CBT likely to stay its hand, for now... We do not anticipate a change in stance by the CBT -- as with the consensus expectation -- at the forthcoming final MPC meeting of the year, as the monetary authority sounds rather satisfied with the outcome of the new monetary framework since its date of inception, October 21; i.e. higher loan rates, lower loan growth, and a stable TRL. However, the reflections on macro framework are yet to be evidenced, with GDP growth -- especially domestic demand -- still vibrant, as suggested by 3Q figures; C/A deficit on the rise; and inflation double the year’s target. Although it looks like a typical time-inconsistency problem, the ex-post performance of previous attempts in restraining the “animal spirits” of the consumer understandably makes most investors lend little credence to a soft landing scenario. On the flip side, recent data should normally have assuaged hard-landing fears and made analysts more upbeat, due to strong growth momentum, whose effects will be observed going forward as well. Unfortunately, this is not the case either for the time being, given mounting EU-related concerns.
CBT’s Inflation Report due in Jan’12: Any inklings of a policy shift? The Eurozone conundrum is the predominant source of difficulty we face in setting our 2012 base case for global economic outlook, with the related uncertainty placing our main assumptions for the domestic economy at risk as well. At any rate, who could carry on with initial assumptions when underlying dynamics shift so rapidly in the global economic landscape? Lack of visibility also increases the need for flexible monetary frameworks for all central banks. That is why we judged the interest rate corridor policy to be an innovative response to prevailing global uncertainties and an instrument addressing the monetary authority’s need to gain time for improved visibility. We also see this experiment as a test drive to determine the equilibrium interest rate at which money demand is equal to money supply. We think that as long as the average cost of funding of CBT facilities (1-week repo, primary dealers facility and O/N Lending) remains significantly above the policy rate, the odds for the policy rate (5.75%) getting closer to the CBT’s blended rate (currently above 8%) would be higher than the reverse case. Based on latest available data, the average ISE O/N repo rate and average blended rate since the inception of the interest rate corridor policy stand at 10.6% and 6.9%, respectively. These figures point to 125-225bp scope for rate hikes when needed, which are likely to be front-loaded under these circumstances. However, the impact on loan rates would be similar and would not place any additional cost on top of that already generated by the interest rate corridor policy. The only difference is that tightening via the policy rate tends to be more permanent.
The main purpose of the interest rate corridor has also changed in time. At the beginning, it was aimed at fending off extreme depreciation of the TRL spurred by global factors. Recently, the trend in loan growth is driving the fine tuning by the CBT. We perceive this as a prudent move, since otherwise it would be extremely difficult to defend certain parity levels amid spikes in risk aversion. The corridor policy should thus continue to help alleviate currency volatility, as stressed by the CBT in recent presentations.
All in all, we continue to think the CBT will need to review this policy after a few months’ implementation, if the global outlook becomes less ambiguous -- for better or worse -- and possibly take a clearer stance on the policy rate (or policy mix) path in the first Inflation Report of 2012 due to be published by end-January, the earliest.
Economy on a slower growth track, based on recent data... Having made our aforementioned assessments on monetary policy, we also find it worthwhile to briefly discuss the current macroeconomic outlook and our base scenario for 2012. In line with the evaluations provided in our earlier reports, and supported both by data releases as of 3Q11 and leading indicators for 4Q11, a rather gradual slowdown remains underway in the Turkish economy, lending support neither to overheating nor to hard landing concerns. A major change appears under way as of the first month of 4Q11 in terms of private consumption and private investments, which had remained strong in the first nine months of 2011, despite all the tightening measures adopted by the Central Bank. Consumption goods and investment goods imports, which had grown by 32% and 48% yoy, respectively, in the first nine months of the year, posted a limited contraction in October. Leading indicators like automobile sales suggest there might be more to come. Similarly, the Consumption Index published by CNBC-e, which might be construed as Turkey’s retail index, has decelerated to 1% growth in November, down from 14% as of the first nine months of the year.
We expect such an outlook, also supported by the high interest rate environment prompted by monetary tightening, to reduce the final quarter’s growth to at least half the 8% observed in the preceding two quarters. While it appears that the re-balancing act anticipated in foreign demand has already started in 3Q11 (volume growth of exports has exceeded imports), foreign trade index readings as of October suggest that this still remains under way. Moreover, the rise in exports on a US$ basis remains quite significant, despite Eurozone related risks and the slowdown under way for quite some time. Although the month of December will see export growth touch its trough year-to-date mostly on the back of last year’s high base, final quarter exports growth is forecast at 10%. While a rather clear slowdown is evident here, the ratio of exports to GDP at 15%, trailing both private consumption (70%) and private investments (20%), underscores the continued relative significance of “final domestic demand” for the Turkish economy, and the fact that Turkey may emerge relatively unscathed from this turbulence, provided that household confidence is sustained and expectations are well managed. Moreover, it should be kept in mind that the share of exports to the EU in total exports, currently slightly below 47%, have been on a declining path in recent years, while their ratio to GDP of 7% is markedly below the EMEA average of 18%. On the other hand, in the event that the EU economy plunges into a deep recession -- unlike the consensus expectation of a limited growth -- the ensuing effects on the Turkish economy would be not only through trade but also through financial channels, i.e. banking relations. This effect might become evident through a diminution in short and long term credit flows to the banking and the non-financial private sector, which are also crucial for the financing of the current account deficit.
Considering the causality between the current account deficit and growth, the implication for the Turkish economy would be the related sectors and hence the overall economy sliding to a lower growth path. The magnitude of the decline in growth would hinge on the roll-over ratio of loans due in 2012. During the global crisis, roll-over ratios for long term loans had declined to 78% for the banking sector and to 71% for the other sectors. It might be feasible to assume these as the lower limits in the event of a credit crunch. Nevertheless, it is worth underlining that as of the end of October, reported roll-over ratios are far above the aforementioned ratios.
A hard landing -- rather than a balance of payments crisis -- seen as the worst case scenario -- Based on our calculations, Turkey’s aggregate foreign debt redemptions (public + CBT + banks + private sector) due in 2012 are around US$135bn. Of this amount, about US$65bn will be repaid by the banks and US$59bn by other sectors. Out of the debt repayments by the banks, a US$32bn portion pertains to loans, and the remainder to FX- and TRL-denominated bank deposits. However, about US$16bn of the bank deposits will be repaid to domestic banks’ branches and affiliates abroad. In other words, they are not an external liability in essence, and are easy to roll over. It was also disclosed by the CBT at the Financial Stability Report that about US$18bn of the redemptions by the banks would be related to syndications/securitisations. It is a commonly agreed upon fact that such loans are an outcome of long-standing relations and a full renewal would not be difficult, if sought by the borrowing bank. As far as the corporate sector is concerned, of the US$59bn total repayment, a US$27bn portion is related to trade credits, i.e. liabilities arising from L/C of imports and pre-financing of exports. These are also liabilities based on developed trade relationships, hence probably not difficult to roll-over either. Of the US$32bn loans ostensibly borrowed from abroad, a c.US$10bn portion pertains to domestic banks’ branches and affiliates abroad; hence, no roll-over difficulty is envisaged. Considering all these factors, an overall US$200bn foreign finance requirement -- including a US$63bn C/A deficit based on our estimates -- for 2012, which looks astounding at first glance, becomes more manageable. Even in the event of rather low roll-over ratios, the implication would be a hard landing, rather than a balance of payments crisis, in our view.
Maintaining our 2.5% growth estimate for the Turkish economy in 2012 -- In conclusion, EU related risks, i.e. recession and deleveraging, remain to be the foremost risk factors facing Turkey’s growth prospects, despite all the mitigating factors cited above. On the other hand, recent data on exports and foreign finance do not reveal any notable worsening in Turkey’s case attributable to the EU. Should the aforementioned risks fail to materialise, the recent strong growth momentum in the Turkish economy might lead it to sustain a relatively impressive growth rate in 2012 -- such as the 4% targeted in the Medium-term Economic Programme (OVP) -- as well. However, given the prevailing environment of uncertainty, with a cautious approach, we continue to consider 2.5% as a plausible growth rate for the Turkish economy in 2012, in a scenario whereby risks partly become reality. On the other hand, in the event of a marked deterioration in trade, finance, and expectations, the three channels via which external shocks may be transmitted to the domestic economy, stagnation or even a mild recession might well be the case.
22 Aralık 2011 Perşembe
21 Kasım 2011 Pazartesi
Kicking The Can Down The Road...
We were one of the very first macroeconomics teams to have stressed the need for tightening prior to the October MPC meeting, as outlined in my article entitled “Hawks to the Fore” published on October 17. Moreover, after the MPC’s decision to widen the interest rate corridor, we underlined that this was the least the CBT could do for the time being, also reiterating our view that the inflation outlook and the TRL still warranted a much tighter stance than the current one.
However, the CBT appears satisfied with the outcome of the new framework since its execution as of October 21; i.e. a stronger TRL and higher loan rates. The average O/N repo rate has jumped to 10.0% as of then, compared to the previous 1-month average of 6.2%. Moreover, after several days of implementation, the CBT Governor indicated at an investor meeting that they did not intend to keep O/N rates at unnecessarily high levels in normal market circumstances, provided that credit conditions remained tight and the TRL stabilised at around current levels. In our view, this statement attests to the flexible and temporary nature of the interest rate corridor policy, also indicating that the CBT continues to kick the can down the road.
