet and the benign pattern is still on track. However, after displaying a sluggish performance when coming out of the recession, Turkish economy has now been pulled into an unbalanced growth structure on the back of robust domestic demand and weak external demand. While this outlook warns against threats to financial stability on one hand, it at the same time raises the question marks regarding the policy reaction of the Central Bank. It is true that the inflation is hovering above the official target and is set to overshoot the year-end target. However, acknowledging that the food component contributes some 4.7 pp to the headline CPI and the annual inflation in the unprocessed food component is at a record high 31.3% as of October, there is a large potential of decline in their contributions going forward and that in turn makes any policy reaction unnecessary. Unless the inflationary pressures become widespread and the inflation in non-food and non-energy segments deteriorates, a wait-and-see approach, accompanied with measures to prevent excess credit expansion, is worth to try, despite all the ambiguities regarding its effectiveness.
26 Kasım 2010 Cuma
The rain in Spain stays mainly in the plain...
Summary: For those who want to see the glass half empty, the EU debt crisis has arisen as the most commonly used argument. In that context, Ireland has become an easy target to attack as the country has one of the most rapidly growing public debt stocks. However the real concern is the possible spill over of the debt saga to more important and bigger countries of Europe, such as Spain. However, Spain has one advantage (residents have a greater share in the debt market) that is not valid for the smaller EU countries. Turkey is in a relatively more advantageous position, as the country has not suffered any deterioration in the debt dynamics and the government debt is mostly owned by the residents. Turkey’s distinct position has been priced by the markets, while it is the rating agencies’ turn to reflect these favorable aspects to credit ratings.
The Eurozone debt crisis, China’s measures to cool off the economy and U.S. labor market that has failed to enjoy a meaningful rebound so far… All have become the major themes this year that feed into the pessimistic views regarding the global economy. These topics happened to be used alternately to justify the stock market sell-offs observed in the long term upward trend. The combination of all of these unpleasant factors tends to exaggerate the pressure even further. The markets have been suffering such bearishness over the last days that dampen the global risk appetite. The stock markets and the bond yields are tumbling, accompanied with a higher U.S. Dollar, lower commodity prices, yet a more valuable gold. Fortunately, the deterioration in sentiment seems to have remained limited. What then is preventing the gauges of risk appetite, such as the VIX index from climbing as extensively as was the case during the Greece debt crisis in May? One reason is that the EU acted quickly to launch the support mechanism, which is co-financed by the IMF (EFSF – European Financial Stability Facility), while the other reason is the relatively small size of Irish economy, like Greece. However, the severity of the problems regarding Ireland is not proportional to the size of the economy. The banking sector in Ireland has grown more than three times as big as GDP, with the main creditors being the private banks of big European countries. Therefore unlike Greece, where the public finances constitute the roots of the crisis, in the case of Ireland there is this fear of contagion to other countries. The real concern is the possibility of the debt problems spreading to more important countries in Europe, such as Spain, where CDS has already climbed to 310 bps, a warning that this risk has started to be partially priced. In order to soothe the fears about Ireland, the EU officials soon announced that some EUR80-90bn may be drawn from the EFSF to bail out Ireland. The details of the rescue package are expected to be shaped at the EU finance ministers’ summit on December 7th. In due course, the ECB has been providing EUR130bn to the Irish banks that correspond to 20% of their total assets. Ireland and Greece have the fastest growing public debt and explains why these countries have become targets for the markets.
At this point, one can question why other countries in the top 5, such as Japan, U.K. and the U.S. do not face similar pressure. We believe that the answer lies at the composition of the creditors. Non-residents own more than 70% of the total government debt instruments in countries like Greece, Ireland and Portugal. This structure of the bond market, where residents have much less power, intensifies the dismal impact from sell-off pressure during periods of surging fears regarding the public debt. Whereas, countries such as Japan, Canada or the U.K can avoid panic more easily, since the public debt is mostly owned by residents. In that context, Portugal and Spain which are often speculated to be the next destination of debt crisis stand at a distinct position and Spain is likely to tackle the pressure more easily despite the recent surge in their risk premiums. Glancing at Turkey’s position, the relatively limited foreign participation in the government debt securities seems to be another advantage for Turkey in the post-crisis environment. In fact, the increase in the debt stock has remained subdued in this period and the share of non-residents is still below 13%, despite some late up-tick. Turkey ranks among the countries with the lowest foreign participation in the public debt market after Japan and Canada. Turkey’s CDS trades at 140 bps as of November 25th, lagging below most developed and developing nations.
While the financial markets rate Turkey’s credit worthiness in the “investment grade,” thanks to the favorable growth performance that improves debt dynamics, there has also been improvement in the rating agencies’ view on the country. The outlook has been upgraded to positive on November 24th by Fitch, who already sees Turkey closer to the investment grade than their peers do. With this move, the big difference between the market valuations and the credit ratings tend to narrow a little bit. Fitch noted that implementation of fiscal policy consistent with a downward trend in the government debt-to-GDP ratio could result in upgrade, adding that if Turkey comes through parliamentary elections and prospective constitutional amendments without a material increase in political instability this would also be supportive. Gathering all these statements, it is understood that the earliest possible timing for upgrade would be after the general elections in mid-2011. This expectation would remain as a catalyst for relative strength of TRY assets.
The Eurozone debt crisis, China’s measures to cool off the economy and U.S. labor market that has failed to enjoy a meaningful rebound so far… All have become the major themes this year that feed into the pessimistic views regarding the global economy. These topics happened to be used alternately to justify the stock market sell-offs observed in the long term upward trend. The combination of all of these unpleasant factors tends to exaggerate the pressure even further. The markets have been suffering such bearishness over the last days that dampen the global risk appetite. The stock markets and the bond yields are tumbling, accompanied with a higher U.S. Dollar, lower commodity prices, yet a more valuable gold. Fortunately, the deterioration in sentiment seems to have remained limited. What then is preventing the gauges of risk appetite, such as the VIX index from climbing as extensively as was the case during the Greece debt crisis in May? One reason is that the EU acted quickly to launch the support mechanism, which is co-financed by the IMF (EFSF – European Financial Stability Facility), while the other reason is the relatively small size of Irish economy, like Greece. However, the severity of the problems regarding Ireland is not proportional to the size of the economy. The banking sector in Ireland has grown more than three times as big as GDP, with the main creditors being the private banks of big European countries. Therefore unlike Greece, where the public finances constitute the roots of the crisis, in the case of Ireland there is this fear of contagion to other countries. The real concern is the possibility of the debt problems spreading to more important countries in Europe, such as Spain, where CDS has already climbed to 310 bps, a warning that this risk has started to be partially priced. In order to soothe the fears about Ireland, the EU officials soon announced that some EUR80-90bn may be drawn from the EFSF to bail out Ireland. The details of the rescue package are expected to be shaped at the EU finance ministers’ summit on December 7th. In due course, the ECB has been providing EUR130bn to the Irish banks that correspond to 20% of their total assets. Ireland and Greece have the fastest growing public debt and explains why these countries have become targets for the markets.
At this point, one can question why other countries in the top 5, such as Japan, U.K. and the U.S. do not face similar pressure. We believe that the answer lies at the composition of the creditors. Non-residents own more than 70% of the total government debt instruments in countries like Greece, Ireland and Portugal. This structure of the bond market, where residents have much less power, intensifies the dismal impact from sell-off pressure during periods of surging fears regarding the public debt. Whereas, countries such as Japan, Canada or the U.K can avoid panic more easily, since the public debt is mostly owned by residents. In that context, Portugal and Spain which are often speculated to be the next destination of debt crisis stand at a distinct position and Spain is likely to tackle the pressure more easily despite the recent surge in their risk premiums. Glancing at Turkey’s position, the relatively limited foreign participation in the government debt securities seems to be another advantage for Turkey in the post-crisis environment. In fact, the increase in the debt stock has remained subdued in this period and the share of non-residents is still below 13%, despite some late up-tick. Turkey ranks among the countries with the lowest foreign participation in the public debt market after Japan and Canada. Turkey’s CDS trades at 140 bps as of November 25th, lagging below most developed and developing nations.
While the financial markets rate Turkey’s credit worthiness in the “investment grade,” thanks to the favorable growth performance that improves debt dynamics, there has also been improvement in the rating agencies’ view on the country. The outlook has been upgraded to positive on November 24th by Fitch, who already sees Turkey closer to the investment grade than their peers do. With this move, the big difference between the market valuations and the credit ratings tend to narrow a little bit. Fitch noted that implementation of fiscal policy consistent with a downward trend in the government debt-to-GDP ratio could result in upgrade, adding that if Turkey comes through parliamentary elections and prospective constitutional amendments without a material increase in political instability this would also be supportive. Gathering all these statements, it is understood that the earliest possible timing for upgrade would be after the general elections in mid-2011. This expectation would remain as a catalyst for relative strength of TRY assets.
12 Kasım 2010 Cuma
From Disorder To This Order…
Summary: There has been a loss of faith in the current international financial system which was hit so deeply in the global crisis that the problems have been extended to this day. Accordingly, the suggestions for building a new global order are blowing up over the recent period. The members of the G20 are seeking a solution by not just talking but also pushing hard their policy options to speed up the way to the new equilibrium. Turkey is close to acquiring a stronger power in IMF and therefore having a greater responsibility in the international decision making arena.
Amidst the ongoing concerns over the global economy, the G20 leaders are dealing with a long agenda at their meeting on November 11th and 12th. The differences of views among countries seem to have become more visible after the Fed launched the new quantitative easing program on November 3rd. The emerging market members of the G20 group, including Turkey are expected to voice their concerns about the loose monetary policy of U.S. at the summit. In advance of the G20 meeting, World Bank President Zolleick proposed a new international monetary system involving multiple reserve currencies and including a role for gold as a reference point for market expectations of inflation and future currency values. We are not sure how seriously his comments are taken, but his thesis has drawn quite a lot of attention. What he is basically suggesting is to include Chinese Yuan to the synthetic currency unit SDR, which is composed of U.S. Dollar, Euro, Yen and Pound. On the other hand, there were two key propositions circulated in the media after the previous G20 meetings. One of them is the U.S. plan that advocates limiting the C/A balance by 4% of GDP. Based on IMF 2010 forecasts, the U.S. and Japan do not violate this rule with their 3.2% deficit and 3.1% surplus, respectively. China is close to the limit, as the country’s surplus is foreseen narrowing to 4.7% this year from 9% in 2008. On the other hand, in addition to the developed Asia such as Taiwan (+10%) and Hong Kong (+8.3%), Germany (6.1%) which is Europe’s engine of growth has excessive surplus. Turkey is also in the group of countries that exceed the suggested border line. Among the BRIC countries, Brazil and India have 2.6% and 3.1% deficit, in the same order, while Russia has 4.7% surplus. Some small countries even face high two-digit external balance ratios, yet they do not play a meaningful role in the global imbalances. Therefore, rather than agreeing on a quantitative target, G20 is likely to focus on the systemically important countries and carry on studies to determine the sustainable levels of C/A balance.
The second hot topic may be the banking regulations. The Financial Stability Board, the global body that implements the G20’s communiqués, is told to be mulling on a list of systemically important bank lists which would be subject to separate regulations. Financial Times claimed two separate systemic bank lists would be created, ‘the first with an estimated 20 global banks whose failure would pose a risk to the international financial system. The second would be a country-by-country list of banks that are systemically important within their home economies, but pose little danger to the world.’ Based on these criteria, Japan and China seem to be exempted given their limited international presence. In due course, the decision on a globally set capital surcharge for systemically important banks, that is in essence the core of arguments, may be delayed. On October 22nd, Deputy Prime Minister Babacan told in an interview with AA news agency that “they should decide about the big banks and start implementing it soon.” His remarks hinted that there are two separate lists being prepared for G20. Therefore, the big and systemically important banks in Turkey will likely take place in the second list. However, it is yet uncertain whether being in that list would be advantageous.
Another important issue for Turkey would be any change in the voting power in International Monetary Fund, a topic to be discussed at G20 summit as well. As in known, the Group of 20 leading economies has reached an agreement on a reform of the IMF’s quota and governing structure on November 5th to give a bigger voice to developing countries. With this reform, G20 agreed to double the IMF’s quotas (SDR476.8). The European countries will give up two of their eight seats on the 24-member board, giving more weight to emerging universe. Turkey, being raised to a quota of 0.98%, i.e. the 20th biggest share in IMF, is claimed to benefit the new structure and to gain one of those seats, based on the recent news flow. In the current mechanism, Turkey is being represented by Belgium.
