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.
26 Kasım 2010 Cuma
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.
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