As we have been underlining from the very start, we consider this strategy viable and effective, but do not think the divergence of the O/N rate from the policy rate is sustainable for long, as the reference rate in that case loses its significance. Normally, the CBT’s tightening stance would justify an outright rate hike -- not the current “hike in disguise”, we think. Although, one might still give the CBT the benefit of the doubt, on the premise that the reluctance to use the policy rate hike mechanism is driven mainly by global economic uncertainties, it seems more probable that this preference will be perceived as the main flaw of the tightening stance and its adequacy will be increasingly questioned down the line. Therefore, we think the CBT will need to review this policy after a few months’ implementation and possibly take a clearer stance on the policy rate (or policy mix) path in the first Inflation Report of 2012 due to be published by end-January the latest.
In an inflation targeting regime where there is a small output gap -- and irrespective of whether the regime is flexible or not -- a central bank should act in a permanent tightening direction only when there is significant deterioration in inflation expectations, as gleaned from expectations surveys or market-based indicators, such as in terms of bond yields and breakeven inflation* in CPI linkers. The reasons underlying higher inflation expectations (depreciation of the currency or higher import prices) are of no significance for a central bank. Three indicators are crucial in this respect: 12-m and 24-m forward-looking CPI expectations from the CBT’s twice monthly survey; 2-year or benchmark bond yields; and B/E inflation level for the CPI linkers. Currently, all of the three indicators are at recent highs. However, this is not a fresh development and more importantly the deterioration has not been significant after the administrative price shock in October and the CBT’s upward revision of year-end CPI forecasts. For now, this is somewhat relieving, but we should follow them closely, as they remain susceptible to macro surprises, going forward.
Having said that, we tend to take a fairly lenient view of this somewhat controversial monetary policy framework the CBT has been implementing since November 2010 in the remainder of this report.
Evolution of “Monetary Policy A La Turca” in Brief
One of the most crucial lessons to have emerged from the global crisis on monetary policy is that failure to safeguard financial stability might lead to the disruption of macroeconomic and price stability in the medium term. In this framework, the notion that central banks should not remain oblivious to asset price bubbles or to risks accumulating in the financial system has been gaining widespread acceptance. This situation has prompted a number of central banks to integrate measures aimed at safeguarding financial stability into the framework of monetary policy, setting the stage for non-conventional monetary policies, which have started to be used extensively by advanced and emerging countries’ central banks.
The Central Bank of Turkey (CBT), one of the first central banks to have mentioned financial stability, has launched works to expand and activate the set of instruments necessary for a monetary authority targeting price stability along with policies intended to defend macro financial stability, as of mid-2010. To this end, the monetary authority has decided to use the reserve requirements and the interest rate corridor (the difference between ON/ borrowing and lending rates) as other instruments alongside the policy rate. In a bid to enhance the effectiveness of reserve requirements as a policy tool, the CBT has ceased paying interest on the reserve requirement liabilities of the banks.
This new approach envisaging the usage of more than one policy instrument by the CBT entails certain risks, such as i) misunderstanding (emphasis on financial stability might create the misperception that deviations from the inflation target might be tolerated); ii) facing difficulties related to communication (the absence of a clear-cut theoretical framework or concrete findings for the effectiveness of non-conventional monetary policy instruments). Moreover, the fact that the Bank has deliberately created uncertainty to deter short term capital inflows at the start of the application, and has predicated its monetary policy communication on the concepts of “policy mix” and “monetary tightening”, rather than providing guidance on interest rate path as in the past, prompts the perception that it will take some time for market players -- accustomed to the previous policy implementation -- to comprehend and accept the new approach.
Although the monetary policy mix concept might seem complicated at first glance, it may be considered as a more flexible form of inflation targeting. While the principal criterion in monetary policy decisions is again deviation in inflation expectations from target, this time macroprudential tools are also brought into the equation, so as to contain financial risks. Hence, monetary policy stance is determined by short term policy rates, as well as the net balance of other variables determining monetary conditions, such as reserve requirement rates and the liquidity situation in the market. How and in which direction policy instruments will be utilised, on the other hand, is designated by price stability and factors affecting financial stability.
This graphical representation of the monetary policy recently introduced by the CBT depicts a variety of policy responses by the monetary authority towards fulfilling its mandates of attaining price and financial stability. While the CBT has started to utilise this framework in its communication as of the final months of 2010, the evolution of policy mix as of then is traceable from the graphical representation above.
It should primarily be underlined that the CBT’s primordial goal is the attainment of price and financial stability, the two main axes of monetary policy. In terms of graphical representation, this would imply being at the crossing point of the four main blocks, i.e. meeting the targets, while corresponding to a neutral stance from a monetary policy standpoint. The choice of monetary policy response hinges on which of the four main blocks we are at (or at which of the four main blocks the Bank perceives us to be). While the state of price stability is determined by whether inflation is on an accelerating or decelerating tendency, from the standpoint of financial stability, key determinants are whether credit growth is on the rise or on the decline. As an example, the policy response given as of November 2010 -- at a time when inflation was on a downward course yet credit growth on the rise -- was a combination of tightening of policy tools other than interest rates (liquidity withdrawal and increases in reserve requirement ratios) and easing in policy rate; i.e. corresponding to Block A.
In the framework of the new monetary policy implementation, there have been two shifts in blocks -- one of them quite recent. The first one of these came right on the heels of the July Inflation Report, when an extraordinary MPC meeting was held amid mounting uncertainties surrounding the Eurozone. The monetary authority then drew attention to global risks as well as to the prospect of a recession in the domestic economy, conveying the view that all instruments would be used in an expansionary manner. The decisions that followed proved consonant with this message, implying a transition to Block B, i.e. the state where policy rate and instruments other than interest rate are employed in an expansionary mode. However, this positioning proved short-lived. With the upward tendency in inflation gaining pace and the ensuing shock to administered/guided prices in October adding further momentum to price increases, the Bank was compelled to switch to a tighter monetary stance. However, this monetary tightening was not in the form of a direct policy rate hike that would comply with Block C, rather through allowing the O/N repo rate to drift higher than the policy rate while expanding the interest rate corridor. Instruments other than the interest rate, on the other hand, were used as expected, with the reserve requirements imposed on TRL liabilities scaled down by 200bp on average, in a bid to alleviate the shock on deposit and credit costs.
It is worth underlining that actual monetary tightening was not as strong as the perception created by O/N repo rates initially hovering at and above 10%. From the perspective of a bank’s funding cost, more than the prevailing rate at the O/N repo market, it is the portion of the funding that the CBT provides via the 1-week repo auction at the 5.75% policy rate. From this standpoint, it is observed that a major portion of the funding need is still met through this channel. Based on our calculations, which incorporate the funding banks receive through mutual funds and repo transactions with clients, alongside the funding provided by the CBT channels (1-week repo, market making, lending), the average funding cost has increased up to 7.8%, up 180bp, from about 6% prior to this implementation. The effect would have been similar, had the tightening been through the policy rate. The only difference is that tightening via the policy rate tends to be more permanent, while that through widened interest rate corridor, given its flexible nature, might prove temporary based on the market conditions that follow.
The fact that the CBT has opted for this mode of tightening might be attributed to the prevailing global uncertainties in the current environment and the monetary authority’s need to gain time for better visibility. In its latest Inflation Report, the CBT declared its 2012 inflation estimate at 5.2%, based on the assumptions that “the gradual slowdown in consumer loan growth continued and that in the framework of the policy decisions made in October, monetary conditions were markedly tightened in the final quarter of the year”. Given the ambiguity of this message sentence in the section of the report devoted to policies, it does not appear possible to clearly discern until when this seemingly temporary tightening will continue and the nature of the stance that will replace it in the new year. In the coming period, barring a marked deterioration in forward looking inflation expectations, we reckon the Bank will be inclined to sustain this strategy. Otherwise, we believe the Bank will need to render monetary tightening permanent through the policy rate.
However, the CBT appears satisfied with the outcome of the new framework since its execution as of October 21; i.e. a stronger TRL and higher loan rates. The average O/N repo rate has jumped to 10.0% as of then, compared to the previous 1-month average of 6.2%. Moreover, after several days of implementation, the CBT Governor indicated at an investor meeting that they did not intend to keep O/N rates at unnecessarily high levels in normal market circumstances, provided that credit conditions remained tight and the TRL stabilised at around current levels. In our view, this statement attests to the flexible and temporary nature of the interest rate corridor policy, also indicating that the CBT continues to kick the can down the road.
As we have been underlining from the very start, we consider this strategy viable and effective, but do not think the divergence of the O/N rate from the policy rate is sustainable for long, as the reference rate in that case loses its significance. Normally, the CBT’s tightening stance would justify an outright rate hike -- not the current “hike in disguise”, we think. Although, one might still give the CBT the benefit of the doubt, on the premise that the reluctance to use the policy rate hike mechanism is driven mainly by global economic uncertainties, it seems more probable that this preference will be perceived as the main flaw of the tightening stance and its adequacy will be increasingly questioned down the line. Therefore, we think the CBT will need to review this policy after a few months’ implementation and possibly take a clearer stance on the policy rate (or policy mix) path in the first Inflation Report of 2012 due to be published by end-January the latest.
In an inflation targeting regime where there is a small output gap -- and irrespective of whether the regime is flexible or not -- a central bank should act in a permanent tightening direction only when there is significant deterioration in inflation expectations, as gleaned from expectations surveys or market-based indicators, such as in terms of bond yields and breakeven inflation* in CPI linkers. The reasons underlying higher inflation expectations (depreciation of the currency or higher import prices) are of no significance for a central bank. Three indicators are crucial in this respect: 12-m and 24-m forward-looking CPI expectations from the CBT’s twice monthly survey; 2-year or benchmark bond yields; and B/E inflation level for the CPI linkers. Currently, all of the three indicators are at recent highs. However, this is not a fresh development and more importantly the deterioration has not been significant after the administrative price shock in October and the CBT’s upward revision of year-end CPI forecasts. For now, this is somewhat relieving, but we should follow them closely, as they remain susceptible to macro surprises, going forward.