Prior to the G20 summit, the focus was on especially the Chinese data. The large foreign trade surplus in October, together with strong industrial output that expanded by a rapid 13.1% and the inflation that surged to 4.4%, overshooting the Central bank target at 3% all justified China’s efforts to cool down the economy, such as the increase in policy rate and required reserve ratio. The risks to inflation and the additional quantitative easing in the U.S. seem to be putting China in a difficult position. If the country does not want to cool off the economy, they may eventually let Yuan appreciate in order to mitigate the inflationary pressures. Such a policy action would help reduce the global imbalances at a faster pace. U.S. Treasury Secretary Geithner emphasized this point at G20 summit in Seoul by saying that “China cannot continue to resist upward market pressure on its Yuan currency without facing higher inflation and rising asset prices.” He also said that “If you resist those market forces that are just a reflection of confidence that you're going to see strong growth in China, strong productivity growth in China, if you resist those market forces, that pressure is not going to go away it is just going to end up in higher inflation or higher asset prices and that'll be bad for China," while claiming that “China will be more confident in allowing Yuan rise if competitors’ currencies rise too. “
Amidst the ongoing concerns over the global economy, the G20 leaders are dealing with a long agenda at their meeting on November 11th and 12th. The differences of views among countries seem to have become more visible after the Fed launched the new quantitative easing program on November 3rd. The emerging market members of the G20 group, including Turkey are expected to voice their concerns about the loose monetary policy of U.S. at the summit. In advance of the G20 meeting, World Bank President Zolleick proposed a new international monetary system involving multiple reserve currencies and including a role for gold as a reference point for market expectations of inflation and future currency values. We are not sure how seriously his comments are taken, but his thesis has drawn quite a lot of attention. What he is basically suggesting is to include Chinese Yuan to the synthetic currency unit SDR, which is composed of U.S. Dollar, Euro, Yen and Pound. On the other hand, there were two key propositions circulated in the media after the previous G20 meetings. One of them is the U.S. plan that advocates limiting the C/A balance by 4% of GDP. Based on IMF 2010 forecasts, the U.S. and Japan do not violate this rule with their 3.2% deficit and 3.1% surplus, respectively. China is close to the limit, as the country’s surplus is foreseen narrowing to 4.7% this year from 9% in 2008. On the other hand, in addition to the developed Asia such as Taiwan (+10%) and Hong Kong (+8.3%), Germany (6.1%) which is Europe’s engine of growth has excessive surplus. Turkey is also in the group of countries that exceed the suggested border line. Among the BRIC countries, Brazil and India have 2.6% and 3.1% deficit, in the same order, while Russia has 4.7% surplus. Some small countries even face high two-digit external balance ratios, yet they do not play a meaningful role in the global imbalances. Therefore, rather than agreeing on a quantitative target, G20 is likely to focus on the systemically important countries and carry on studies to determine the sustainable levels of C/A balance.
The second hot topic may be the banking regulations. The Financial Stability Board, the global body that implements the G20’s communiqués, is told to be mulling on a list of systemically important bank lists which would be subject to separate regulations. Financial Times claimed two separate systemic bank lists would be created, ‘the first with an estimated 20 global banks whose failure would pose a risk to the international financial system. The second would be a country-by-country list of banks that are systemically important within their home economies, but pose little danger to the world.’ Based on these criteria, Japan and China seem to be exempted given their limited international presence. In due course, the decision on a globally set capital surcharge for systemically important banks, that is in essence the core of arguments, may be delayed. On October 22nd, Deputy Prime Minister Babacan told in an interview with AA news agency that “they should decide about the big banks and start implementing it soon.” His remarks hinted that there are two separate lists being prepared for G20. Therefore, the big and systemically important banks in Turkey will likely take place in the second list. However, it is yet uncertain whether being in that list would be advantageous.
Another important issue for Turkey would be any change in the voting power in International Monetary Fund, a topic to be discussed at G20 summit as well. As in known, the Group of 20 leading economies has reached an agreement on a reform of the IMF’s quota and governing structure on November 5th to give a bigger voice to developing countries. With this reform, G20 agreed to double the IMF’s quotas (SDR476.8). The European countries will give up two of their eight seats on the 24-member board, giving more weight to emerging universe. Turkey, being raised to a quota of 0.98%, i.e. the 20th biggest share in IMF, is claimed to benefit the new structure and to gain one of those seats, based on the recent news flow. In the current mechanism, Turkey is being represented by Belgium.
Prior to the G20 summit, the focus was on especially the Chinese data. The large foreign trade surplus in October, together with strong industrial output that expanded by a rapid 13.1% and the inflation that surged to 4.4%, overshooting the Central bank target at 3% all justified China’s efforts to cool down the economy, such as the increase in policy rate and required reserve ratio. The risks to inflation and the additional quantitative easing in the U.S. seem to be putting China in a difficult position. If the country does not want to cool off the economy, they may eventually let Yuan appreciate in order to mitigate the inflationary pressures. Such a policy action would help reduce the global imbalances at a faster pace. U.S. Treasury Secretary Geithner emphasized this point at G20 summit in Seoul by saying that “China cannot continue to resist upward market pressure on its Yuan currency without facing higher inflation and rising asset prices.” He also said that “If you resist those market forces that are just a reflection of confidence that you're going to see strong growth in China, strong productivity growth in China, if you resist those market forces, that pressure is not going to go away it is just going to end up in higher inflation or higher asset prices and that'll be bad for China," while claiming that “China will be more confident in allowing Yuan rise if competitors’ currencies rise too. “
5 Kasım 2010 Cuma
Just A Second...
Summary: While the markets seem to have been satisfied with the Fed’s decisions, the developing countries have once again started to feel the pressure of currency appreciation and the rapid capital inflows. In due course, Turkey continues to proceed with their plan to struggle amidst the new global economic backdrop and tries to intervene via new and old tools, where the constraint is the inflation outlook.
The long awaited decision by the FOMC has finally been revealed and the market reaction has so far been as expected. The Fed’s quantitative easing (QE) program has garnered almost all of the market attention that it even has taken the front seat to the U.S. midterm elections. Fed announced that they would purchase an additional $600bn of Treasury securities, with the overall purchases reaching $850mn-$900mn in 8 months, including some $250-300bn worth of reinvestments from the previous program. The assets purchased will have an average duration of between 5 and 6 years, which is the single feature of the program that may have created disappointment. Almost half of the assets will have a maturity of 5 to 10 years, while the 40% is planned to be of maturities between 2.5-5 years. Following the FOMC statement, the 2-year Treasury yield has slid to a historical low of 0.34% and the Fed funds futures indicate that no rate change is expected until the last quarter of 2012. Note that this is the case, despite the absence of any enhancement to the Fed’s phrase regarding the necessity of ‘low levels for the federal funds rate for an extended period’. Note also that ‘the Committee will regularly review the pace of its securities purchases and the overall size of the asset-purchase program in light of incoming information and will adjust the program as needed.’ This would leave the door open to changes in both directions. Moreover, just as the rate decisions are subject to growth and employment outlook, the above phrase assumes conditionality for the QE size and provides some flexibility to the Fed. As shall be recalled, the key properties of an ideal QE program mentioned in our comment published on October 12th listed exactly the same aspects. Therefore, the decisions did not come as a surprise. Accordingly, the financial markets have now returned to their positive trend and to the strong risk appetite environment. It seems that going forward, we will keep discussing about the appreciation pressure on TRY, as well as how further the country risk premiums and interest rates would fall, accompanied with the new record highs in the stock markets.
The Fed decisions would no doubt intensify the pressure on the emerging country central banks, which have already been dealing with the rapid capital inflows to their countries that result in appreciation of local currencies and has the risk of generating asset bubbles. Amidst this contentious environment, Turkey stands at a different point, being concerned with rapid domestic credit expansion and searching ways to suppress it, unlike the U.S. Turkish Central Bank Deputy Governor Basci told in a conference last week that Turkey should impede the credit expansion in its economy which has enjoyed a fast rebound after the global crisis and that new policy instruments may be required for that purpose. This was not much unexpected and the banking sector should be ready for creative and new tools, atop of the already introduced measures such as the increase in required reserves, abolishment of interest paid on reserves and the increase in the KKDF (Resource Utilization Support Fund) rate on consumer credits. The road-map regarding to these new instruments may be disclosed at the 2011 Foreign Exchange and Monetary Policy report due to be released at the beginning of the next month, the latest. However, the inflation pattern would play a critical role in order to give the Bank enough space to follow their plan.
Turkish Consumer Price Index rose by 1.83% m/m in October, overshooting the consensus, while the deviation from forecast was mostly due to the significant jump of 4.5% in food prices. Accordingly, the annual food inflation reached 17.1%, remaining above the Bank’s year-end assumption of 10.5%. The cumulative increase in food prices in the last two months of the last year was 7.7%, meaning that the prices should remain unchanged in the rest of this year in order to bring the annual inflation in line with the Bank’s forecast. Given the seasonal and other factors, this scenario seems quite unlikely. The unprocessed food prices that surged significantly over the last three months (from 8% to 31% y/y) have been the reason behind the elevated food component. In essence, the high level of volatility in food prices is one of the major obstacles against the process of disinflationary goals. A Central Bank study that covers the period between 2006-2009 shows that the volatility of monthly food price inflation in Turkey is 4 times of the EU-27, while this ratio goes up to 6 for the unprocessed food component, with Turkey having a higher volatility of monthly unprocessed food price inflation than each of the EU27 members. It should be noted that the volatility is two-sided and the inflation can fall as rapidly as it ascended. Nevertheless, recognizing that this would not happen all of a sudden, I revised my year-end CPI forecast to 7.7% from 7.2% due to the change in our food price assumptions. On the other hand, I continue to anticipate CPI easing to 6.0% by the end of 2011 with the help of the taming in food segment.
Contrary to the increase in the annual headline inflation, there were declines in the core indicators. The annual price change of the Central Bank’s favorite core indicator (excluding food, energy, gold, alcoholic beverages and tobacco), namely the “core-I” index, declined by a significant 1.2 pp m/m to 2.5%. While this is the sixth consecutive fall in annual core inflation, current level is its lowest level in the history of the series that started in 2003. Furthermore, the annual price change in services declined by 0.4 pp to 4.2%, again the lowest in the history of the series.
All in all, there is no doubt that the underlying inflation proceeds at a benign pace. Yet this does not change the fact that there is this disturbingly wide gap between the headline and the core. The Central Bank is also concerned with this issue by emphasizing the risk of jeopardy in pricing behavior. The Bank warns that they may hike earlier than planned, in case this risk materializes. On the other hand, the Central Bank seems quite comfortable here, as a recent CBRT working paper titled “A New Core Inflation Indicator for Turkey” concludes that ‘...when inflation deviates from core inflation, it converges back to the core inflation; but not the other way around.’ However, this does not necessarily mean that the headline CPI would converge to 2.5%. The empirical data show that even though there are cases where headline converges to the core, the two indices happen to meet somewhere in the middle following a significant decoupling.
Therefore, while the leading indicators warn against some revival in the economic activity going forward, it would unlikely ring any alarm bells in the Central Bank with such an encouraging underlying inflation trend. While this data is supportive of the already dovish stance of the Central Bank, we continue to expect the rate hikes to start in the last quarter of next year and amount to 100bps in 2011.
The long awaited decision by the FOMC has finally been revealed and the market reaction has so far been as expected. The Fed’s quantitative easing (QE) program has garnered almost all of the market attention that it even has taken the front seat to the U.S. midterm elections. Fed announced that they would purchase an additional $600bn of Treasury securities, with the overall purchases reaching $850mn-$900mn in 8 months, including some $250-300bn worth of reinvestments from the previous program. The assets purchased will have an average duration of between 5 and 6 years, which is the single feature of the program that may have created disappointment. Almost half of the assets will have a maturity of 5 to 10 years, while the 40% is planned to be of maturities between 2.5-5 years. Following the FOMC statement, the 2-year Treasury yield has slid to a historical low of 0.34% and the Fed funds futures indicate that no rate change is expected until the last quarter of 2012. Note that this is the case, despite the absence of any enhancement to the Fed’s phrase regarding the necessity of ‘low levels for the federal funds rate for an extended period’. Note also that ‘the Committee will regularly review the pace of its securities purchases and the overall size of the asset-purchase program in light of incoming information and will adjust the program as needed.’ This would leave the door open to changes in both directions. Moreover, just as the rate decisions are subject to growth and employment outlook, the above phrase assumes conditionality for the QE size and provides some flexibility to the Fed. As shall be recalled, the key properties of an ideal QE program mentioned in our comment published on October 12th listed exactly the same aspects. Therefore, the decisions did not come as a surprise. Accordingly, the financial markets have now returned to their positive trend and to the strong risk appetite environment. It seems that going forward, we will keep discussing about the appreciation pressure on TRY, as well as how further the country risk premiums and interest rates would fall, accompanied with the new record highs in the stock markets.
The Fed decisions would no doubt intensify the pressure on the emerging country central banks, which have already been dealing with the rapid capital inflows to their countries that result in appreciation of local currencies and has the risk of generating asset bubbles. Amidst this contentious environment, Turkey stands at a different point, being concerned with rapid domestic credit expansion and searching ways to suppress it, unlike the U.S. Turkish Central Bank Deputy Governor Basci told in a conference last week that Turkey should impede the credit expansion in its economy which has enjoyed a fast rebound after the global crisis and that new policy instruments may be required for that purpose. This was not much unexpected and the banking sector should be ready for creative and new tools, atop of the already introduced measures such as the increase in required reserves, abolishment of interest paid on reserves and the increase in the KKDF (Resource Utilization Support Fund) rate on consumer credits. The road-map regarding to these new instruments may be disclosed at the 2011 Foreign Exchange and Monetary Policy report due to be released at the beginning of the next month, the latest. However, the inflation pattern would play a critical role in order to give the Bank enough space to follow their plan.