Having said that, we tend to take a fairly lenient view of this somewhat controversial monetary policy framework the CBT has been implementing since November 2010 in the remainder of this report.
Evolution of “Monetary Policy A La Turca” in Brief
One of the most crucial lessons to have emerged from the global crisis on monetary policy is that failure to safeguard financial stability might lead to the disruption of macroeconomic and price stability in the medium term. In this framework, the notion that central banks should not remain oblivious to asset price bubbles or to risks accumulating in the financial system has been gaining widespread acceptance. This situation has prompted a number of central banks to integrate measures aimed at safeguarding financial stability into the framework of monetary policy, setting the stage for non-conventional monetary policies, which have started to be used extensively by advanced and emerging countries’ central banks.
The Central Bank of Turkey (CBT), one of the first central banks to have mentioned financial stability, has launched works to expand and activate the set of instruments necessary for a monetary authority targeting price stability along with policies intended to defend macro financial stability, as of mid-2010. To this end, the monetary authority has decided to use the reserve requirements and the interest rate corridor (the difference between ON/ borrowing and lending rates) as other instruments alongside the policy rate. In a bid to enhance the effectiveness of reserve requirements as a policy tool, the CBT has ceased paying interest on the reserve requirement liabilities of the banks.
This new approach envisaging the usage of more than one policy instrument by the CBT entails certain risks, such as i) misunderstanding (emphasis on financial stability might create the misperception that deviations from the inflation target might be tolerated); ii) facing difficulties related to communication (the absence of a clear-cut theoretical framework or concrete findings for the effectiveness of non-conventional monetary policy instruments). Moreover, the fact that the Bank has deliberately created uncertainty to deter short term capital inflows at the start of the application, and has predicated its monetary policy communication on the concepts of “policy mix” and “monetary tightening”, rather than providing guidance on interest rate path as in the past, prompts the perception that it will take some time for market players -- accustomed to the previous policy implementation -- to comprehend and accept the new approach.
Although the monetary policy mix concept might seem complicated at first glance, it may be considered as a more flexible form of inflation targeting. While the principal criterion in monetary policy decisions is again deviation in inflation expectations from target, this time macroprudential tools are also brought into the equation, so as to contain financial risks. Hence, monetary policy stance is determined by short term policy rates, as well as the net balance of other variables determining monetary conditions, such as reserve requirement rates and the liquidity situation in the market. How and in which direction policy instruments will be utilised, on the other hand, is designated by price stability and factors affecting financial stability.
This graphical representation of the monetary policy recently introduced by the CBT depicts a variety of policy responses by the monetary authority towards fulfilling its mandates of attaining price and financial stability. While the CBT has started to utilise this framework in its communication as of the final months of 2010, the evolution of policy mix as of then is traceable from the graphical representation above.
It should primarily be underlined that the CBT’s primordial goal is the attainment of price and financial stability, the two main axes of monetary policy. In terms of graphical representation, this would imply being at the crossing point of the four main blocks, i.e. meeting the targets, while corresponding to a neutral stance from a monetary policy standpoint. The choice of monetary policy response hinges on which of the four main blocks we are at (or at which of the four main blocks the Bank perceives us to be). While the state of price stability is determined by whether inflation is on an accelerating or decelerating tendency, from the standpoint of financial stability, key determinants are whether credit growth is on the rise or on the decline. As an example, the policy response given as of November 2010 -- at a time when inflation was on a downward course yet credit growth on the rise -- was a combination of tightening of policy tools other than interest rates (liquidity withdrawal and increases in reserve requirement ratios) and easing in policy rate; i.e. corresponding to Block A.
In the framework of the new monetary policy implementation, there have been two shifts in blocks -- one of them quite recent. The first one of these came right on the heels of the July Inflation Report, when an extraordinary MPC meeting was held amid mounting uncertainties surrounding the Eurozone. The monetary authority then drew attention to global risks as well as to the prospect of a recession in the domestic economy, conveying the view that all instruments would be used in an expansionary manner. The decisions that followed proved consonant with this message, implying a transition to Block B, i.e. the state where policy rate and instruments other than interest rate are employed in an expansionary mode. However, this positioning proved short-lived. With the upward tendency in inflation gaining pace and the ensuing shock to administered/guided prices in October adding further momentum to price increases, the Bank was compelled to switch to a tighter monetary stance. However, this monetary tightening was not in the form of a direct policy rate hike that would comply with Block C, rather through allowing the O/N repo rate to drift higher than the policy rate while expanding the interest rate corridor. Instruments other than the interest rate, on the other hand, were used as expected, with the reserve requirements imposed on TRL liabilities scaled down by 200bp on average, in a bid to alleviate the shock on deposit and credit costs.
It is worth underlining that actual monetary tightening was not as strong as the perception created by O/N repo rates initially hovering at and above 10%. From the perspective of a bank’s funding cost, more than the prevailing rate at the O/N repo market, it is the portion of the funding that the CBT provides via the 1-week repo auction at the 5.75% policy rate. From this standpoint, it is observed that a major portion of the funding need is still met through this channel. Based on our calculations, which incorporate the funding banks receive through mutual funds and repo transactions with clients, alongside the funding provided by the CBT channels (1-week repo, market making, lending), the average funding cost has increased up to 7.8%, up 180bp, from about 6% prior to this implementation. The effect would have been similar, had the tightening been through the policy rate. The only difference is that tightening via the policy rate tends to be more permanent, while that through widened interest rate corridor, given its flexible nature, might prove temporary based on the market conditions that follow.
The fact that the CBT has opted for this mode of tightening might be attributed to the prevailing global uncertainties in the current environment and the monetary authority’s need to gain time for better visibility. In its latest Inflation Report, the CBT declared its 2012 inflation estimate at 5.2%, based on the assumptions that “the gradual slowdown in consumer loan growth continued and that in the framework of the policy decisions made in October, monetary conditions were markedly tightened in the final quarter of the year”. Given the ambiguity of this message sentence in the section of the report devoted to policies, it does not appear possible to clearly discern until when this seemingly temporary tightening will continue and the nature of the stance that will replace it in the new year. In the coming period, barring a marked deterioration in forward looking inflation expectations, we reckon the Bank will be inclined to sustain this strategy. Otherwise, we believe the Bank will need to render monetary tightening permanent through the policy rate.
17 Ekim 2011 Pazartesi
Hawks to the Fore....
This month’s Monetary Policy Committee (MPC) meeting (October 20) is even more significant than it usually is. First of all, it will be followed by the quarterly Inflation Report (October 26), hints regarding which will probably be provided in the accompanying statement. Secondly, the CBT had stated at the extraordinary MPC meeting dated August 4 -- right after the issuance of the previous inflation report -- that it was shifting towards the more pessimistic scenario, and started to make decisions compatible with this stance. Hence, the forthcoming statement is significant in that, the new base scenario will gain an official status with it. Yet, what is even more important than these two factors is a possible indication the statement might provide as to the type of monetary stance the CBT will opt for to meet next year’s 5% inflation target, having let this year’s inflation rate digress substantially from target.
Let us assert our conclusion at the very beginning: this ambitious target prompts a tighter stance than today. Should the CBT communicate a policy guidance, this will be included in the brief message sentence where it typically provides its inflation estimates. At the July statement, it was indicated that assuming that the annual rate of credit growth declined to 25% by the end of 2011, and the policy rate remained constant until the end of 2011, inflation was expected to be 6.9% at the end of 2011, and 5.2% at the end of 2012. As of then, there have been major changes with respect to the assumptions included in this sentence, as well as the course of inflation. First of all, the 25% credit growth target has been revised to indicate an annual credit growth rate of 25% adjusted for the FX effect. Secondly, the policy rate has not been kept stable; rather, a 50bp rate cut has been effectuated as of August 4. Thirdly, with the loss in value of the TRL having outpaced the expectations, inflation is expected to even exceed the CBT’s target (6.9%), which was already above target (5%), by the year-end. In our opinion, the CBT will be inclined to convey the message that at some point within today and YE12, it will need to embark on a measured tightening of the policy rate or policy mix, given that a marked divergence from the YE12 inflation target, which is within its control horizon, will not be permissible. At a time when it is widely discussed that all policy instruments might be employed in an expansionary mode due to downside risks, the Bank signalling some kind of tightening, albeit for a future period of time, would undoubtedly have an element of surprise to it.
While it would be rather difficult to gauge the precise timing of a potential tightening, it seems rather unlikely before the second quarter of 2012. Another possibility would be the Bank not signalling a tightening stance, rather shifting to a neutral stance, which would imply that policy instruments would not be employed in an expansionary mode. The fact that the Bank has recently adopted an approach that lays emphasis on growth and financial stability leads us to conclude that this possibility should not be underestimated either.
On the other hand, it appears that the CBT will revise its YE11 CPI projection to minimum 7.8% from currently 6.9% as MTP shows, or even higher to around 9% if all STC adjustments considered. The key factor underlying this revision would be import prices and the wider-than-projected depreciation of the TRL, while the fact that food and oil prices trend below projections (7.5% and US$115) will have precluded a greater deviation. Furthermore, a limited downward revision of the output gap, which denotes the difference between potential and realised growth, also seems in the cards.
Ahead of critical days when we expect the CBT to take the aforementioned decisions, we also opted to take a look at the current state of economic affairs. We aim to provide below a general review of the economic situation, without going too much into the details.
It could be stated that a rather gradual slowdown remains underway in the economy, lending support neither to overheating nor to hard landing concerns. While exports are yet to return to their pre-crisis levels due to the anaemic recovery in emerging economies and the Eurozone’s debt woes, the 20+% growth rates as of the first half of the year have been sustained, and the Export Quantity Index -- indicative for GDP computations -- has posted an increase slightly above 10% within July-August compared to the year-ago period. On the other hand, in the comparable period, the pace of growth in imports has eased notably (28.2%) compared to the first half of the year (43.5%), and the increase in Import Quantity Index has remained at 6.5%. This might suggest that net external demand might contribute to growth following a prolonged hiatus. As for the other major constituent of growth, domestic consumption, leading indicators point to a strengthening of the slowdown evident in the second quarter. While the 25% growth recorded in the total automotive sales in the second quarter has given way to c.2% contraction, CNBC-e Consumption Index, which comprises this sector’s data along with other consumer durables and retail products sales, also validates this picture. The Index, which posted respective growth rates of 22.9% in the first quarter and 15.5% in the second quarter, slowed down to 4.7% for the third quarter. Hence, it might be concluded that the re-balancing of domestic and external demand remains underway, and serves as a basis for the reversal of the deterioration in the C/A deficit. One critical signal to this end was received in August, when growth in the 12-month cumulative C/A deficit excluding energy came to a halt. However, one key factor to have precluded the visibility of the improvement in the short run has been the jump in gold imports in recent months. While Turkey has undertaken gold imports worth US$1.17bn in August, this figure is estimated to have risen to US$1.25bn in September. On the other hand, excluding energy and gold, the annual increase in imports as of August (16%) remains well below the total imports growth rate of 26%.
On the investments front, a pronounced slowdown is underway as well. Data related to imports and production of capital goods as of the third quarter point to similar results. While the rate of growth in imports has retreated from 63% to around 28%, production growth has slipped from above 20% levels to slightly below 10% as of the end of August. Given that 6.6pp of the 8.8% growth in GDP as of the second quarter was driven by private sector investments, it appears that private sector investments look set to drag the growth rate lower in the final quarter of the year. Hence, a decline in real growth in GDP to below the 4-5% range within the third quarter seems of significant probability, which implies that the qoq change in seasonally-adjusted GDP will have slipped to negative territory for the first time in a long period of time.
On the inflation front, while the headline inflation (CPI) follows an uneven course, core inflation has been posting an uninterrupted upward trajectory. The CBT has expressed its view that the H index, which had been reported at 7.4% as of the end of September, would reach 8% in the final quarter, and that core inflation would shift to a declining course as of the early months of the new year. The primary basis for this expectation is that the monthly change in the seasonally adjusted core inflation was a limited 0.3% on average in the final quarter of last year; i.e. setting an unfavourable base effect, though rose to 0.8% and 0.6% levels in the first and second quarters of 2011; i.e. setting a favourable base effect. It is worth reminding investors that while the seasonally adjusted core inflation growth consistent with the coming year’s inflation target is 0.4%, a rate of increase of 0.5% has been recorded in September. While increases in import prices prompted by advances in commodity prices, along with losses in the value of the TRL tend to put upward pressure on inflation, conversely stability in these variables prompts a return to averages consistent with the inflation target. In analyses conducted in Turkey, generally focus remains on the exchange rate pass-through effect, while pass-through from import prices tends to be ignored. However, CBT studies indicate that the pass-through from these two factors is comparable at around 15% each. The notable increase in core inflation this year stems from the fact that both variables have posted substantial increases. As such, for the CBT to be vindicated in its expectation of a decline in core inflation, the TRL should no longer lose value, and a fresh wave of commodity price increases should not be observed. Otherwise, even if the TRL were to depreciate, there would need to be a concomitant decline in commodity prices to offset this effect, as had been the case during the global crisis that erupted at the end of 2008.
Our final words are on exchange rate policy and FX reserves. Due to the factors we have drawn attention to above, the widely held perception is that the CBT is inclined to switch from the free floating exchange rate regime, in effect since 2002, to a managed float. The CBT, given its frequent verbal and direct interventions, does not seem to deny this perception. One source of concern here is that the rapid reserve erosion might heighten scepticism as to the sufficiency of the Bank’s FX reserves, potentially lifting Turkey’s risk premium. The related IMF guideline is for FX reserves to be at a level to meet 3 months’ imports, along with the entirety of short-term debt. Based on recent figures, Turkey’s respective levels are 4.3 months and 98.5%; i.e. not comfortably above the respective thresholds. Moreover, Turkey ranks at the lower end of the scale on an international comparison basis. The CBT, aware of growing misgivings, introduced a new definition to help markets gauge the effectiveness of the reserves, at the latest meeting in Ankara. To summarise, the Bank comes up with a variable that incorporates all external debt with maturity below 1 year -- more indicative than the short-term foreign debt stock -- and excludes foreign liabilities arising from the overseas branches of local banks, thereby reaching a more realistic foreign debt value. This rate, while being slightly below 100% as of end-July, is nevertheless significantly more comfortable than the 73% level as of 2008 and 86% for 2009.
In fact, the message that the CBT aims to communicate is that the FX reserves are more sufficient than during the global crisis and that the Bank would not fear losing reserves if need be, even if such a move would force the relevant adequacy ratios lower. As an example, FX reserves should decline to up to US$63bn for the adequacy ratio to return to 2008 levels, and to US$75bn to 2009 levels. As underlined earlier, more than 99% of the Bank’s reserves are usable and liquid. Furthermore, the CBT has a net FX surplus of US$55bn, accumulated over the years by the CBT through FX purchases in exchange for the TRL, and fully owned by the Bank. The remainder of the reserves comprise the banks' FX RR, the Treasury’s FX deposits and Dresdner Accounts (non-resident Turkish workers abroad) liabilities. Hence, while we reckon the Bank will be frugal in its use of FX reserves to the extent possible, we think it will not refrain from engaging in sizable FX sales when necessary. Yet, even this stance does not change the fact that the fate of the TRL remains linked to non-resident portfolio flows, which in turn hinge on global risk appetite. If the Bank does not introduce a new tool such as allowing banks to hold their TRL reserve requirements in FX, it could opt to use the following instruments to increase FX liquidity: reduction in FX RRRs (the 11% RRR for maturities up to 1 year might be reduced up to the pre-crisis level of 9%); a proportional increase in the %age of TRL RRRs that may be kept as FX (the 20% rate may be raised in tandem with the banks’ ability to borrow from abroad); re-activation of the FX depo facility (this facility, whose limit was set at US$10.8bn, has been dormant; usage might be encouraged through a reduction in interest rates); continuation of daily FX sell auctions; and direct FX sales to banks.
To sum up, if the Bank maintains its current stance for the short term, yet signals a more hawkish stance for the medium term, in line with our expectations, we reckon this would support the attainability of the 2012 inflation target; would be more convincing from an expectations management standpoint; and would underpin the value of the TRL against hard currencies. This support would be stronger if the signal were in the form of a policy rate hike, though somewhat limited if via policy mix tightening. If the monetary authority merely signals a transition to a neutral stance, it will have scuppered a genuine opportunity. This is because, signalling a tightening stance today would not amount to a pledge, as this signal might be changed, going forward, in line with global and local conditions. However, refraining from sending this signal today and doing so in the future when it becomes a necessity would largely diminish the benefit of the move.
Let us assert our conclusion at the very beginning: this ambitious target prompts a tighter stance than today. Should the CBT communicate a policy guidance, this will be included in the brief message sentence where it typically provides its inflation estimates. At the July statement, it was indicated that assuming that the annual rate of credit growth declined to 25% by the end of 2011, and the policy rate remained constant until the end of 2011, inflation was expected to be 6.9% at the end of 2011, and 5.2% at the end of 2012. As of then, there have been major changes with respect to the assumptions included in this sentence, as well as the course of inflation. First of all, the 25% credit growth target has been revised to indicate an annual credit growth rate of 25% adjusted for the FX effect. Secondly, the policy rate has not been kept stable; rather, a 50bp rate cut has been effectuated as of August 4. Thirdly, with the loss in value of the TRL having outpaced the expectations, inflation is expected to even exceed the CBT’s target (6.9%), which was already above target (5%), by the year-end. In our opinion, the CBT will be inclined to convey the message that at some point within today and YE12, it will need to embark on a measured tightening of the policy rate or policy mix, given that a marked divergence from the YE12 inflation target, which is within its control horizon, will not be permissible. At a time when it is widely discussed that all policy instruments might be employed in an expansionary mode due to downside risks, the Bank signalling some kind of tightening, albeit for a future period of time, would undoubtedly have an element of surprise to it.
While it would be rather difficult to gauge the precise timing of a potential tightening, it seems rather unlikely before the second quarter of 2012. Another possibility would be the Bank not signalling a tightening stance, rather shifting to a neutral stance, which would imply that policy instruments would not be employed in an expansionary mode. The fact that the Bank has recently adopted an approach that lays emphasis on growth and financial stability leads us to conclude that this possibility should not be underestimated either.
On the other hand, it appears that the CBT will revise its YE11 CPI projection to minimum 7.8% from currently 6.9% as MTP shows, or even higher to around 9% if all STC adjustments considered. The key factor underlying this revision would be import prices and the wider-than-projected depreciation of the TRL, while the fact that food and oil prices trend below projections (7.5% and US$115) will have precluded a greater deviation. Furthermore, a limited downward revision of the output gap, which denotes the difference between potential and realised growth, also seems in the cards.