Turkish Consumer Price Index rose by 1.83% m/m in October, overshooting the consensus, while the deviation from forecast was mostly due to the significant jump of 4.5% in food prices. Accordingly, the annual food inflation reached 17.1%, remaining above the Bank’s year-end assumption of 10.5%. The cumulative increase in food prices in the last two months of the last year was 7.7%, meaning that the prices should remain unchanged in the rest of this year in order to bring the annual inflation in line with the Bank’s forecast. Given the seasonal and other factors, this scenario seems quite unlikely. The unprocessed food prices that surged significantly over the last three months (from 8% to 31% y/y) have been the reason behind the elevated food component. In essence, the high level of volatility in food prices is one of the major obstacles against the process of disinflationary goals. A Central Bank study that covers the period between 2006-2009 shows that the volatility of monthly food price inflation in Turkey is 4 times of the EU-27, while this ratio goes up to 6 for the unprocessed food component, with Turkey having a higher volatility of monthly unprocessed food price inflation than each of the EU27 members. It should be noted that the volatility is two-sided and the inflation can fall as rapidly as it ascended. Nevertheless, recognizing that this would not happen all of a sudden, I revised my year-end CPI forecast to 7.7% from 7.2% due to the change in our food price assumptions. On the other hand, I continue to anticipate CPI easing to 6.0% by the end of 2011 with the help of the taming in food segment.
Contrary to the increase in the annual headline inflation, there were declines in the core indicators. The annual price change of the Central Bank’s favorite core indicator (excluding food, energy, gold, alcoholic beverages and tobacco), namely the “core-I” index, declined by a significant 1.2 pp m/m to 2.5%. While this is the sixth consecutive fall in annual core inflation, current level is its lowest level in the history of the series that started in 2003. Furthermore, the annual price change in services declined by 0.4 pp to 4.2%, again the lowest in the history of the series.
All in all, there is no doubt that the underlying inflation proceeds at a benign pace. Yet this does not change the fact that there is this disturbingly wide gap between the headline and the core. The Central Bank is also concerned with this issue by emphasizing the risk of jeopardy in pricing behavior. The Bank warns that they may hike earlier than planned, in case this risk materializes. On the other hand, the Central Bank seems quite comfortable here, as a recent CBRT working paper titled “A New Core Inflation Indicator for Turkey” concludes that ‘...when inflation deviates from core inflation, it converges back to the core inflation; but not the other way around.’ However, this does not necessarily mean that the headline CPI would converge to 2.5%. The empirical data show that even though there are cases where headline converges to the core, the two indices happen to meet somewhere in the middle following a significant decoupling.
Therefore, while the leading indicators warn against some revival in the economic activity going forward, it would unlikely ring any alarm bells in the Central Bank with such an encouraging underlying inflation trend. While this data is supportive of the already dovish stance of the Central Bank, we continue to expect the rate hikes to start in the last quarter of next year and amount to 100bps in 2011.
25 Ekim 2010 Pazartesi
Rebalancing Bargain...
Summary: Whether you name it the “currency wars” or the war between Asian reflection and U.S. deflation, the implication would be intensified financial stability risk for Turkey, where growth is already constrained by the depressed external demand. Turkey is among the countries that exacerbate the global imbalances, which is seen as the culprits of the wars. Instead of pushing forward with the reforms to address the structural deficit, Turkey has so far been more engaged in reducing risks regarding the deficit financing. The Central Bank has taken such measures and they will likely continue doing so in the upcoming period to curtail these risks.
The surprise rate hike from the Central Bank of China last week has raised speculation regarding the G-20 decisions to be shaped at their weekend meeting. Moreover, this tightening move from China induced the markets to deviate from their current trend and exacerbate the market volatility. Basically, what we see was the softening of EUR/$, accompanied with the stock market sell-off. The mentioned speculation is about a “grand bargain between the U.S. and China.” The bargain assumes that the Federal Reserve to be less aggressive in an expected second round of quantitative easing when the FOMC meets on November 3rd in return for China tightening monetary policy and letting their currency Yuan to appreciate at a faster pace. On the other hand, Martin Wolf in example, from Financial Times is in the camp that perceives the recent developments in the context of a war between Asian reflation and U.S. deflation. Wolf says the U.S. would win the war thanks to their ability to print unlimited amount of dollar which is the reserve currency (either by pushing inflation higher or appreciating currencies against dollar in the rest of the World). The first rate hike from China since end-2007 is also interpreted to be a pre-emptive move, hinting that the monetary policy tools, aside from the F/X policy are part of the arsenal now. All in all, it is believed that the countries in Asia would guard against the ultra loose monetary policy objective of the U.S. which would export inflation to Asia through asset price bubbles. The market has perceived this new battle to be a risk against asset prices and the risk appetite has lost some ground. It is difficult to argue which of the above theses is true. However, there is one thing certain that the World continues to suffer from the lingering malaise in the post global crisis environment. Whether you name it the “currency wars” or the war between Asian reflation and U.S. deflation, the implication seems to be intensified financial stability risk for Turkey, where growth is already constrained by the depressed external demand. The good news is that the Central Bank has already been underscoring these risks for a while and acting fast in launching measures to combat these risks.
Behind the wars lie the global imbalances (high current account surplus in Asia, high C/A deficit in the U.S.) which failed to be corrected by the crisis, while the decoupling between countries during the recovery has made the situation even worse. In that context, the issue of maintaining a strong, balanced and sustainable growth has also been discussed by Oliver Blanchard, IMF Economic Counselor, who emphasized the difficulty of reaching this goal and outlined two complex global rebalancing acts that are required. First, internal rebalancing, that is based on the private demand taking the lead again in developed countries and on the consolidation of fiscal balances that were ruined during crisis. The second aspect of rebalancing is external rebalancing, which includes many advanced countries, most notably the U.S., relying more on net exports and many emerging countries, most notably China, turning more to domestic demand. Blanchard says both of these balancing acts have been proceeding, albeit at a very slow pace.
Turkey is also among the countries that inflate the global imbalances with an estimated current account deficit of above 5% this year. In essence, both cyclical and structural factors play role in rapid expansion of the current account deficit in Turkey, which in that sense does not match the emerging market prototype having external surpluses on the back of their commodity or industrial goods exports. Nevertheless, instead of pushing forward with the reforms to address the structural deficit, Turkey has so far been more engaged in reducing risks regarding the deficit financing that has become more vulnerable recently.
The Central Bank’s decisions announced from September onwards are also in this category. In our previous posts, we mentioned about how the Turkish Central Bank describes the new conjuncture. The Central Bank had warned that the intensive capital flows into trusted and dynamic emerging market economies during this period underscore the risk of overheating, excess borrowing and emergence of asset bubbles in these economies, eventually pushing the current account deficit to levels that may jeopardize the financial stability. The Bank had also said that the Bank’s latest decisions (about required reserves and F/X purchase auctions) should be seen as a preparation in advance of the new conjuncture. The Central Bank continued to stress these risks in the MPC meeting held afterwards. In the last meeting, the Bank said ‘While not yet a significant concern regarding financial stability, the Committee has indicated that these developments support the implementation of the “exit strategy” measures.’ As we noted many times before, we expect these measures to continue, while the pace of domestic demand, in particular the domestic loan growth rate of the banking system, would be the key criteria in determining how fast the Central Bank would act. The weekly data for domestic loans have so far implied no change in the rate of expansion since the measures were taken.
In the Inflation Report due October 26th or in the 2011 Monetary and Exchange Rate Policy due December, the latest, the Central Bank would likely outline in more detail the roadmap about required reserves, which have become a more effective tool in curtailing macroeconomic and financial stability risks. This would help the banking sector to better visualize the future and hence fulfill their intermediary role between the monetary authority and the household and real sector in a more stable way.
The surprise rate hike from the Central Bank of China last week has raised speculation regarding the G-20 decisions to be shaped at their weekend meeting. Moreover, this tightening move from China induced the markets to deviate from their current trend and exacerbate the market volatility. Basically, what we see was the softening of EUR/$, accompanied with the stock market sell-off. The mentioned speculation is about a “grand bargain between the U.S. and China.” The bargain assumes that the Federal Reserve to be less aggressive in an expected second round of quantitative easing when the FOMC meets on November 3rd in return for China tightening monetary policy and letting their currency Yuan to appreciate at a faster pace. On the other hand, Martin Wolf in example, from Financial Times is in the camp that perceives the recent developments in the context of a war between Asian reflation and U.S. deflation. Wolf says the U.S. would win the war thanks to their ability to print unlimited amount of dollar which is the reserve currency (either by pushing inflation higher or appreciating currencies against dollar in the rest of the World). The first rate hike from China since end-2007 is also interpreted to be a pre-emptive move, hinting that the monetary policy tools, aside from the F/X policy are part of the arsenal now. All in all, it is believed that the countries in Asia would guard against the ultra loose monetary policy objective of the U.S. which would export inflation to Asia through asset price bubbles. The market has perceived this new battle to be a risk against asset prices and the risk appetite has lost some ground. It is difficult to argue which of the above theses is true. However, there is one thing certain that the World continues to suffer from the lingering malaise in the post global crisis environment. Whether you name it the “currency wars” or the war between Asian reflation and U.S. deflation, the implication seems to be intensified financial stability risk for Turkey, where growth is already constrained by the depressed external demand. The good news is that the Central Bank has already been underscoring these risks for a while and acting fast in launching measures to combat these risks.
Behind the wars lie the global imbalances (high current account surplus in Asia, high C/A deficit in the U.S.) which failed to be corrected by the crisis, while the decoupling between countries during the recovery has made the situation even worse. In that context, the issue of maintaining a strong, balanced and sustainable growth has also been discussed by Oliver Blanchard, IMF Economic Counselor, who emphasized the difficulty of reaching this goal and outlined two complex global rebalancing acts that are required. First, internal rebalancing, that is based on the private demand taking the lead again in developed countries and on the consolidation of fiscal balances that were ruined during crisis. The second aspect of rebalancing is external rebalancing, which includes many advanced countries, most notably the U.S., relying more on net exports and many emerging countries, most notably China, turning more to domestic demand. Blanchard says both of these balancing acts have been proceeding, albeit at a very slow pace.
Turkey is also among the countries that inflate the global imbalances with an estimated current account deficit of above 5% this year. In essence, both cyclical and structural factors play role in rapid expansion of the current account deficit in Turkey, which in that sense does not match the emerging market prototype having external surpluses on the back of their commodity or industrial goods exports. Nevertheless, instead of pushing forward with the reforms to address the structural deficit, Turkey has so far been more engaged in reducing risks regarding the deficit financing that has become more vulnerable recently.
The Central Bank’s decisions announced from September onwards are also in this category. In our previous posts, we mentioned about how the Turkish Central Bank describes the new conjuncture. The Central Bank had warned that the intensive capital flows into trusted and dynamic emerging market economies during this period underscore the risk of overheating, excess borrowing and emergence of asset bubbles in these economies, eventually pushing the current account deficit to levels that may jeopardize the financial stability. The Bank had also said that the Bank’s latest decisions (about required reserves and F/X purchase auctions) should be seen as a preparation in advance of the new conjuncture. The Central Bank continued to stress these risks in the MPC meeting held afterwards. In the last meeting, the Bank said ‘While not yet a significant concern regarding financial stability, the Committee has indicated that these developments support the implementation of the “exit strategy” measures.’ As we noted many times before, we expect these measures to continue, while the pace of domestic demand, in particular the domestic loan growth rate of the banking system, would be the key criteria in determining how fast the Central Bank would act. The weekly data for domestic loans have so far implied no change in the rate of expansion since the measures were taken.
In the Inflation Report due October 26th or in the 2011 Monetary and Exchange Rate Policy due December, the latest, the Central Bank would likely outline in more detail the roadmap about required reserves, which have become a more effective tool in curtailing macroeconomic and financial stability risks. This would help the banking sector to better visualize the future and hence fulfill their intermediary role between the monetary authority and the household and real sector in a more stable way.
18 Ekim 2010 Pazartesi
Bernanke fed QE2 hopes...
Summary: The expectations regarding more accommodative monetary policies in developed markets have recently found further support, with the measures against deflation being discussed more intensely. Despite the decoupling between developed and developing countries, the ultra-loose monetary policies in the former limit the central banks’ maneuvers in the latter. Therefore, many central banks choose to rely on monetary policy tools other than interest rates, such as decisions to prevent currency appreciation or macro prudential tools. Turkey also follows suit.
The news flow have continued to feed into the expectations that the Fed would start the second round of quantitative easing in November meeting and the anticipations of abundant global liquidity conditions have remained supportive of the financial markets. The FOMC minutes of the September 21st meeting was the last example. The FOMC members sounded very hopeless regarding the growth and inflation outlook, while most members favored more easing in monetary policy ‘before long’. Although the Committee members considered it unlikely that the economy would reenter a recession, many expressed concern that output growth, and the associated progress in reducing the level of unemployment, could be slow for some time. Participants noted a number of factors that were restraining growth, including low levels of household and business confidence, heightened risk aversion, and the still weak financial conditions of some households and small firms. Note that Fed has been uncomfortable with inflation being below levels consistent with the FOMC's dual mandate of maintaining full employment and price stability in the long run. While a minority in the Committee believes that additional accommodation would be warranted only if ‘the outlook worsened’ and ‘the odds of deflation increased materially’, many participants see a ‘too slow economic growth that would prevent satisfactory progress toward reducing the unemployment rate’ or ‘inflation surfacing below target levels’ as appropriate to provide additional monetary policy accommodation. In that context, a number of new alternative policy measures have been discussed at September FOMC meeting, as well. Among them ‘expanding long term bond purchases’ and ‘steps that would lift inflation expectations’ were the key focus areas. The minutes show that the members also discussed the best means to calibrate and implement additional asset purchases. Previously, we mentioned the key points of comments from New York Fed official Sack. Recall that his remarks hinted that the asset purchases would be in relatively continuous but smaller steps, rather than in infrequent but large increments.
Sack emphasized that asset purchases that would enlarge the balance sheet should be seen as a substitute for the changes in federal funds rate. The key points in Sacks speech were as follows: 1) the balance sheet should be adjusted in relatively continuous but smaller steps, rather than in infrequent but large increments. 2) The balance sheet decisions should be governed to a large extent by the evolution of the FOMC’s economic forecasts. 3) The movements in balance sheets should be stressed to have some persistency in order to make them more influential. 4) Providing information about the likely course of the balance sheet could be desirable. 5) Some flexibility should be incorporated into the program.
Last but not the least; we also want to touch on the monetary policy measures discussed by the Fed that would affect short term inflation expectations. As is known, real interest rate (that is the difference between nominal interest rates and expected inflation) is influential on total demand. Especially, the inflation expectations turn to be more important for monetary policy makers when policy rates are virtually zero. That is because; a decline in short-term inflation expectations increases short-term real interest rates, thereby damping aggregate demand. Conversely, in such circumstances, an increase in inflation expectations lowers short-term real interest rates, stimulating the economy. Therefore, Fed seems to have started mulling on alternative strategies that would lift short term inflation expectations higher, including providing more detailed information about the rates of inflation the Committee considered consistent with its dual mandate, targeting a path for the price level rather than the rate of inflation, and targeting a path for the level of nominal GDP. The last two strategies are new approaches for the central banking and there are no other countries that use them. Accordingly, these policy alternatives would unlikely be implemented in the short term.
While there are growing signs that the Fed would opt for more monetary easing, other Central Banks have also started to feel the pressure. Glancing at home, the outlook is quite mixed. The surprisingly strong industrial output in August triggered upgrades in growth forecasts, while the automotive sales and domestic demand in general have remained robust. These factors have the potential to put upward pressure on interest rates. On the other hand, the downside risk to external demand, the slowdown signals from leading economic activity indicators, TRY appreciation, the decline in bond yields and risk premiums, the impression of a tighter fiscal policy stance thanks to the Medium Term Program budget targets are all among the factors that would necessitate for lower policy rate or at least would urge for the maintenance of the current stance. The MPC meeting on October 14th was supposed to shed more light on how these developments would affect the Central Bank’s position. This meeting had an added importance since it was the last one to be held prior to the Inflation Report (where the Bank would update the inflation and output gap forecasts) due October 26th. The MPC decision did not involve much surprise and the statement indicated that the exit strategy would remain on course. After the meeting, the Central Bank also announced new decisions regarding the F/X market and open market operations. The Bank seemed to have slightly upgraded their assessment of the economic outlook in general. They said the economic activity continues to recover and domestic demand displays a relatively stronger outlook. In due course the Central Bank presumed headline inflation to be in a declining path, while core inflation was projected to remain consistent with medium term targets. From here, one may conclude that despite the decline in the core price inflation to as low as 3.7% in September, the Bank preferred to remain cautious due to the upside risks on headline CPI regarding the food price inflation. On the policy rate front, the Bank left their rhetoric untouched by reiterating that current levels would be maintained for some time and interest rate would remain low for a long period. The Bank seems to have preferred to wait for Inflation Report to describe the likely interest rate path more clearly. Meanwhile, the Bank also emphasized that the expectations of more accommodative monetary policies in developed economies which boost capital flows toward emerging markets and the accompanied decline in risk premiums, as well as the resulting appreciation of TRY and downside pressure on interest rates exacerbate upside risks to domestic demand and eventually underscore the threats against financial stability. In that concept, it is obvious that the Bank would continue relying on tools other than policy rate. The Bank continued to proceed with measures that would help normalization of the F/X, TRY and open market operations (the Bank abolished its intermediary function in the foreign exchange deposit market, ceased 3-month repo auctions, cut the O/N borrowing rates by an additional 50 bps and cancelled the provision of one-week funding to the primary dealers) and additional increase in TRY required reserve ratio should be expected soon.
The news flow have continued to feed into the expectations that the Fed would start the second round of quantitative easing in November meeting and the anticipations of abundant global liquidity conditions have remained supportive of the financial markets. The FOMC minutes of the September 21st meeting was the last example. The FOMC members sounded very hopeless regarding the growth and inflation outlook, while most members favored more easing in monetary policy ‘before long’. Although the Committee members considered it unlikely that the economy would reenter a recession, many expressed concern that output growth, and the associated progress in reducing the level of unemployment, could be slow for some time. Participants noted a number of factors that were restraining growth, including low levels of household and business confidence, heightened risk aversion, and the still weak financial conditions of some households and small firms. Note that Fed has been uncomfortable with inflation being below levels consistent with the FOMC's dual mandate of maintaining full employment and price stability in the long run. While a minority in the Committee believes that additional accommodation would be warranted only if ‘the outlook worsened’ and ‘the odds of deflation increased materially’, many participants see a ‘too slow economic growth that would prevent satisfactory progress toward reducing the unemployment rate’ or ‘inflation surfacing below target levels’ as appropriate to provide additional monetary policy accommodation. In that context, a number of new alternative policy measures have been discussed at September FOMC meeting, as well. Among them ‘expanding long term bond purchases’ and ‘steps that would lift inflation expectations’ were the key focus areas. The minutes show that the members also discussed the best means to calibrate and implement additional asset purchases. Previously, we mentioned the key points of comments from New York Fed official Sack. Recall that his remarks hinted that the asset purchases would be in relatively continuous but smaller steps, rather than in infrequent but large increments.
Sack emphasized that asset purchases that would enlarge the balance sheet should be seen as a substitute for the changes in federal funds rate. The key points in Sacks speech were as follows: 1) the balance sheet should be adjusted in relatively continuous but smaller steps, rather than in infrequent but large increments. 2) The balance sheet decisions should be governed to a large extent by the evolution of the FOMC’s economic forecasts. 3) The movements in balance sheets should be stressed to have some persistency in order to make them more influential. 4) Providing information about the likely course of the balance sheet could be desirable. 5) Some flexibility should be incorporated into the program.
Last but not the least; we also want to touch on the monetary policy measures discussed by the Fed that would affect short term inflation expectations. As is known, real interest rate (that is the difference between nominal interest rates and expected inflation) is influential on total demand. Especially, the inflation expectations turn to be more important for monetary policy makers when policy rates are virtually zero. That is because; a decline in short-term inflation expectations increases short-term real interest rates, thereby damping aggregate demand. Conversely, in such circumstances, an increase in inflation expectations lowers short-term real interest rates, stimulating the economy. Therefore, Fed seems to have started mulling on alternative strategies that would lift short term inflation expectations higher, including providing more detailed information about the rates of inflation the Committee considered consistent with its dual mandate, targeting a path for the price level rather than the rate of inflation, and targeting a path for the level of nominal GDP. The last two strategies are new approaches for the central banking and there are no other countries that use them. Accordingly, these policy alternatives would unlikely be implemented in the short term.
While there are growing signs that the Fed would opt for more monetary easing, other Central Banks have also started to feel the pressure. Glancing at home, the outlook is quite mixed. The surprisingly strong industrial output in August triggered upgrades in growth forecasts, while the automotive sales and domestic demand in general have remained robust. These factors have the potential to put upward pressure on interest rates. On the other hand, the downside risk to external demand, the slowdown signals from leading economic activity indicators, TRY appreciation, the decline in bond yields and risk premiums, the impression of a tighter fiscal policy stance thanks to the Medium Term Program budget targets are all among the factors that would necessitate for lower policy rate or at least would urge for the maintenance of the current stance. The MPC meeting on October 14th was supposed to shed more light on how these developments would affect the Central Bank’s position. This meeting had an added importance since it was the last one to be held prior to the Inflation Report (where the Bank would update the inflation and output gap forecasts) due October 26th. The MPC decision did not involve much surprise and the statement indicated that the exit strategy would remain on course. After the meeting, the Central Bank also announced new decisions regarding the F/X market and open market operations. The Bank seemed to have slightly upgraded their assessment of the economic outlook in general. They said the economic activity continues to recover and domestic demand displays a relatively stronger outlook. In due course the Central Bank presumed headline inflation to be in a declining path, while core inflation was projected to remain consistent with medium term targets. From here, one may conclude that despite the decline in the core price inflation to as low as 3.7% in September, the Bank preferred to remain cautious due to the upside risks on headline CPI regarding the food price inflation. On the policy rate front, the Bank left their rhetoric untouched by reiterating that current levels would be maintained for some time and interest rate would remain low for a long period. The Bank seems to have preferred to wait for Inflation Report to describe the likely interest rate path more clearly. Meanwhile, the Bank also emphasized that the expectations of more accommodative monetary policies in developed economies which boost capital flows toward emerging markets and the accompanied decline in risk premiums, as well as the resulting appreciation of TRY and downside pressure on interest rates exacerbate upside risks to domestic demand and eventually underscore the threats against financial stability. In that concept, it is obvious that the Bank would continue relying on tools other than policy rate. The Bank continued to proceed with measures that would help normalization of the F/X, TRY and open market operations (the Bank abolished its intermediary function in the foreign exchange deposit market, ceased 3-month repo auctions, cut the O/N borrowing rates by an additional 50 bps and cancelled the provision of one-week funding to the primary dealers) and additional increase in TRY required reserve ratio should be expected soon.
12 Ekim 2010 Salı
Bartenders Refill Punchbowl…
Summary: The financial markets, being convinced that a new phase of quantitative easing would be launched, have started to search for a new equilibrium. The ultra loose monetary policies in developed countries triggered intervention in F/X markets and other measures to discourage capital inflows in many countries, giving the impression of currency wars across the globe. The Central Bank has been prepared to take action to secure financial stability, bearing in mind that this new conjuncture may result in volatility in financial markets. It remains to be seen whether new measures for price stability would also be introduced.
The post-crisis economic backdrop seems to have entered into a new phase of unconventional monetary easing, or more specifically the second round of quantitative easing (QE2). This tool has been especially preferred by developed countries which experience slow economic recovery after the recession and who have already cut policy rates to rock-bottom levels. In September meeting, Fed put greater emphasis on deflation risk and has become the first Central Bank that signaled for expansion in its balance sheet. Moreover, the remarks by a number of Fed officials since then have further fueled into the expectations that Fed would launch QE2 as early as the November 3rd meeting. Japan also joined this camp by lowering the policy rate to 0.0-0.1% range, accompanied with additional asset purchase program. These decisions that would further boost already abundant global liquidity have started to drive the financial markets to a new equilibrium. The Fed’s relative position in terms of monetary policy stance has deteriorated due to their bias for ultra loose monetary policy, consequentially dragging US$ lower across all currencies. The 2-year U.S. Treasury yield slumped to a record low of 0.4%, with the market seeming more deeply convinced that the interest rates would remain low for an extended period. This has also formed the basis for growing appetite for riskier assets. Especially the stock markets across the globe and the emerging market assets in general have become the beneficiaries of this new environment, with the repercussions in Turkey being lower F/X basket and $/TRY, as well as tighter yields along the curve and record highs in stock market. The Central Bank names the key features of this new economic conjuncture as the ‘occurrence of the risks of overheating, excessive indebtness and emergence of asset bubbles as a result of intensive capital inflows towards reliable and dynamic emerging market economies, and the probability of elevated levels of current account deficit threatening financial stability.’ The Bank also says that the additional measures they have taken recently are preparation for the new economic situation, which would dominate the whole world in the upcoming period.
Note that the markets have got very much accustomed to the idea of additional expansion in Fed’s balance sheet (which has expanded to $2.3trn from $860bn prior to the crisis) so that they were not surprised to hear some Fed officials giving details regarding how QE2 would operate. A good example was the speech by Brian Sack from the NY Fed about “Managing the Federal Reserve's Balance Sheet" where he outlined five policy questions that could be considered in designing a purchase program. Sack emphasized that asset purchases that would enlarge the balance sheet should be seen as a substitute for the changes in federal funds rate. The key points in Sacks speech were:
1) Similar to the manner in which the FOMC has historically adjusted the federal funds rate, the balance sheet should be adjusted in relatively continuous but smaller steps, rather than in infrequent but large increments.
2) The balance sheet decisions should be governed to a large extent by the evolution of the FOMC’s economic forecasts just was the case for the decisions regarding the federal funds target rate.
3) The movements in balance sheets should be stressed to have some persistency in order to make them more influential.
4) Providing information about the likely course of the balance sheet could be desirable, similar to the case for federal funds rate.
5) Some flexibility should be incorporated into the program, providing some discretion to change course as market conditions evolve and as more is learned about the instrument.
Note that the ultimate goal of the QE2 is to change the yield curve and revive the economic activity through the banking sector. While doing this, Fed is likely to expand the balance sheet gradually and in small amounts, rather than a substantial and front-loaded approach of the earlier round of asset purchases. While the BoE is foreseen to mirror the steps of its peers BoJ and Fed, the implications of this new round of monetary easing on other Central Banks should be discussed as well. This may urge those Central Banks who have already moved forward with some tightening to give a second thought to their decisions. Moreover, the appreciation of emerging market currencies would potentially have favorable repercussions on inflation with some lag and that could create room for monetary easing maneuvers in some countries, considering also that the risk premiums would remain low in such environments. Ironically, going forward, macroprudential tools may be used more intensively for the sake of financial stability while at the same time a loose monetary policy stance may be adopted to address the price stability objective.