Ahead of critical days when we expect the CBT to take the aforementioned decisions, we also opted to take a look at the current state of economic affairs. We aim to provide below a general review of the economic situation, without going too much into the details.
It could be stated that a rather gradual slowdown remains underway in the economy, lending support neither to overheating nor to hard landing concerns. While exports are yet to return to their pre-crisis levels due to the anaemic recovery in emerging economies and the Eurozone’s debt woes, the 20+% growth rates as of the first half of the year have been sustained, and the Export Quantity Index -- indicative for GDP computations -- has posted an increase slightly above 10% within July-August compared to the year-ago period. On the other hand, in the comparable period, the pace of growth in imports has eased notably (28.2%) compared to the first half of the year (43.5%), and the increase in Import Quantity Index has remained at 6.5%. This might suggest that net external demand might contribute to growth following a prolonged hiatus. As for the other major constituent of growth, domestic consumption, leading indicators point to a strengthening of the slowdown evident in the second quarter. While the 25% growth recorded in the total automotive sales in the second quarter has given way to c.2% contraction, CNBC-e Consumption Index, which comprises this sector’s data along with other consumer durables and retail products sales, also validates this picture. The Index, which posted respective growth rates of 22.9% in the first quarter and 15.5% in the second quarter, slowed down to 4.7% for the third quarter. Hence, it might be concluded that the re-balancing of domestic and external demand remains underway, and serves as a basis for the reversal of the deterioration in the C/A deficit. One critical signal to this end was received in August, when growth in the 12-month cumulative C/A deficit excluding energy came to a halt. However, one key factor to have precluded the visibility of the improvement in the short run has been the jump in gold imports in recent months. While Turkey has undertaken gold imports worth US$1.17bn in August, this figure is estimated to have risen to US$1.25bn in September. On the other hand, excluding energy and gold, the annual increase in imports as of August (16%) remains well below the total imports growth rate of 26%.
On the investments front, a pronounced slowdown is underway as well. Data related to imports and production of capital goods as of the third quarter point to similar results. While the rate of growth in imports has retreated from 63% to around 28%, production growth has slipped from above 20% levels to slightly below 10% as of the end of August. Given that 6.6pp of the 8.8% growth in GDP as of the second quarter was driven by private sector investments, it appears that private sector investments look set to drag the growth rate lower in the final quarter of the year. Hence, a decline in real growth in GDP to below the 4-5% range within the third quarter seems of significant probability, which implies that the qoq change in seasonally-adjusted GDP will have slipped to negative territory for the first time in a long period of time.
On the inflation front, while the headline inflation (CPI) follows an uneven course, core inflation has been posting an uninterrupted upward trajectory. The CBT has expressed its view that the H index, which had been reported at 7.4% as of the end of September, would reach 8% in the final quarter, and that core inflation would shift to a declining course as of the early months of the new year. The primary basis for this expectation is that the monthly change in the seasonally adjusted core inflation was a limited 0.3% on average in the final quarter of last year; i.e. setting an unfavourable base effect, though rose to 0.8% and 0.6% levels in the first and second quarters of 2011; i.e. setting a favourable base effect. It is worth reminding investors that while the seasonally adjusted core inflation growth consistent with the coming year’s inflation target is 0.4%, a rate of increase of 0.5% has been recorded in September. While increases in import prices prompted by advances in commodity prices, along with losses in the value of the TRL tend to put upward pressure on inflation, conversely stability in these variables prompts a return to averages consistent with the inflation target. In analyses conducted in Turkey, generally focus remains on the exchange rate pass-through effect, while pass-through from import prices tends to be ignored. However, CBT studies indicate that the pass-through from these two factors is comparable at around 15% each. The notable increase in core inflation this year stems from the fact that both variables have posted substantial increases. As such, for the CBT to be vindicated in its expectation of a decline in core inflation, the TRL should no longer lose value, and a fresh wave of commodity price increases should not be observed. Otherwise, even if the TRL were to depreciate, there would need to be a concomitant decline in commodity prices to offset this effect, as had been the case during the global crisis that erupted at the end of 2008.
Our final words are on exchange rate policy and FX reserves. Due to the factors we have drawn attention to above, the widely held perception is that the CBT is inclined to switch from the free floating exchange rate regime, in effect since 2002, to a managed float. The CBT, given its frequent verbal and direct interventions, does not seem to deny this perception. One source of concern here is that the rapid reserve erosion might heighten scepticism as to the sufficiency of the Bank’s FX reserves, potentially lifting Turkey’s risk premium. The related IMF guideline is for FX reserves to be at a level to meet 3 months’ imports, along with the entirety of short-term debt. Based on recent figures, Turkey’s respective levels are 4.3 months and 98.5%; i.e. not comfortably above the respective thresholds. Moreover, Turkey ranks at the lower end of the scale on an international comparison basis. The CBT, aware of growing misgivings, introduced a new definition to help markets gauge the effectiveness of the reserves, at the latest meeting in Ankara. To summarise, the Bank comes up with a variable that incorporates all external debt with maturity below 1 year -- more indicative than the short-term foreign debt stock -- and excludes foreign liabilities arising from the overseas branches of local banks, thereby reaching a more realistic foreign debt value. This rate, while being slightly below 100% as of end-July, is nevertheless significantly more comfortable than the 73% level as of 2008 and 86% for 2009.
In fact, the message that the CBT aims to communicate is that the FX reserves are more sufficient than during the global crisis and that the Bank would not fear losing reserves if need be, even if such a move would force the relevant adequacy ratios lower. As an example, FX reserves should decline to up to US$63bn for the adequacy ratio to return to 2008 levels, and to US$75bn to 2009 levels. As underlined earlier, more than 99% of the Bank’s reserves are usable and liquid. Furthermore, the CBT has a net FX surplus of US$55bn, accumulated over the years by the CBT through FX purchases in exchange for the TRL, and fully owned by the Bank. The remainder of the reserves comprise the banks' FX RR, the Treasury’s FX deposits and Dresdner Accounts (non-resident Turkish workers abroad) liabilities. Hence, while we reckon the Bank will be frugal in its use of FX reserves to the extent possible, we think it will not refrain from engaging in sizable FX sales when necessary. Yet, even this stance does not change the fact that the fate of the TRL remains linked to non-resident portfolio flows, which in turn hinge on global risk appetite. If the Bank does not introduce a new tool such as allowing banks to hold their TRL reserve requirements in FX, it could opt to use the following instruments to increase FX liquidity: reduction in FX RRRs (the 11% RRR for maturities up to 1 year might be reduced up to the pre-crisis level of 9%); a proportional increase in the %age of TRL RRRs that may be kept as FX (the 20% rate may be raised in tandem with the banks’ ability to borrow from abroad); re-activation of the FX depo facility (this facility, whose limit was set at US$10.8bn, has been dormant; usage might be encouraged through a reduction in interest rates); continuation of daily FX sell auctions; and direct FX sales to banks.
To sum up, if the Bank maintains its current stance for the short term, yet signals a more hawkish stance for the medium term, in line with our expectations, we reckon this would support the attainability of the 2012 inflation target; would be more convincing from an expectations management standpoint; and would underpin the value of the TRL against hard currencies. This support would be stronger if the signal were in the form of a policy rate hike, though somewhat limited if via policy mix tightening. If the monetary authority merely signals a transition to a neutral stance, it will have scuppered a genuine opportunity. This is because, signalling a tightening stance today would not amount to a pledge, as this signal might be changed, going forward, in line with global and local conditions. However, refraining from sending this signal today and doing so in the future when it becomes a necessity would largely diminish the benefit of the move.
29 Eylül 2011 Perşembe
Investor's Guide to the Fiscal Galaxy
The medium-term programme, which is expected to be unveiled in conjunction with the 2012 draft budget by October 17 the latest -- the latter as per a constitutional requirement -- is keenly anticipated by market players. Key aspects of the programme that are eagerly awaited are the macro framework to be presented for the 2012-2014 period and measures to be adopted to prompt structural improvements in the C/A deficit, as well as budget targets that will help us gauge the role accorded to public savings in this process. Issuing this report ahead of these crucial disclosures, we aim to provide investors with an insight into where Turkey stands from a fiscal balances perspective and -- making use of the IMF’s recently issued ”Fiscal Monitor” study -- make an assessment of the status quo with a global perspective. This way, once budget targets for the coming years are announced, we aim to be ready to figure out what they represent from a fiscal stance standpoint.
Global perspective: Turkey compares favourably with global peers in terms of key budget performance indicators; yet... Starting our analysis with the global comparison, we infer from last week’s IMF data, disregarding minor differences in definition, that Turkey ranks highly favourably on the basis of the 2011 values of the “general government balance (% of GDP)” and the “general government primary balance (% of GDP)”. While the respective values for Turkey are -0.9% and 1.8%, the global averages are -5.0% and -3.0%, and the comparison does not change when conducted on the basis of developed or emerging countries. Nor does Turkey’s comparative ranking change when the budget is adjusted for cyclical effects. With respective values of -2.1% and 0.6%, Turkey still stands well above comparable global averages of -4.1% and -2.2%.
...actual budget balances need to be cyclically adjusted... It is worth underlining that actual budget balances are imperfect indicators for assessing public finances and fiscal policies, since they are influenced by a number of factors that are both transitory and beyond the direct control of fiscal authorities. Predominant among those are the fluctuations in economic activity. The indicators of cyclically-adjusted budget balances seek to correct the fiscal outcomes for the effects of cyclical variations. In other words, they aim to determine what the budget balance would have been if the economy were on its “normal” growth path; i.e. characterised by roughly constant increases in output over the medium-term.