The key question would be whether Turkish Central Bank would also join this camp. Despite the jump in the headline CPI in September, core indices remained below the medium term targets. Moreover, the leading economic activity indicators hinted at some slowdown going forward. These were the developments that supported the Central Bank to at east keep the current monetary policy stance for a longer time. However, it is yet early to conclude whether the fresh developments would be enough to induce the Central Bank for a remarkably change in their baseline scenario that includes limited rate hikes in 2011. We will keep monitoring the signals regarding such a change.
The post-crisis economic backdrop seems to have entered into a new phase of unconventional monetary easing, or more specifically the second round of quantitative easing (QE2). This tool has been especially preferred by developed countries which experience slow economic recovery after the recession and who have already cut policy rates to rock-bottom levels. In September meeting, Fed put greater emphasis on deflation risk and has become the first Central Bank that signaled for expansion in its balance sheet. Moreover, the remarks by a number of Fed officials since then have further fueled into the expectations that Fed would launch QE2 as early as the November 3rd meeting. Japan also joined this camp by lowering the policy rate to 0.0-0.1% range, accompanied with additional asset purchase program. These decisions that would further boost already abundant global liquidity have started to drive the financial markets to a new equilibrium. The Fed’s relative position in terms of monetary policy stance has deteriorated due to their bias for ultra loose monetary policy, consequentially dragging US$ lower across all currencies. The 2-year U.S. Treasury yield slumped to a record low of 0.4%, with the market seeming more deeply convinced that the interest rates would remain low for an extended period. This has also formed the basis for growing appetite for riskier assets. Especially the stock markets across the globe and the emerging market assets in general have become the beneficiaries of this new environment, with the repercussions in Turkey being lower F/X basket and $/TRY, as well as tighter yields along the curve and record highs in stock market. The Central Bank names the key features of this new economic conjuncture as the ‘occurrence of the risks of overheating, excessive indebtness and emergence of asset bubbles as a result of intensive capital inflows towards reliable and dynamic emerging market economies, and the probability of elevated levels of current account deficit threatening financial stability.’ The Bank also says that the additional measures they have taken recently are preparation for the new economic situation, which would dominate the whole world in the upcoming period.
Note that the markets have got very much accustomed to the idea of additional expansion in Fed’s balance sheet (which has expanded to $2.3trn from $860bn prior to the crisis) so that they were not surprised to hear some Fed officials giving details regarding how QE2 would operate. A good example was the speech by Brian Sack from the NY Fed about “Managing the Federal Reserve's Balance Sheet" where he outlined five policy questions that could be considered in designing a purchase program. Sack emphasized that asset purchases that would enlarge the balance sheet should be seen as a substitute for the changes in federal funds rate. The key points in Sacks speech were:
1) Similar to the manner in which the FOMC has historically adjusted the federal funds rate, the balance sheet should be adjusted in relatively continuous but smaller steps, rather than in infrequent but large increments.
2) The balance sheet decisions should be governed to a large extent by the evolution of the FOMC’s economic forecasts just was the case for the decisions regarding the federal funds target rate.
3) The movements in balance sheets should be stressed to have some persistency in order to make them more influential.
4) Providing information about the likely course of the balance sheet could be desirable, similar to the case for federal funds rate.
5) Some flexibility should be incorporated into the program, providing some discretion to change course as market conditions evolve and as more is learned about the instrument.
Note that the ultimate goal of the QE2 is to change the yield curve and revive the economic activity through the banking sector. While doing this, Fed is likely to expand the balance sheet gradually and in small amounts, rather than a substantial and front-loaded approach of the earlier round of asset purchases. While the BoE is foreseen to mirror the steps of its peers BoJ and Fed, the implications of this new round of monetary easing on other Central Banks should be discussed as well. This may urge those Central Banks who have already moved forward with some tightening to give a second thought to their decisions. Moreover, the appreciation of emerging market currencies would potentially have favorable repercussions on inflation with some lag and that could create room for monetary easing maneuvers in some countries, considering also that the risk premiums would remain low in such environments. Ironically, going forward, macroprudential tools may be used more intensively for the sake of financial stability while at the same time a loose monetary policy stance may be adopted to address the price stability objective.
The key question would be whether Turkish Central Bank would also join this camp. Despite the jump in the headline CPI in September, core indices remained below the medium term targets. Moreover, the leading economic activity indicators hinted at some slowdown going forward. These were the developments that supported the Central Bank to at east keep the current monetary policy stance for a longer time. However, it is yet early to conclude whether the fresh developments would be enough to induce the Central Bank for a remarkably change in their baseline scenario that includes limited rate hikes in 2011. We will keep monitoring the signals regarding such a change.
4 Ekim 2010 Pazartesi
New Mission of CBT: Financial Stability
Summary: Lately the Central Bank has been putting a greater emphasis on financial stability. In order to fulfill this goal, they have started using the alternative monetary policy tools other than interest rate more effectively. Having already made some revisions about the RR, the Bank signals that the RR may also be employed as a tool to extend the maturities of deposits. The Central Bank also underlines that the cost associated with the accumulation of financial risks would be higher level of interest rates and therefore a more limited interest rate hike than normally expected may suffice provided that the macroprudential tools are put into force.
The repercussions of the alternative monetary policy tools started to be used by the Central Bank continue to be felt in the markets. Among last week’s decisions launched by the Central Bank, the removal of the interest paid on required reserves (RR) was the major shock to the markets, rather than the increase in the RR ratios. The Central Bank’s exit strategy had not mentioned such a change in regulation and therefore the decision should be considered as a surprise. The Central Bank said their aim is to use RR ratios more actively as a policy tool to mitigate the macroeconomic and financial risks. After all, it was obvious that the increase in the RR by itself would not be enough to limit the credit expansion, given the interest paid on TRY RR which is 80% of the Central Bank’s O/N borrowing rate. Moreover, the news that in order to extend the maturities of deposits the Central Bank may apply varying RR ratios depending on their maturities is a sign that the Central Bank would continue using this alternative policy tool more actively. In the meantime, the Central Bank’s emphasis on further possible reduction in the O/N borrowing rates hints that the Bank would keep utilizing liquidity management facilities more effectively. Having summarized the fresh developments regarding the monetary policy framework, we will now have a closer look into the “financial stability” concept that appears to be the reason behind the regeneration of alternative monetary policy tools, as well as the implications of this concept for the Central Bank’s monetary policy. The financial stability can be defined as avoiding or dispelling the financial system inadequacies and disruptions that could potentially have major distortions on the real economy. Recently, the Central Bank has been putting a special emphasis on this concept, as should be understood from the latest MPC meeting summary where the Bank said that “….global crisis has demonstrated the importance of central banks having an auxiliary financial stability mandate as well as the objective of price stability.” Accordingly, this adds another objective to the Bank’s current obligations of fighting inflation, as well as supporting growth and employment. It at the same time hints that the Central Bank anticipates this objective to become more widespread going forward. The CBRT Law says: “The primary objective of the Bank shall be to achieve and maintain price stability. The Bank shall determine on its own discretion the monetary policy that it shall implement and the monetary policy instruments that it is going to use in order to achieve and maintain price stability.“ Whereas, via the presentations recently made by Central Bank Governor, another mandate has been added and the Bank’s primary roles have been defined as follows: 1. To achieve price stability; 2. To take measures to enhance stability in the financial system; 3. To support the growth and employment policies of the government provided that it shall not be in confliction with the objective of price stability.
This new mandate would likely be included in the Central Bank Law as soon as there is a chance for such an amendment. On the other hand, there is another independent entity in Turkey, namely BRSA that has the responsibility of supervision of the financial system. Therefore, it seems that there may be problems associated with enlarging the authorization of the Central Bank, as was understood from BRSA Governor’s comments that came after the Central Bank’s decision to raise the RR.
Returning to the Central Bank’s financial stability mandate, the Bank defines primary objectives as given in the following lines. Therefore, following the Bank’s plans about applying varying RR ratios for deposits depending on their maturities, other steps associated with either of these items may also be expected going forward.
1. Debt Ratios: Use of more equity, less debt
2. Debt Maturities: Extending maturities of external borrowing and domestic deposits
3. FX Positions: Strengthening FX position of the public and the private sectors
4. Risk management practices: More effective management of financial risks by all agents in the economy
In another presentation, the Bank lists the macroprudential tools that can be used to achieve these objectives as follows: Reserve Requirements, Central Bank’s Liquidity Provision, Bank’s Capital Requirements, Banks’ Liquidity Requirements and Taxes.
The first two of these are the Central Bank’s responsibility, while the BRSA is authorized for the following two and the Finance Ministry has the control over the last tool. Therefore, institutions must cooperate in order to use these tools efficiently.
The graphs in the Central Bank’s mentioned presentation suggest that, financial stability curve would urge for a higher interest rate if there is positive output gap, while a lower interest rate would be implied by the curve when output gap turns negative. On the other hand, if macroprudential tools are employed to meet the financial stability objective, then the Taylor rule, which is the most common approach to determine the policy rate, would suggest lower interest rate when output gap is positive and higher interest rate when output gap is negative. A straightforward interpretation of this might be that in the period ahead when the output gap would be closed and eventually turn positive, the Central Bank is likely to keep the interest rate at a lower level than would be suggested by Taylor rule under normal circumstances, thanks to the macroprudential tools.
The repercussions of the alternative monetary policy tools started to be used by the Central Bank continue to be felt in the markets. Among last week’s decisions launched by the Central Bank, the removal of the interest paid on required reserves (RR) was the major shock to the markets, rather than the increase in the RR ratios. The Central Bank’s exit strategy had not mentioned such a change in regulation and therefore the decision should be considered as a surprise. The Central Bank said their aim is to use RR ratios more actively as a policy tool to mitigate the macroeconomic and financial risks. After all, it was obvious that the increase in the RR by itself would not be enough to limit the credit expansion, given the interest paid on TRY RR which is 80% of the Central Bank’s O/N borrowing rate. Moreover, the news that in order to extend the maturities of deposits the Central Bank may apply varying RR ratios depending on their maturities is a sign that the Central Bank would continue using this alternative policy tool more actively. In the meantime, the Central Bank’s emphasis on further possible reduction in the O/N borrowing rates hints that the Bank would keep utilizing liquidity management facilities more effectively. Having summarized the fresh developments regarding the monetary policy framework, we will now have a closer look into the “financial stability” concept that appears to be the reason behind the regeneration of alternative monetary policy tools, as well as the implications of this concept for the Central Bank’s monetary policy. The financial stability can be defined as avoiding or dispelling the financial system inadequacies and disruptions that could potentially have major distortions on the real economy. Recently, the Central Bank has been putting a special emphasis on this concept, as should be understood from the latest MPC meeting summary where the Bank said that “….global crisis has demonstrated the importance of central banks having an auxiliary financial stability mandate as well as the objective of price stability.” Accordingly, this adds another objective to the Bank’s current obligations of fighting inflation, as well as supporting growth and employment. It at the same time hints that the Central Bank anticipates this objective to become more widespread going forward. The CBRT Law says: “The primary objective of the Bank shall be to achieve and maintain price stability. The Bank shall determine on its own discretion the monetary policy that it shall implement and the monetary policy instruments that it is going to use in order to achieve and maintain price stability.“ Whereas, via the presentations recently made by Central Bank Governor, another mandate has been added and the Bank’s primary roles have been defined as follows: 1. To achieve price stability; 2. To take measures to enhance stability in the financial system; 3. To support the growth and employment policies of the government provided that it shall not be in confliction with the objective of price stability.
This new mandate would likely be included in the Central Bank Law as soon as there is a chance for such an amendment. On the other hand, there is another independent entity in Turkey, namely BRSA that has the responsibility of supervision of the financial system. Therefore, it seems that there may be problems associated with enlarging the authorization of the Central Bank, as was understood from BRSA Governor’s comments that came after the Central Bank’s decision to raise the RR.
Returning to the Central Bank’s financial stability mandate, the Bank defines primary objectives as given in the following lines. Therefore, following the Bank’s plans about applying varying RR ratios for deposits depending on their maturities, other steps associated with either of these items may also be expected going forward.
1. Debt Ratios: Use of more equity, less debt
2. Debt Maturities: Extending maturities of external borrowing and domestic deposits
3. FX Positions: Strengthening FX position of the public and the private sectors
4. Risk management practices: More effective management of financial risks by all agents in the economy
In another presentation, the Bank lists the macroprudential tools that can be used to achieve these objectives as follows: Reserve Requirements, Central Bank’s Liquidity Provision, Bank’s Capital Requirements, Banks’ Liquidity Requirements and Taxes.
The first two of these are the Central Bank’s responsibility, while the BRSA is authorized for the following two and the Finance Ministry has the control over the last tool. Therefore, institutions must cooperate in order to use these tools efficiently.
The graphs in the Central Bank’s mentioned presentation suggest that, financial stability curve would urge for a higher interest rate if there is positive output gap, while a lower interest rate would be implied by the curve when output gap turns negative. On the other hand, if macroprudential tools are employed to meet the financial stability objective, then the Taylor rule, which is the most common approach to determine the policy rate, would suggest lower interest rate when output gap is positive and higher interest rate when output gap is negative. A straightforward interpretation of this might be that in the period ahead when the output gap would be closed and eventually turn positive, the Central Bank is likely to keep the interest rate at a lower level than would be suggested by Taylor rule under normal circumstances, thanks to the macroprudential tools.
20 Eylül 2010 Pazartesi
Two Sides of The Economy…
Summary: The latest data disclosures support our long-held view for a high growth rate for this year, while we also realize that the divergence between domestic and external demand has turned more visible. This outlook would unlikely change the monetary stance of the Central Bank, but ease the downside risks on the policy rates. The Bank is more likely to respond via instruments other than interest rate in case this divergence continues. Separately, the fresh budget figures seem to be relieving for the Bank, who emphasized that they would be monitoring the implementation at the absence of fiscal rule.
The data disclosures over the recent term suggest that divergence between growth rates of domestic and external demand has turned more apparent in Turkey. The Consumption Index reached all time high in August, posting around 20% y/y gains in each of the last two months, while the annual expansion in the domestic loans climbed above 35%. Meanwhile, the unemployment rate remained on a steep decline pattern and more importantly the seasonally adjusted rate receded to its lowest level since October 2008. Also, after the limited drop in May, the economy continued to generate jobs in June, as was valid in the m/m increase of 161K in the total payrolls (the average increase in the first five months was 100K). The consumption and investment contribitued above-expected 4.5 pp and 5.9 pp to the overall GDP growth in Q2. Despite this healthy domestic demand outlook, the industrial output has lost pace over the last months due to the slowdown in exports. The seasonally adjusted industrial output could only recoup by 0.3% m/m in June atop of the sharp 2.2% slump in June. Note also that the net exports erased some 1.6 pp off the GDP in Q2. Nevertheless, Q2 GDP came better than expected; posting a seasonally adjusted quarterly growth rate of 3.7% and GDP level has reached mildly above its pre-crisis peak. The fresh data disclosures such as the increase in current account deficit, improvement in labor market and budget performance, suggest a slightly better economic outlook. On the contrary, the leading indicators of economic activity indicate that economy would enter to a somewhat slower pace in the third quarter and display a flattish trend. Separately, as we approach to a period where the weak base effect would fade off, the Turkish economy is likely to post more conservative single-digit growth rates in the following quarters (we expect around 6% growth in Q3, followed by 4% in the following quarters). In other words, we stick to our baseline scenario that includes below-potential growth rate and slow recovery.
While the growth outlook is a bit stronger than what the market expected, we stick to our above-consensus GDP growth forecast of 7.0% for 2010. Note that the risks now are upside on this forecast. However, we reckon the growth rate would decelerate to 4.0% vicinity in 2011, due to the weak global backdrop, unfavorable base effect linked to this year’s strong performance and likely deterioration in confidence in the election year. Thus, the fresh data would unlikely change the monetary stance of the Central Bank, but ease the downside risks on the policy rates. Recall that in the August MPC meeting summary, the Bank mentioned the ‘Economic Contraction At Home’ scenario whereby global economic problems intensify and contribute to a contraction of domestic economic activity, consequently triggering a new easing cycle. Back then, the Bank had also said “If this [exacerbating pattern of the divergence between the pace of recovery in the domestic demand and external demand] pattern of growth coexists with rapid credit expansion and a deterioration in the current account balance, consequently leading to financial stability concerns, it would be necessary to utilize other policy instruments such as reserve requirement ratios and liquidity tools more effectively.” In this context, the Bank introduced the technical rate cut in September MPC meeting, while also noting that it would be appropriate to proceed with the other measures outlined in the exit strategy. We expect soon there will be increase in F/X and TRY reserve requirements and anticipate the Bank resuming rate hikes by May next year reaching 200 bps in end-2011.
On the other hand, the Central Bank frequently signals that they keep a close eye on the fiscal policies while forming their monetary policy strategy. Recalling from the August meeting summary, the Bank had noted that “…the delay in the enactment of the fiscal rule has increased the importance of current fiscal policy implementation.” In that context, the July-August budget realizations that were disclosed a month later than normal timing due to fiscal holiday would probably give some relief to the Bank. The Bank’s assessment regarding the 1H performance was positive and the Bank had said “… the better-than-expected performance in budget revenues, due to stronger economic activity than envisaged in the Medium Term Program (MTP), is largely being used to reduce government debt,” signaling that they do not see any problem with the fiscal discipline. We think that July-August budget performance is likely to deserve a similar assessment.
Having a closer look at the fiscal outlook, the central government budget produced TRY8.8bn primary surplus in July-August period, much better than the TRY5.1bn surplus in the look-alike slice of last year. There is substantial improvement in revenues on the back of strong tax proceeds that is more than enough to counterbalance the increase in primary expenditures, while around TRY2.0bn transfers from unemployment insurance fund and privatization revenues also helped the revenue performance. Adding the visible decline in interest payments, the budget balance improved at an even greater pace as the two-month budget produced a surplus of TRY1.0bn vs. last year’s TRY8.1bn deficit. All in all, the 12-month central government budget deficit to GDP declined to 3.4% vs. the year-end target of 4.9% in the Medium Term Program (MTP). This improvement is in line with our estimates disclosed in the ‘Fiscal Outlook’ report published on Monday. This may indicate that there is an extra room for 1.5 pp more (TRY15.8bn) for expenditures boosting or revenue-damping policies. In other words, extra improvement in July-August budget implies that the fiscal area that can be turned into higher expenditures is enlarged and both Finance Minister Simsek’s words that “we will be loyal to our targets” and Economy Minister Babacan’s emphasis that the year-end budget deficit will be in line with MTP targets are consistent with deterioration vs. the current point. Along with the Central Bank, we will continue to monitor how this fiscal area will be used in the following period. However, even if budget performance deteriorates somewhat in the period ahead, we do not anticipate the Bank would react unless this deterioration yields upward pressure on inflation via for example indirect tax hikes.
The data disclosures over the recent term suggest that divergence between growth rates of domestic and external demand has turned more apparent in Turkey. The Consumption Index reached all time high in August, posting around 20% y/y gains in each of the last two months, while the annual expansion in the domestic loans climbed above 35%. Meanwhile, the unemployment rate remained on a steep decline pattern and more importantly the seasonally adjusted rate receded to its lowest level since October 2008. Also, after the limited drop in May, the economy continued to generate jobs in June, as was valid in the m/m increase of 161K in the total payrolls (the average increase in the first five months was 100K). The consumption and investment contribitued above-expected 4.5 pp and 5.9 pp to the overall GDP growth in Q2. Despite this healthy domestic demand outlook, the industrial output has lost pace over the last months due to the slowdown in exports. The seasonally adjusted industrial output could only recoup by 0.3% m/m in June atop of the sharp 2.2% slump in June. Note also that the net exports erased some 1.6 pp off the GDP in Q2. Nevertheless, Q2 GDP came better than expected; posting a seasonally adjusted quarterly growth rate of 3.7% and GDP level has reached mildly above its pre-crisis peak. The fresh data disclosures such as the increase in current account deficit, improvement in labor market and budget performance, suggest a slightly better economic outlook. On the contrary, the leading indicators of economic activity indicate that economy would enter to a somewhat slower pace in the third quarter and display a flattish trend. Separately, as we approach to a period where the weak base effect would fade off, the Turkish economy is likely to post more conservative single-digit growth rates in the following quarters (we expect around 6% growth in Q3, followed by 4% in the following quarters). In other words, we stick to our baseline scenario that includes below-potential growth rate and slow recovery.
While the growth outlook is a bit stronger than what the market expected, we stick to our above-consensus GDP growth forecast of 7.0% for 2010. Note that the risks now are upside on this forecast. However, we reckon the growth rate would decelerate to 4.0% vicinity in 2011, due to the weak global backdrop, unfavorable base effect linked to this year’s strong performance and likely deterioration in confidence in the election year. Thus, the fresh data would unlikely change the monetary stance of the Central Bank, but ease the downside risks on the policy rates. Recall that in the August MPC meeting summary, the Bank mentioned the ‘Economic Contraction At Home’ scenario whereby global economic problems intensify and contribute to a contraction of domestic economic activity, consequently triggering a new easing cycle. Back then, the Bank had also said “If this [exacerbating pattern of the divergence between the pace of recovery in the domestic demand and external demand] pattern of growth coexists with rapid credit expansion and a deterioration in the current account balance, consequently leading to financial stability concerns, it would be necessary to utilize other policy instruments such as reserve requirement ratios and liquidity tools more effectively.” In this context, the Bank introduced the technical rate cut in September MPC meeting, while also noting that it would be appropriate to proceed with the other measures outlined in the exit strategy. We expect soon there will be increase in F/X and TRY reserve requirements and anticipate the Bank resuming rate hikes by May next year reaching 200 bps in end-2011.
On the other hand, the Central Bank frequently signals that they keep a close eye on the fiscal policies while forming their monetary policy strategy. Recalling from the August meeting summary, the Bank had noted that “…the delay in the enactment of the fiscal rule has increased the importance of current fiscal policy implementation.” In that context, the July-August budget realizations that were disclosed a month later than normal timing due to fiscal holiday would probably give some relief to the Bank. The Bank’s assessment regarding the 1H performance was positive and the Bank had said “… the better-than-expected performance in budget revenues, due to stronger economic activity than envisaged in the Medium Term Program (MTP), is largely being used to reduce government debt,” signaling that they do not see any problem with the fiscal discipline. We think that July-August budget performance is likely to deserve a similar assessment.
Having a closer look at the fiscal outlook, the central government budget produced TRY8.8bn primary surplus in July-August period, much better than the TRY5.1bn surplus in the look-alike slice of last year. There is substantial improvement in revenues on the back of strong tax proceeds that is more than enough to counterbalance the increase in primary expenditures, while around TRY2.0bn transfers from unemployment insurance fund and privatization revenues also helped the revenue performance. Adding the visible decline in interest payments, the budget balance improved at an even greater pace as the two-month budget produced a surplus of TRY1.0bn vs. last year’s TRY8.1bn deficit. All in all, the 12-month central government budget deficit to GDP declined to 3.4% vs. the year-end target of 4.9% in the Medium Term Program (MTP). This improvement is in line with our estimates disclosed in the ‘Fiscal Outlook’ report published on Monday. This may indicate that there is an extra room for 1.5 pp more (TRY15.8bn) for expenditures boosting or revenue-damping policies. In other words, extra improvement in July-August budget implies that the fiscal area that can be turned into higher expenditures is enlarged and both Finance Minister Simsek’s words that “we will be loyal to our targets” and Economy Minister Babacan’s emphasis that the year-end budget deficit will be in line with MTP targets are consistent with deterioration vs. the current point. Along with the Central Bank, we will continue to monitor how this fiscal area will be used in the following period. However, even if budget performance deteriorates somewhat in the period ahead, we do not anticipate the Bank would react unless this deterioration yields upward pressure on inflation via for example indirect tax hikes.
6 Eylül 2010 Pazartesi
Global Real-ISM…
The Purchasing Managers Index (PMI) that is disclosed in the first day of every month and is followed as the most important leading indicator for economic activity showed that the World economy remained in a weakening trend in August. The Global PMI that is the average of the country PMIs across the World took the value of 53.8 and held above the 50 threshold that demarcates the expansion and contraction periods. Nevertheless, this was the lowest print over the last 1 year. Contrary to the surprising jump in the U.S., the index in China (51.7) and Japan (50.1), which are the engines of global growth, dropped below this average. No doubt, the growth implication of a PMI that is slightly above the threshold would not be the same for developing countries, with high potential growth rate like China, and developed countries. However, what is certain is that in both country groups the PMI levels imply a near potential at best and most probably a weaker growth rate. In due course, the downtrend in the leading indicators also suggests that the most robust phase of the post-recession recovery has been over. Obviously, the extent that the countries could benefit from this fast rebound period differed depending on the initial shape of the economy prior to the recession. The countries which performed poorly in that respect would also be most vulnerable to a new slowdown cycle. Glancing at home, the leading indicators (Real Sector Confidence Index (RCSI), Turkish PMI and Central Bank Composite Leading Indicator) indicate that Turkey stands at a similar point in terms of the economic cycle. Tracking the global trends, the PMI and RSCI started to fall after peaking in April-May period, hinting that the robust growth performance in H1 would not be extended into H2. Meanwhile, the Central Bank’s Composite Leading Indicator signaled for the turning point of the industrial production two-three months ahead, as usual and the annual expansion of the industrial output eased to around 3% from around 10% after that point. This is a very weak recovery pace and let alone narrowing, the output gap would widen further in these circumstances.
Now, the question is whether this is an irreversible trend? How does the Central Bank perceive these developments and what are the measures they plan? We will be seeking answers to these questions in this weekly.
In order to have a better view of the picture above, the economy needs to be cleared from last year’s weak base effect. In essence it seems that the weak economic outlook that is described above may be undermined due to a number of reasons. For instance we expect 9.2% annual GDP growth in Q2 and 9.5% annual expansion in July industrial output both due to be released in the following weeks. Moreover, the domestic demand depicts a relatively better picture, thanks to the support from monetary policy. What then is going to be our benchmark? The rate of growth in the consecutive periods… A slowdown in GDP to 5-6% in Q3 and to 3-4% in Q4 would be acceptable, while growth rates below these intervals would be alarming.