The IMF method... A number of different methods could be used for this adjustment process, out of which we have opted for the IMF method cited in Regional Economic Outlook 2006, for the sake of simplicity and convenience.
With this analysis, we aim to discern the nature of the fiscal stance (pro- or counter-cyclical) pursued in recent years and whether a fiscal impulse has been utilised. To this end, we have implemented the IMF’s methodology for fiscal impulse calculations, developed by Abrego and Clements. According to this methodology, fiscal impulse is the change in fiscal stance between two consecutive years, which in turn is calculated as the difference between the actual and cyclically neutral fiscal balance. Implementation of an expansionary (contractionary) fiscal policy in times of economic contraction (expansion) points to the presence of a counter-cyclical fiscal policy. On the contrary, implementation of a contractionary (expansionary) fiscal policy in times of economic contraction (expansion) indicates that the fiscal policy is pro-cyclical. The details of the methodology are presented below (Annex)
Our assumptions... Before proceeding to the findings of our study, we find it worthwhile to lay out a few key aspects of our assumptions. Similar to the IMF’s methodological approach, we assumed Turkey’s potential growth rate as its average growth rate for the past 20 years; i.e. 4%. Moreover, as the base year for our calculations, we opted for the year 2007, which preceded the inception of the effects of the global crisis, and we assumed that in that year there was no output gap; i.e. nominal GDP was equal to potential GDP.
While computing the “primary balance to GDP” ratios on an annual basis using current GDP data and budget primary balance realisations, we also aimed to calculate the cyclically-adjusted “primary balance to GDP” ratios, employing the potential GDP level. As with the IMF method, to compute cyclically-adjusted revenues, we multiplied the base year “revenues/GDP” ratio with the actual GDP level of each year, and to estimate cyclically-adjusted primary expenditures, we multiplied the base year expenditures/GDP ratio with the potential GDP level of each year. Hence, the difference between cyclically-adjusted revenues and primary expenditures provides the “cyclically-adjusted primary balance to GDP”, and the difference between the latter and the “actual primary balance to GDP” reflects the fiscal stance of a given year. A positive difference would indicate an expansionary fiscal policy. The difference in “fiscal stance” in between two consecutive years would tell us whether and to what extent “fiscal impulse” was applied.
Our findings... As is evident from the table below, while the fiscal stance is found neutral in 2008, the 1.7% value computed for 2009, when fiscal measures were adopted to assuage the effects of the global crisis, unsurprisingly points to an expansionary fiscal policy for the year. The 1.9% value computed for 2010, on the other hand, indicates that although the effects of the crisis have dissipated, fiscal policy still remains expansionary and that despite growth having reached 9%, “fiscal impulse” has been used, albeit to a limited degree. However, in a year whereby the C/A deficit to GDP ratio deteriorated markedly, at least a “neutral” fiscal stance would have been a more appropriate choice, in our view.
It seems somewhat premature to make an assessment of the year 2011 from a fiscal stance standpoint. This is because the current performance is ahead of the fundamental aggregates such as growth and inflation foreseen in the macro framework of the medium-term programme for the year 2011. Moreover, the budgetary effects of the restructuring of public receivables are perceived to have become sizable. According to our estimations, based on a growth forecast of around 6%, the neutral primary balance to GDP level for the year 2011 would be 3.1%. We should note that each 0.5bp growth overshoot would prompt a 0.1bp upward shift in this balance level. While the 12-month primary surplus/GDP ratio as of August stands at 1.8%, the 2011 primary surplus target of 1.1% appears bound to be revised upwards. Hence, while a level below 3.1% for the actual primary balance to GDP ratio by the year-end would imply the usage of an expansionary fiscal policy in the year 2011, a difference of at most 1.9% between the neutral primary balance to GDP ratio and the actual primary balance to GDP ratio would make us conclude that at least no “fiscal impulse” has been applied.
Undoubtedly, how the TRL13.5bn revenues projected for the current year from the public receivables restructuring plan (1% of the GDP) or the improvement in primary expenditures (whose magnitude we are unable to precisely estimate at this point) via a reduction in budgetary transfers through social security institution (SGK) premium collections are included in the analysis are also crucial. (The plan in question envisages additional revenue collections of TRL10.3bn (2012); TRL8.6bn (2013); TRL3.1bn (2014); and TRL1.0bn (2015)). While such revenues, given their one-off nature, might be excluded from the scope of the analysis to reveal the actual performance, conversely they might be maintained on the premise that they amount to the depletion of an accumulated receivable inventory. For example, in the programme defined data issued for the budget, the Treasury Undersecretariat makes adjustments for one-off items such as privatisations and public banks’ profit transfers, while making no adjustments for related collections. Moreover, the delivery of tax and premium payments to the Finance Ministry and the SGK initially has a contractionary effect on household disposable income and hence in this way amounts to a contractionary fiscal policy. Eventually, this effect is neutralised based on the extent to which these additional revenues are transformed into expenditures.
Conclusion: Cyclical variations paramount for a realistic assessment of fiscal framework... Turkey is one of the few countries to have implemented exit strategies from expansionary fiscal policies in the aftermath of the global crisis. This has helped Turkey rank favourably on a global scale in terms of fiscal balances and indebtedness indicators. However, adjusting for the cyclical variations induced by high growth, the resulting picture indicates that in fact expansionary fiscal policies have not been completely discontinued, and that fiscal impulse remained in use in 2010, albeit to a minor degree. While this stance observed in the past two years has failed to stem the deterioration in the C/A deficit, it has also narrowed the manoeuvring space for counter-cyclical fiscal policies. Hence, we believe it would be appropriate to evaluate the fiscal framework to be laid out in the medium-term programme not solely on the basis of budget targets, but with an approach that takes cyclical variations into consideration, and hope our study would help investors to this end.
Annex: Methodology for Fiscal Impulse Calculations The fiscal impulse is calculated as the change in the fiscal stance between two consecutive years, which in turn is calculated as the difference between the actual and a cyclically neutral fiscal balance. The first step in the process is to estimate the fiscal stance:
FS = (T – G) – (T* – G*) (1)
where T and G refer to actual revenues and expenditures in the current year, and T* and G* to cyclically neutral revenues and expenditures (all as a share of GDP). T* and G* are from a base year when actual output was at its potential, with two additional assumptions: (i) T* remains constant and (ii) G* remains constant only as long as actual growth equals potential growth. In the case that actual growth is greater than (less than) potential growth, G* falls (rises). For the present exercise, potential GDP growth was assumed to be the average annual growth rate over the past 20 years.
The fiscal impulse is the change in the fiscal stance in (1), multiplied by negative one (to indicate that a weakening of the fiscal stance imparts a positive fiscal impulse):
FI = (ΔG – ΔG*) – (ΔT– ΔT*) (2)
The first term in the fiscal impulse captures an increase in the spending to GDP ratio above what would occur if spending rose at the rate of potential output. The second term is equivalent to the change in the revenue to GDP ratio, since by assumption T* is held constant. Thus, the fiscal impulse, on the revenue side, simply reflects changes in actual ratio of revenue to GDP.
Source: IMF, Regional Economic Outlook: Western Hemisphere, November 2006
Global perspective: Turkey compares favourably with global peers in terms of key budget performance indicators; yet... Starting our analysis with the global comparison, we infer from last week’s IMF data, disregarding minor differences in definition, that Turkey ranks highly favourably on the basis of the 2011 values of the “general government balance (% of GDP)” and the “general government primary balance (% of GDP)”. While the respective values for Turkey are -0.9% and 1.8%, the global averages are -5.0% and -3.0%, and the comparison does not change when conducted on the basis of developed or emerging countries. Nor does Turkey’s comparative ranking change when the budget is adjusted for cyclical effects. With respective values of -2.1% and 0.6%, Turkey still stands well above comparable global averages of -4.1% and -2.2%.
...actual budget balances need to be cyclically adjusted... It is worth underlining that actual budget balances are imperfect indicators for assessing public finances and fiscal policies, since they are influenced by a number of factors that are both transitory and beyond the direct control of fiscal authorities. Predominant among those are the fluctuations in economic activity. The indicators of cyclically-adjusted budget balances seek to correct the fiscal outcomes for the effects of cyclical variations. In other words, they aim to determine what the budget balance would have been if the economy were on its “normal” growth path; i.e. characterised by roughly constant increases in output over the medium-term.
The IMF method... A number of different methods could be used for this adjustment process, out of which we have opted for the IMF method cited in Regional Economic Outlook 2006, for the sake of simplicity and convenience.
With this analysis, we aim to discern the nature of the fiscal stance (pro- or counter-cyclical) pursued in recent years and whether a fiscal impulse has been utilised. To this end, we have implemented the IMF’s methodology for fiscal impulse calculations, developed by Abrego and Clements. According to this methodology, fiscal impulse is the change in fiscal stance between two consecutive years, which in turn is calculated as the difference between the actual and cyclically neutral fiscal balance. Implementation of an expansionary (contractionary) fiscal policy in times of economic contraction (expansion) points to the presence of a counter-cyclical fiscal policy. On the contrary, implementation of a contractionary (expansionary) fiscal policy in times of economic contraction (expansion) indicates that the fiscal policy is pro-cyclical. The details of the methodology are presented below (Annex)
Our assumptions... Before proceeding to the findings of our study, we find it worthwhile to lay out a few key aspects of our assumptions. Similar to the IMF’s methodological approach, we assumed Turkey’s potential growth rate as its average growth rate for the past 20 years; i.e. 4%. Moreover, as the base year for our calculations, we opted for the year 2007, which preceded the inception of the effects of the global crisis, and we assumed that in that year there was no output gap; i.e. nominal GDP was equal to potential GDP.
While computing the “primary balance to GDP” ratios on an annual basis using current GDP data and budget primary balance realisations, we also aimed to calculate the cyclically-adjusted “primary balance to GDP” ratios, employing the potential GDP level. As with the IMF method, to compute cyclically-adjusted revenues, we multiplied the base year “revenues/GDP” ratio with the actual GDP level of each year, and to estimate cyclically-adjusted primary expenditures, we multiplied the base year expenditures/GDP ratio with the potential GDP level of each year. Hence, the difference between cyclically-adjusted revenues and primary expenditures provides the “cyclically-adjusted primary balance to GDP”, and the difference between the latter and the “actual primary balance to GDP” reflects the fiscal stance of a given year. A positive difference would indicate an expansionary fiscal policy. The difference in “fiscal stance” in between two consecutive years would tell us whether and to what extent “fiscal impulse” was applied.
Our findings... As is evident from the table below, while the fiscal stance is found neutral in 2008, the 1.7% value computed for 2009, when fiscal measures were adopted to assuage the effects of the global crisis, unsurprisingly points to an expansionary fiscal policy for the year. The 1.9% value computed for 2010, on the other hand, indicates that although the effects of the crisis have dissipated, fiscal policy still remains expansionary and that despite growth having reached 9%, “fiscal impulse” has been used, albeit to a limited degree. However, in a year whereby the C/A deficit to GDP ratio deteriorated markedly, at least a “neutral” fiscal stance would have been a more appropriate choice, in our view.
It seems somewhat premature to make an assessment of the year 2011 from a fiscal stance standpoint. This is because the current performance is ahead of the fundamental aggregates such as growth and inflation foreseen in the macro framework of the medium-term programme for the year 2011. Moreover, the budgetary effects of the restructuring of public receivables are perceived to have become sizable. According to our estimations, based on a growth forecast of around 6%, the neutral primary balance to GDP level for the year 2011 would be 3.1%. We should note that each 0.5bp growth overshoot would prompt a 0.1bp upward shift in this balance level. While the 12-month primary surplus/GDP ratio as of August stands at 1.8%, the 2011 primary surplus target of 1.1% appears bound to be revised upwards. Hence, while a level below 3.1% for the actual primary balance to GDP ratio by the year-end would imply the usage of an expansionary fiscal policy in the year 2011, a difference of at most 1.9% between the neutral primary balance to GDP ratio and the actual primary balance to GDP ratio would make us conclude that at least no “fiscal impulse” has been applied.
Undoubtedly, how the TRL13.5bn revenues projected for the current year from the public receivables restructuring plan (1% of the GDP) or the improvement in primary expenditures (whose magnitude we are unable to precisely estimate at this point) via a reduction in budgetary transfers through social security institution (SGK) premium collections are included in the analysis are also crucial. (The plan in question envisages additional revenue collections of TRL10.3bn (2012); TRL8.6bn (2013); TRL3.1bn (2014); and TRL1.0bn (2015)). While such revenues, given their one-off nature, might be excluded from the scope of the analysis to reveal the actual performance, conversely they might be maintained on the premise that they amount to the depletion of an accumulated receivable inventory. For example, in the programme defined data issued for the budget, the Treasury Undersecretariat makes adjustments for one-off items such as privatisations and public banks’ profit transfers, while making no adjustments for related collections. Moreover, the delivery of tax and premium payments to the Finance Ministry and the SGK initially has a contractionary effect on household disposable income and hence in this way amounts to a contractionary fiscal policy. Eventually, this effect is neutralised based on the extent to which these additional revenues are transformed into expenditures.
Conclusion: Cyclical variations paramount for a realistic assessment of fiscal framework... Turkey is one of the few countries to have implemented exit strategies from expansionary fiscal policies in the aftermath of the global crisis. This has helped Turkey rank favourably on a global scale in terms of fiscal balances and indebtedness indicators. However, adjusting for the cyclical variations induced by high growth, the resulting picture indicates that in fact expansionary fiscal policies have not been completely discontinued, and that fiscal impulse remained in use in 2010, albeit to a minor degree. While this stance observed in the past two years has failed to stem the deterioration in the C/A deficit, it has also narrowed the manoeuvring space for counter-cyclical fiscal policies. Hence, we believe it would be appropriate to evaluate the fiscal framework to be laid out in the medium-term programme not solely on the basis of budget targets, but with an approach that takes cyclical variations into consideration, and hope our study would help investors to this end.
Annex: Methodology for Fiscal Impulse Calculations The fiscal impulse is calculated as the change in the fiscal stance between two consecutive years, which in turn is calculated as the difference between the actual and a cyclically neutral fiscal balance. The first step in the process is to estimate the fiscal stance:
FS = (T – G) – (T* – G*) (1)
where T and G refer to actual revenues and expenditures in the current year, and T* and G* to cyclically neutral revenues and expenditures (all as a share of GDP). T* and G* are from a base year when actual output was at its potential, with two additional assumptions: (i) T* remains constant and (ii) G* remains constant only as long as actual growth equals potential growth. In the case that actual growth is greater than (less than) potential growth, G* falls (rises). For the present exercise, potential GDP growth was assumed to be the average annual growth rate over the past 20 years.
The fiscal impulse is the change in the fiscal stance in (1), multiplied by negative one (to indicate that a weakening of the fiscal stance imparts a positive fiscal impulse):
FI = (ΔG – ΔG*) – (ΔT– ΔT*) (2)
The first term in the fiscal impulse captures an increase in the spending to GDP ratio above what would occur if spending rose at the rate of potential output. The second term is equivalent to the change in the revenue to GDP ratio, since by assumption T* is held constant. Thus, the fiscal impulse, on the revenue side, simply reflects changes in actual ratio of revenue to GDP.
Source: IMF, Regional Economic Outlook: Western Hemisphere, November 2006
16 Eylül 2011 Cuma
Interventionistas
The scheduled August MPC meeting could be an opportunity to revert to a wait-and-see mode, while monitoring critical events concerning EU debt problems… The interim MPC meeting on August 4, along with the decisions taken then and later would normally have rendered the scheduled August MPC meeting a non-event. However, stability still remains elusive, with financial markets largely prone to event risk. Moreover, our Central Bank is shy of pronouncing a clear outlook for inflation and growth; rather, they opt for presenting two alternative global scenarios, given the elevated uncertainty, and clearly aim to buy time to make healthier decisions, going forward. In our view, the pre-emptive u-turn in monetary policy has been presented as a means of containing the downside risks for our economy, given the state of the global economy, but it was purely a verbal intervention to the growth perceptions of market players. Therefore, the CBT’s view still has to be tested with macro data, while it seems that the intervention has served to temper growth expectations. This is seemingly helping the CBT set the playing field, as overheating arguments and C/A concerns might be taking a back seat.
The CBT, guiding for its next monetary policy moves, has become markedly vocal on the value of the TRL against hard currencies, in a bid to engineer a soft landing... In order to predict the next move, we should know the scenario to which the CBT is currently attaching greater weight. In the first scenario, in case of concrete and satisfactory solutions to recent European debt problems, the CBT expects a rapid appreciation of the TRL, along with commodity price increases. In the framework of this scenario, the CBT would have to keep the RRR high and the policy rate low, in order to avert hot money inflows. Moreover, tighter measures to curb loan growth, such as a marginal reserve requirement, speed limit to borrowings, and restrictions to leverage ratios would be necessary. In the second scenario, featuring a delayed and dissatisfactory solution to recent problems, the CBT expects further TRL depreciation and envisages greater risk of a recession. Therefore, the RRR on TRL liabilities might be reduced gradually or aggressively, depending on the extent of the slowdown in that scenario. However, in both scenarios, the CBT leaves the door open for measured policy rate cuts, while underscoring that this would not necessarily be in the form of a series of rate cuts. On the other hand, at his recent interviews in some local TV channels, CBT Governor Basci sounded more hopeful about a resolution to EU debt problems: probably the mood change was related to the FOMC meeting dated August 9, where the FED expressed a commitment to hold FED funds rate at current low levels at least till mid-2013, while opening the door to QE3, as well as ECB secondary debt market buying Italian and Spanish bonds. However, the MPC is likely to remain cautious about the repercussions of financial shocks for the domestic economy, until it gets clearer signs of an improvement. For the time being, this would imply that the CBT still ascribes a higher possibility to the second scenario, as the root causes of global jitters -- record high Italian and Spanish yields -- were the sole trigger for the interim meeting, although the CBT Governor sounded otherwise recently. However, we think the current slight tendency in favour of the latter scenario is conditional and susceptible to data and event evolution.
Accumulating downside risks could trigger more drastic downward revisions… Globally and locally, growth view will hinge largely on short-term economic activity, domestic demand, and leading indicators, going forward, since downside risks are accumulating, as recent macro data releases have generally produced negative surprises. More importantly, this could trigger significant downward revisions to GDP forecasts and confirm the recent trend in stock markets.