The Central Banks are always concerned with the growth-inflation balance, while growth outlook outweighs in their monetary policy response function during crisis periods. The CBRT adopted countercyclical monetary policy strategy during and post recession period as much as the inflation outlook allowed them to do so. The Bank still sticks to this approach, as implied by the latest MPC meeting summary. Recall that in April the Bank had announced an exit strategy and pointed at Q4 this year as the start of the rate hikes, while coming to July, the risks associated with the global economy and the accompanying slowdown in the domestic economic activity urged the Bank to postpone rate hikes to an uncertain date next year, together with a delay in the exit strategy towards the end of this year. The Bank’s rhetoric seems to have changed a little bit since then as well. Among the alternative scenarios to the baseline described in the July Inflation Report, the Bank picked the one that we name as “economic contraction at home” and emphasized it in the latest MPC meeting summary. This has given the impression that they may be closer to this scenario than other alternatives (Pls. see below the Box for Central Bank Scenarios). In this scenario the Bank says should problems in the global economy further intensify, thereby increasing the possibility of a domestic recession, a new easing cycle may be considered. Even though in the meeting summary the Bank hints that they stick to the baseline scenario by saying that the outlook is in line with the July Inflation Report, the Bank only underlined the “economic contraction at home” scenario, without mentioning of “delayed recovery at home” scenario. This may be a sign that the alternative scenario that assumes first rate hike through the end of 2011 is now the Bank’s baseline scenario.
Against this backdrop, the Central Bank underlines that there is no change in the presumed timing of the steps in exit strategy (gradual increase in the TRY-FX reserve requirement rate and technical rate cut), which are planned to be introduced this year. Nevertheless, the Bank leaves the door open to different cases, mentioning of the risks that would either cause those steps to be brought forward or delayed. For instance, in the “economic contraction at home” scenario, the exit strategy was assumed to be delayed. Therefore, if this scenario is to be priced, that should consider both rate cuts and not implementing exit strategy. Needless to say, the above conclusions do depend on the domestic and foreign data disclosures more than ever.
In summary, the global economy remains in a slowdown trend, making it clearer that the strongest phase of recovery has been left behind. However, the uncertainties regarding the pace of recovery feed into double dip fears. Despite the support from monetary policy in Turkey, there is a significant deceleration in industrial output, while the leading indicators suggest deepening of this slowdown going forward. It is relieving to see that the Bank would keep the countercyclical monetary policy to combat this threat, which is not fully acknowledged by public opinion yet.
Central Bank Scenarios
Baseline: No important change in the recovery pace of economic activity is foreseen, with limited rate hikes starting sometime in 2011.
Delayed Recovery At Home: Should the global economy face a longer-than-anticipated period of anemic growth, which would consequently delay the domestic recovery significantly, the monetary tightening envisaged in 2011 under the baseline scenario may be postponed towards the end of 2011.
Economic Contraction At Home: An outcome whereby global economic problems intensify and contribute to a contraction of domestic economic activity may trigger a new easing cycle.
Faster Global Recovery: Monetary tightening may be implemented in an earlier period during 2011, should the recovery in economic activity turns out to be faster than expected.
Now, the question is whether this is an irreversible trend? How does the Central Bank perceive these developments and what are the measures they plan? We will be seeking answers to these questions in this weekly.
In order to have a better view of the picture above, the economy needs to be cleared from last year’s weak base effect. In essence it seems that the weak economic outlook that is described above may be undermined due to a number of reasons. For instance we expect 9.2% annual GDP growth in Q2 and 9.5% annual expansion in July industrial output both due to be released in the following weeks. Moreover, the domestic demand depicts a relatively better picture, thanks to the support from monetary policy. What then is going to be our benchmark? The rate of growth in the consecutive periods… A slowdown in GDP to 5-6% in Q3 and to 3-4% in Q4 would be acceptable, while growth rates below these intervals would be alarming.
The Central Banks are always concerned with the growth-inflation balance, while growth outlook outweighs in their monetary policy response function during crisis periods. The CBRT adopted countercyclical monetary policy strategy during and post recession period as much as the inflation outlook allowed them to do so. The Bank still sticks to this approach, as implied by the latest MPC meeting summary. Recall that in April the Bank had announced an exit strategy and pointed at Q4 this year as the start of the rate hikes, while coming to July, the risks associated with the global economy and the accompanying slowdown in the domestic economic activity urged the Bank to postpone rate hikes to an uncertain date next year, together with a delay in the exit strategy towards the end of this year. The Bank’s rhetoric seems to have changed a little bit since then as well. Among the alternative scenarios to the baseline described in the July Inflation Report, the Bank picked the one that we name as “economic contraction at home” and emphasized it in the latest MPC meeting summary. This has given the impression that they may be closer to this scenario than other alternatives (Pls. see below the Box for Central Bank Scenarios). In this scenario the Bank says should problems in the global economy further intensify, thereby increasing the possibility of a domestic recession, a new easing cycle may be considered. Even though in the meeting summary the Bank hints that they stick to the baseline scenario by saying that the outlook is in line with the July Inflation Report, the Bank only underlined the “economic contraction at home” scenario, without mentioning of “delayed recovery at home” scenario. This may be a sign that the alternative scenario that assumes first rate hike through the end of 2011 is now the Bank’s baseline scenario.
Against this backdrop, the Central Bank underlines that there is no change in the presumed timing of the steps in exit strategy (gradual increase in the TRY-FX reserve requirement rate and technical rate cut), which are planned to be introduced this year. Nevertheless, the Bank leaves the door open to different cases, mentioning of the risks that would either cause those steps to be brought forward or delayed. For instance, in the “economic contraction at home” scenario, the exit strategy was assumed to be delayed. Therefore, if this scenario is to be priced, that should consider both rate cuts and not implementing exit strategy. Needless to say, the above conclusions do depend on the domestic and foreign data disclosures more than ever.
In summary, the global economy remains in a slowdown trend, making it clearer that the strongest phase of recovery has been left behind. However, the uncertainties regarding the pace of recovery feed into double dip fears. Despite the support from monetary policy in Turkey, there is a significant deceleration in industrial output, while the leading indicators suggest deepening of this slowdown going forward. It is relieving to see that the Bank would keep the countercyclical monetary policy to combat this threat, which is not fully acknowledged by public opinion yet.
Central Bank Scenarios
Baseline: No important change in the recovery pace of economic activity is foreseen, with limited rate hikes starting sometime in 2011.
Delayed Recovery At Home: Should the global economy face a longer-than-anticipated period of anemic growth, which would consequently delay the domestic recovery significantly, the monetary tightening envisaged in 2011 under the baseline scenario may be postponed towards the end of 2011.
Economic Contraction At Home: An outcome whereby global economic problems intensify and contribute to a contraction of domestic economic activity may trigger a new easing cycle.
Faster Global Recovery: Monetary tightening may be implemented in an earlier period during 2011, should the recovery in economic activity turns out to be faster than expected.
31 Ağustos 2010 Salı
Hole In The Wall…
The data flow in the U.S. and Europe continued to give bad surprises in the week behind. The week started in a depressed mood with the prolonged repercussions of the jobless claims that had jumped to 500K the week before, while the dismal data continued to hit the prospects regarding the pace of growth with the U.S. July home sales dipping to the lowest level of the last 15 years and PMIs in the Eurozone, which had posted a surprisingly high growth in Q2, deteriorating in August. The dismal outlook pushed the stock markets lower to test their weak levels suffered in the beginning of July amidst the EU debt crisis, while the long term bond yields headed towards their historic lows. In due course, markets were all ears for Fed Chairman Bernanke’s speech in Jackson Hole conference, wondering the possible monetary policy measures that could be taken in the “unusually uncertain” economic outlook, as he describes.
Recall that in testimony to U.S. Congress in July, Fed Chairman Bernanke had outlined several options available to Fed if the “recovery seems faltering”: 1) Further changes or modifications to their language on interest rate strategy, 2) lowering the interest rate they pay on excess reserves and 3) changes in their balance sheet - either not letting securities run off or making additional purchases. In August FOMC meeting, the Fed introduced the third option by announcing that the Federal Reserve's holdings of securities would be kept constant at their current level and this decision paved the idea that the Fed sees the economic recovery as faltering. The chance of further expansion in quantitative easing, i.e. enlarging the Fed’s holding of securities, is believed to be more likely nowadays. However, at the same time, there are signs that even the Fed’s decision to keep the portfolio size constant rather than letting it diminish was a close call, with a higher-than-expected number of FOMC members opposing the idea. Accordingly, there is a challenging period ahead for Bernanke, since he has to fine tune the Fed’s policy action by taking into account that aggressive steps may fuel the panic even further while on the other hand, a less assertive position may fail to break the negative feedback loop.
We have been long emphasizing that the economic recovery would be very gradual and extended through time, considering that the housing sector and labor market took big hits from the recession. However, we consistently argue that even though we envisage a slowdown in economic activity this would not turn into a double dip thanks to the fast rebound enjoyed in global trade, as well as the relatively more robust outlooks of the most manufacturing sectors. Moreover, the manufacturers are cautious and reluctant to build up much inventory this time due to the sluggish nature of recovery, thus eliminating the chance of being caught by lofty stocks amidst periods of sudden decline in demand. Neither the leading indicators such as PMIs, nor the shape of the yield curves (accepted to be harbinger of recession when negatively sloped) suggest that the economy would head into a recession in the near future. Nevertheless, if the sell-off pressure and the market volatility remain for a long time, this may weaken consumer and business confidence, eventually transforming the current slowdown into contraction.
Meanwhile, the fresh data on domestic economic activity also suggested slowdown in economic activity. Capacity utilization rate in August rose by 5.2 pp y/y to 73.4%, which is worse than the market consensus for 74.1%. The seasonally adjusted index that we calculate edged down by 0.1 pp m/m to 73.0%. The index has been hovering at around 73% since April and hints that after gaining steam in the beginning of the year, the economic activity can barely hold gains, without any progress. Meanwhile, the RSCI dropped to 111.0 in August, with 1.7 pp m/m decrease. Nevertheless, the current level is much higher than the critical threshold of 100, which separates the expansion and contraction periods in the economy and therefore it is consistent with ongoing growth, albeit at a slower pace. The index is some 7.8 pp lower than its recent peak at 118.8, 4 months ago. The limited revival in the capacity utilization rate and Real Sector Confidence Index in July is not sustained in August, the fresh data showed. The leading activity indicators point that the recovery continues at a sluggish pace, without gaining any momentum. This outlook is in line with the global trends and fits into the trajectory envisaged by the Central Bank. Accordingly, the data supports the base scenario where interest rates remain low for more going forward. However, if the recent downbeat data regarding the global economy deteriorates even further, this would have the risk of slowing the already fragile domestic economy beyond expectations. Note that in the Inflation Report, the Central Bank assumed to resume rate cuts in such a scenario.
On the other hand, there were also fresh statements about the fiscal discipline and budget performance within the week behind. Both the comments by Finance Minister and Deputy Minister in charge of economy indicated that the budget deficit would end the year in line with the Medium Term Plan (MTP), which had put the target at 4.9%. We had previously argued that a better-than-target balance would have been the natural result of the (likely) significant upward revision in the 3.5% GDP growth, as well as the robust fiscal performance in 1H this year. (Please see August 16th). Therefore, if the realizations turned out to be close to the target, this would have been a signal of dismal budget performance in 2H. Deputy Minister Babacan said both the revenues and expenditures surface above the presumed levels, hinting that the robust revenue performance is used to finance above-forecast expenditures. Even though Babacan was the most dedicative advocate of the fiscal rule in the government, he chose to remain silent against the questions by saying that he will not make any comment on fiscal rule for a while. Therefore, the fiscal bill seems less likely to come to the agenda when the Parliament convenes in October, while it is also uncertain whether the rule would be applied to the following years.
In conclusion, the string of dismal data flow in developed countries hits recovery prospects and urges markets to demand more from monetary policy. However, the monetary authorities should balance their decisions in a way to fine tune between being more aggressive than the market expects and failing to give less than the market hopes. In due course, the data disclosures regarding the domestic economy assure the ongoing slowdown in growth rate and support the current monetary policy stance. However, if the recent downbeat data regarding the global economy deteriorates even further, the Bank may revisit their strategy. Meanwhile, there are growing signs that the fiscal policy would not give the expected support to the monetary policy.
Recall that in testimony to U.S. Congress in July, Fed Chairman Bernanke had outlined several options available to Fed if the “recovery seems faltering”: 1) Further changes or modifications to their language on interest rate strategy, 2) lowering the interest rate they pay on excess reserves and 3) changes in their balance sheet - either not letting securities run off or making additional purchases. In August FOMC meeting, the Fed introduced the third option by announcing that the Federal Reserve's holdings of securities would be kept constant at their current level and this decision paved the idea that the Fed sees the economic recovery as faltering. The chance of further expansion in quantitative easing, i.e. enlarging the Fed’s holding of securities, is believed to be more likely nowadays. However, at the same time, there are signs that even the Fed’s decision to keep the portfolio size constant rather than letting it diminish was a close call, with a higher-than-expected number of FOMC members opposing the idea. Accordingly, there is a challenging period ahead for Bernanke, since he has to fine tune the Fed’s policy action by taking into account that aggressive steps may fuel the panic even further while on the other hand, a less assertive position may fail to break the negative feedback loop.
We have been long emphasizing that the economic recovery would be very gradual and extended through time, considering that the housing sector and labor market took big hits from the recession. However, we consistently argue that even though we envisage a slowdown in economic activity this would not turn into a double dip thanks to the fast rebound enjoyed in global trade, as well as the relatively more robust outlooks of the most manufacturing sectors. Moreover, the manufacturers are cautious and reluctant to build up much inventory this time due to the sluggish nature of recovery, thus eliminating the chance of being caught by lofty stocks amidst periods of sudden decline in demand. Neither the leading indicators such as PMIs, nor the shape of the yield curves (accepted to be harbinger of recession when negatively sloped) suggest that the economy would head into a recession in the near future. Nevertheless, if the sell-off pressure and the market volatility remain for a long time, this may weaken consumer and business confidence, eventually transforming the current slowdown into contraction.
Meanwhile, the fresh data on domestic economic activity also suggested slowdown in economic activity. Capacity utilization rate in August rose by 5.2 pp y/y to 73.4%, which is worse than the market consensus for 74.1%. The seasonally adjusted index that we calculate edged down by 0.1 pp m/m to 73.0%. The index has been hovering at around 73% since April and hints that after gaining steam in the beginning of the year, the economic activity can barely hold gains, without any progress. Meanwhile, the RSCI dropped to 111.0 in August, with 1.7 pp m/m decrease. Nevertheless, the current level is much higher than the critical threshold of 100, which separates the expansion and contraction periods in the economy and therefore it is consistent with ongoing growth, albeit at a slower pace. The index is some 7.8 pp lower than its recent peak at 118.8, 4 months ago. The limited revival in the capacity utilization rate and Real Sector Confidence Index in July is not sustained in August, the fresh data showed. The leading activity indicators point that the recovery continues at a sluggish pace, without gaining any momentum. This outlook is in line with the global trends and fits into the trajectory envisaged by the Central Bank. Accordingly, the data supports the base scenario where interest rates remain low for more going forward. However, if the recent downbeat data regarding the global economy deteriorates even further, this would have the risk of slowing the already fragile domestic economy beyond expectations. Note that in the Inflation Report, the Central Bank assumed to resume rate cuts in such a scenario.
On the other hand, there were also fresh statements about the fiscal discipline and budget performance within the week behind. Both the comments by Finance Minister and Deputy Minister in charge of economy indicated that the budget deficit would end the year in line with the Medium Term Plan (MTP), which had put the target at 4.9%. We had previously argued that a better-than-target balance would have been the natural result of the (likely) significant upward revision in the 3.5% GDP growth, as well as the robust fiscal performance in 1H this year. (Please see August 16th). Therefore, if the realizations turned out to be close to the target, this would have been a signal of dismal budget performance in 2H. Deputy Minister Babacan said both the revenues and expenditures surface above the presumed levels, hinting that the robust revenue performance is used to finance above-forecast expenditures. Even though Babacan was the most dedicative advocate of the fiscal rule in the government, he chose to remain silent against the questions by saying that he will not make any comment on fiscal rule for a while. Therefore, the fiscal bill seems less likely to come to the agenda when the Parliament convenes in October, while it is also uncertain whether the rule would be applied to the following years.
In conclusion, the string of dismal data flow in developed countries hits recovery prospects and urges markets to demand more from monetary policy. However, the monetary authorities should balance their decisions in a way to fine tune between being more aggressive than the market expects and failing to give less than the market hopes. In due course, the data disclosures regarding the domestic economy assure the ongoing slowdown in growth rate and support the current monetary policy stance. However, if the recent downbeat data regarding the global economy deteriorates even further, the Bank may revisit their strategy. Meanwhile, there are growing signs that the fiscal policy would not give the expected support to the monetary policy.
13 Ağustos 2010 Cuma
Don’t Take My Word For It…
The Fed’s decision about purchases of new securities to ease monetary policy was the key development in the external arena last week, while at home the focus was on the news regarding the delay of the fiscal rule, which would not be ready for 2011 budget and which would be subject to parameter changes.
Let’s start with looking into the Fed decision first: The Bank announced that they would reinvest principal payments from agency debt and agency mortgage-backed securities in longer-term Treasury securities so that the Federal Reserve's holdings of securities would be kept constant at their current level. The Fed had purchased some US$1.25trn of mortgage-backed securities and some US$175bn of other agency debt. Considering that Fed had previously planned to gradually narrow their security portfolio in the context of exit strategy, this new decision pointed to a looser monetary stance. Recall that in testimony to U.S. Congress in July, Fed Chairman Bernanke had outlined several options available to Fed if the “recovery seems faltering”: Further changes or modifications to their language on interest rates strategy, lowering the interest rate they pay on excess reserves and changes in their balance sheet - either not letting securities run off or making additional purchases. Therefore, Fed’s decision to activate one of these options implied that the Fed sees the economic recovery as faltering. In essence, Fed also downgraded their assessment of the economic outlook in the FOMC statement. The key developments, in our opinion, that urged the Bank to change monetary stance were the non-farm payrolls and unemployment rate. After the job losses reached 8.3 mn, accompanied by the unemployment rate peaking at 10.1%, the labor market indicators have improved somewhat. However, over the last months, the increase in private payrolls and the decline in unemployment rate have cut pace. After the FOMC meeting, the 10-year U.S. Treasury yield slumped to 2.7%, the lowest of the year (vs. the historical low of 2%), while rate hike expectations have been postponed towards 2012 in the Fed fund futures. This outlook may be an important indicator that the interest rates would remain low across the globe for longer-than-expected.
As opposed to this external support for low interest rate environment, the news at home that the fiscal rule would not be applied for 2011 budget brought the risk of erasing the positive repercussions. The Central Bank had said they monitor fiscal policy developments closely while formulating monetary policy and that the fiscal space created by the stronger-than-expected economic activity leading to better-than expected performance in budget revenues should be used mostly to reduce the government debt stock. The Bank also had noted that should the fiscal discipline implemented through institutional and structural improvements, such as enacting and establishing the fiscal rule, it would be possible to keep policy rates at single-digit levels over the medium term. Despite the Bank’s sensitivity to this issue, it is not straightforward to assume that the recent developments regarding the fiscal rule would yield a change in monetary policy stance. Given the fact that the monetary policy did not even react to the substantial deformation in budget vs. the targets during the crisis, it is not easy to speculate whether this time would be different. A possible scenario may involve the Bank saying that they would continue monitoring how the fiscal space created by higher-than-expected revenues would be spent. If they chose to do so, they may later say they are satisfied with the 2011 budget being prepared with respect to the framework described in the previous MTP. Finally, they may even end up saying that “the fiscal rule would have been better, yet the implementation is more important.”
The best we can do now is watching the current trend in the fiscal outlook on one hand and on the other hand to dig into the budget targets for 2010-2012 to be described in the MTP due out in September ahead of the submission of the 2011 budget to the Parliament’s approval on October 17th. Glancing at the performance as of June, the 12-month rolling central government budget deficit to GDP ratio, which is the best indicator for trend, declined to 4.3%, accompanied with 0.9% primary surplus (0.5% primary deficit in IMF defined figures). This picture guarantees that the deficit would remain below the 4.9% target by the year-end even in the absence of any y/y improvement. Our guess is that the deficit would regress to 3.7%, assuming that there would be no additional expenditure burden. To put it differently, meeting the official year-end target for the deficit or surpassing the levels mentioned above would simply imply deterioration for the second half of the year.
No doubt, when the new MTP is disclosed, the target for 2010 budget deficit should be expected to be revised down on the back of upgraded growth forecasts (to 5.5% or 6.0% from 3.5%). The extent of revision is important, yet more important than that would be whether the 2011 and 2012 deficit targets (4.0% and 3.2%) would be modified. For example, if the long run targets of 1.0% budget deficit and 5.0% GDP growth in the fiscal rule were applied, the budget deficit would have to be brought down to 3.1% in 2011 and to 2.8% in 2012, based on our 3.7% estimate for 2010 budget. Therefore, in essence, the officials’ announcements that the budget would be prepared in line with the MTP indicate at a looser fiscal stance than the original framework assumed when the MTP had been first disclosed last year, as the 2010 outlook is much better than the targets.
Upon the news regarding the delay of the fiscal rule, the rating agencies ruled out direct linkage between the fiscal rule and ratings, as expected. Yet they raised concerns regarding the credibility of the government in the absence of the rule, while underscoring that the implementation is more important than the fiscal rule itself, so that the patterns of budget deficit and debt/GDP ratios going forward would be important for the ratings.
In conclusion, the perceptions regarding the growth outlook have deteriorated after the Fed decided to keep constant the security portfolio size, which was one of the alternative measures previously outlined by Fed Chairman Bernanke, should the economic recovery falters. Meanwhile, Fed’s decision has also created an appropriate background for the interest rates to remain low for longer than expected. The news regarding the delay of the fiscal rule at home has the risk of jeopardizing the interest-rate-friendly atmosphere. Nevertheless, the Central Bank seems unlikely to develop a monetary policy response against this despite their previous emphasis on the importance of fiscal rule. The Bank may prefer to monitor the budget outcome for some more time. The rating agencies also tend to favor a similar approach.
Let’s start with looking into the Fed decision first: The Bank announced that they would reinvest principal payments from agency debt and agency mortgage-backed securities in longer-term Treasury securities so that the Federal Reserve's holdings of securities would be kept constant at their current level. The Fed had purchased some US$1.25trn of mortgage-backed securities and some US$175bn of other agency debt. Considering that Fed had previously planned to gradually narrow their security portfolio in the context of exit strategy, this new decision pointed to a looser monetary stance. Recall that in testimony to U.S. Congress in July, Fed Chairman Bernanke had outlined several options available to Fed if the “recovery seems faltering”: Further changes or modifications to their language on interest rates strategy, lowering the interest rate they pay on excess reserves and changes in their balance sheet - either not letting securities run off or making additional purchases. Therefore, Fed’s decision to activate one of these options implied that the Fed sees the economic recovery as faltering. In essence, Fed also downgraded their assessment of the economic outlook in the FOMC statement. The key developments, in our opinion, that urged the Bank to change monetary stance were the non-farm payrolls and unemployment rate. After the job losses reached 8.3 mn, accompanied by the unemployment rate peaking at 10.1%, the labor market indicators have improved somewhat. However, over the last months, the increase in private payrolls and the decline in unemployment rate have cut pace. After the FOMC meeting, the 10-year U.S. Treasury yield slumped to 2.7%, the lowest of the year (vs. the historical low of 2%), while rate hike expectations have been postponed towards 2012 in the Fed fund futures. This outlook may be an important indicator that the interest rates would remain low across the globe for longer-than-expected.
As opposed to this external support for low interest rate environment, the news at home that the fiscal rule would not be applied for 2011 budget brought the risk of erasing the positive repercussions. The Central Bank had said they monitor fiscal policy developments closely while formulating monetary policy and that the fiscal space created by the stronger-than-expected economic activity leading to better-than expected performance in budget revenues should be used mostly to reduce the government debt stock. The Bank also had noted that should the fiscal discipline implemented through institutional and structural improvements, such as enacting and establishing the fiscal rule, it would be possible to keep policy rates at single-digit levels over the medium term. Despite the Bank’s sensitivity to this issue, it is not straightforward to assume that the recent developments regarding the fiscal rule would yield a change in monetary policy stance. Given the fact that the monetary policy did not even react to the substantial deformation in budget vs. the targets during the crisis, it is not easy to speculate whether this time would be different. A possible scenario may involve the Bank saying that they would continue monitoring how the fiscal space created by higher-than-expected revenues would be spent. If they chose to do so, they may later say they are satisfied with the 2011 budget being prepared with respect to the framework described in the previous MTP. Finally, they may even end up saying that “the fiscal rule would have been better, yet the implementation is more important.”
The best we can do now is watching the current trend in the fiscal outlook on one hand and on the other hand to dig into the budget targets for 2010-2012 to be described in the MTP due out in September ahead of the submission of the 2011 budget to the Parliament’s approval on October 17th. Glancing at the performance as of June, the 12-month rolling central government budget deficit to GDP ratio, which is the best indicator for trend, declined to 4.3%, accompanied with 0.9% primary surplus (0.5% primary deficit in IMF defined figures). This picture guarantees that the deficit would remain below the 4.9% target by the year-end even in the absence of any y/y improvement. Our guess is that the deficit would regress to 3.7%, assuming that there would be no additional expenditure burden. To put it differently, meeting the official year-end target for the deficit or surpassing the levels mentioned above would simply imply deterioration for the second half of the year.
No doubt, when the new MTP is disclosed, the target for 2010 budget deficit should be expected to be revised down on the back of upgraded growth forecasts (to 5.5% or 6.0% from 3.5%). The extent of revision is important, yet more important than that would be whether the 2011 and 2012 deficit targets (4.0% and 3.2%) would be modified. For example, if the long run targets of 1.0% budget deficit and 5.0% GDP growth in the fiscal rule were applied, the budget deficit would have to be brought down to 3.1% in 2011 and to 2.8% in 2012, based on our 3.7% estimate for 2010 budget. Therefore, in essence, the officials’ announcements that the budget would be prepared in line with the MTP indicate at a looser fiscal stance than the original framework assumed when the MTP had been first disclosed last year, as the 2010 outlook is much better than the targets.
Upon the news regarding the delay of the fiscal rule, the rating agencies ruled out direct linkage between the fiscal rule and ratings, as expected. Yet they raised concerns regarding the credibility of the government in the absence of the rule, while underscoring that the implementation is more important than the fiscal rule itself, so that the patterns of budget deficit and debt/GDP ratios going forward would be important for the ratings.
In conclusion, the perceptions regarding the growth outlook have deteriorated after the Fed decided to keep constant the security portfolio size, which was one of the alternative measures previously outlined by Fed Chairman Bernanke, should the economic recovery falters. Meanwhile, Fed’s decision has also created an appropriate background for the interest rates to remain low for longer than expected. The news regarding the delay of the fiscal rule at home has the risk of jeopardizing the interest-rate-friendly atmosphere. Nevertheless, the Central Bank seems unlikely to develop a monetary policy response against this despite their previous emphasis on the importance of fiscal rule. The Bank may prefer to monitor the budget outcome for some more time. The rating agencies also tend to favor a similar approach.
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