Consecutive slumps in stock indices and the sharp retreat in bond yields prompt the perception that, more than a slowdown scenario, it is the scenario of a recession in the global economy that is being priced in... The foremost -- and as yet perhaps the single -- factor to support this perception to date is a key leading indicator, the Purchasing Managers Index (PMI), which has edged closer to the critical 50 threshold, considered to separate economic growth from contraction phases. Past data suggest that nearly each time that the index in question has dipped clearly below the 50 mark (levels at and below 45); an episode of economic contraction has ensued. Moreover, as growth has failed to gather adequate momentum despite quantitative easing programmes launched in developed economies and bail-out packages aimed at debt-stricken countries, overall sentiment has faltered, undermining hopes as to the effectiveness of potential additional measures. In case of a lack of developments to assuage these concerns and the persistence of risk aversion, we could evidence more dramatic declines in consumer and real sector confidence, and the risk of a negative feedback loop could increase notably. While such risks have started to become factored into market prices, they are yet to be duly reflected to economic forecasts. Such changes in global economic outlook will clearly have adverse ramifications for the Turkish economy, though the extent of the impact remains critical. Given the marked uncertainties concerning global economic outlook at this stage, we have opted for a scenario-based approach to come up with estimates for economic and financial aggregates for the near future. With this purpose, while maintaining our estimates in the framework of our baseline scenario for 2011-2012 despite accumulating downside risks, we add two further scenarios: i) “soft landing”; ii) “mild recession”. The scenarios include our estimates regarding the values other economic and financial indicators may take on the basis of quarterly and annual projections for GDP growth until YE12. Whilst forming our GDP estimates, we made assumptions regarding qoq changes in seasonally-adjusted GDP data, the primary indicator for the growth trend. For example, we assumed in the framework of our baseline scenario that there would be no change in growth in 2Q11 vis-à-vis the prior quarter of the year; that sub-potential growth would be registered in the subsequent three quarters (0.5%, 0.9% and 0.8%); and that once again above-potential growth would be recorded in the remaining three quarters (1.8%, 2.1% and 1.2%) until YE12. In this respect, our GDP growth estimates for 2011 and 2012 are 6% and 4.5%, respectively.
Our more negative alternative scenarios include our estimates as to the values growth rate may take in case of a series of flat/declining seasonally-adjusted quarterly GDP readings. In both scenarios, while the 2011 growth rate does not change substantially with respect to the baseline scenario, the effect is evidenced most notably on the 2012 growth rate. Even in the soft landing scenario, annual GDP change becomes 2.5%, undershooting the 4.5-5.0% range considered as the potential growth rate for the Turkish economy. This notwithstanding, even in the worst-case scenario that we envisage at this point, we do not expect the Turkish economic growth to slip to negative territory; i.e. contract, on an annual basis in 2012, even though we do not rule out quarterly contractions (Table 1). Our opinion is underpinned by technical, as well as fundamental reasons. The technical reason is that, the slowdown, which has deepened due to negative shocks, is poised to show its impact as of the latter half of the year, and this factor will diffuse the deceleration in growth to a two-year time frame. The fundamental reasons, on the other hand, are key factors such as the absolute and comparative relief provided by Turkey’s indebtedness indicators, and the soundness of the banking system, as well as the ability of the Central Bank and the government to resort to counter-cyclical monetary and fiscal policy moves in case of necessity.
Moreover, the CBT’s guidance on growth was not very negative for 2H11. Governor Basci pointed out that qoq changes in seasonally-adjusted GDP would be flat in 2Q and would be slightly positive in the remaining quarters. In other words, the CBT’s projections were not much different from our base-case scenario. However, they probably see downside risk to their forecasts, especially for 3Q and 4Q, since the measures adopted on August 4 have been presented as a means of containing the downside risks for our economy. As technical recession occurs when the level of real gross domestic product (sa) declines over two successive quarters, the CBT will consider this risk seriously and act accordingly. Let us remind you that even in the Eurozone, the epicentre of global financial tensions, GDP growth showed a positive, albeit small, change in 2Q.
All in all, given the limited time frame since the interim meeting and the persisting uncertainties regarding global economic outlook, we think the CBT should return to a wait-and-see mode to monitor the critical events related to EU debt problems. Given that the President of the European Council is assigned to make concrete proposals (to improve working methods and enhance crisis management) by October the earliest, we do not expect any rapid solutions in the near future. Therefore, the CBT is likely to tend more towards the pessimistic scenario; thus looks set to maintain an “easing” bias. However, this does not necessarily mean an imminent further easing at the scheduled August meeting. Although, we do not rule out another measured (25bp) policy rate cut, this is not our central view. Nor do we expect an RRR cut on TRL liabilities for the time being. Please note that even in our base-case scenario, we foresee around 200bp cut in RRR on TRL liabilities till the year-end.
The TRL may benefit in the short-term from a pause in easing, but this would be temporary, since the “easing” bias appears poised to be maintained. Hence, there will be a need for further verbal interventions (Governor Basci said they reckon the TRL basket should be 5-10% lower) and prevailing facilities (regular FX selling auctions, decrease in RRR on FX liabilities, US$10.8bn CBT FX deposit facility to banks) providing FX liquidity. Furthermore, the CBT could leave its FX selling unsterilized, meaning not compensate for TRL liquidity withdrawal and let the secondary market repo rates climb to the upper (PD at 8 %) limit to support the TRL against hard currencies. Other key factors to support the TRL might be 1) The 27% depreciation of the TRL against EM averages (Graph 3) since the beginning of 2010 on the heels of the CBT’s new monetary policy implementation; 2) The CPI-based real effective exchange rate index slipping remarkably below its long term averages, and becoming only 10% overvalued against the index with base-year 2003 (Graph 4). (REER against EM countries 8.6% undervalued, REER against Developed countries 18% overvalued, PPI-based REER 6.8% overvalued and unit labour cost based REER 20% overvalued) You might notice that none of the official indexes other than the REER against EM supports the Governor’s argument about the TRL’s undervaluation.
On the rates, we still see a downside potential for the benchmark bond yield, despite around 1pp fall since the August 4 meeting. We expect bond yields to trade within the 7.0-8.0% range in the coming months, due to non-residents’ ongoing quest for higher yields. We reckon that the historic trough of 6.88% (Jan’11) could be tested again, but only in case of benign CPI prints.
The CBT, guiding for its next monetary policy moves, has become markedly vocal on the value of the TRL against hard currencies, in a bid to engineer a soft landing... In order to predict the next move, we should know the scenario to which the CBT is currently attaching greater weight. In the first scenario, in case of concrete and satisfactory solutions to recent European debt problems, the CBT expects a rapid appreciation of the TRL, along with commodity price increases. In the framework of this scenario, the CBT would have to keep the RRR high and the policy rate low, in order to avert hot money inflows. Moreover, tighter measures to curb loan growth, such as a marginal reserve requirement, speed limit to borrowings, and restrictions to leverage ratios would be necessary. In the second scenario, featuring a delayed and dissatisfactory solution to recent problems, the CBT expects further TRL depreciation and envisages greater risk of a recession. Therefore, the RRR on TRL liabilities might be reduced gradually or aggressively, depending on the extent of the slowdown in that scenario. However, in both scenarios, the CBT leaves the door open for measured policy rate cuts, while underscoring that this would not necessarily be in the form of a series of rate cuts. On the other hand, at his recent interviews in some local TV channels, CBT Governor Basci sounded more hopeful about a resolution to EU debt problems: probably the mood change was related to the FOMC meeting dated August 9, where the FED expressed a commitment to hold FED funds rate at current low levels at least till mid-2013, while opening the door to QE3, as well as ECB secondary debt market buying Italian and Spanish bonds. However, the MPC is likely to remain cautious about the repercussions of financial shocks for the domestic economy, until it gets clearer signs of an improvement. For the time being, this would imply that the CBT still ascribes a higher possibility to the second scenario, as the root causes of global jitters -- record high Italian and Spanish yields -- were the sole trigger for the interim meeting, although the CBT Governor sounded otherwise recently. However, we think the current slight tendency in favour of the latter scenario is conditional and susceptible to data and event evolution.
Accumulating downside risks could trigger more drastic downward revisions… Globally and locally, growth view will hinge largely on short-term economic activity, domestic demand, and leading indicators, going forward, since downside risks are accumulating, as recent macro data releases have generally produced negative surprises. More importantly, this could trigger significant downward revisions to GDP forecasts and confirm the recent trend in stock markets.
Consecutive slumps in stock indices and the sharp retreat in bond yields prompt the perception that, more than a slowdown scenario, it is the scenario of a recession in the global economy that is being priced in... The foremost -- and as yet perhaps the single -- factor to support this perception to date is a key leading indicator, the Purchasing Managers Index (PMI), which has edged closer to the critical 50 threshold, considered to separate economic growth from contraction phases. Past data suggest that nearly each time that the index in question has dipped clearly below the 50 mark (levels at and below 45); an episode of economic contraction has ensued. Moreover, as growth has failed to gather adequate momentum despite quantitative easing programmes launched in developed economies and bail-out packages aimed at debt-stricken countries, overall sentiment has faltered, undermining hopes as to the effectiveness of potential additional measures. In case of a lack of developments to assuage these concerns and the persistence of risk aversion, we could evidence more dramatic declines in consumer and real sector confidence, and the risk of a negative feedback loop could increase notably. While such risks have started to become factored into market prices, they are yet to be duly reflected to economic forecasts. Such changes in global economic outlook will clearly have adverse ramifications for the Turkish economy, though the extent of the impact remains critical. Given the marked uncertainties concerning global economic outlook at this stage, we have opted for a scenario-based approach to come up with estimates for economic and financial aggregates for the near future. With this purpose, while maintaining our estimates in the framework of our baseline scenario for 2011-2012 despite accumulating downside risks, we add two further scenarios: i) “soft landing”; ii) “mild recession”. The scenarios include our estimates regarding the values other economic and financial indicators may take on the basis of quarterly and annual projections for GDP growth until YE12. Whilst forming our GDP estimates, we made assumptions regarding qoq changes in seasonally-adjusted GDP data, the primary indicator for the growth trend. For example, we assumed in the framework of our baseline scenario that there would be no change in growth in 2Q11 vis-à-vis the prior quarter of the year; that sub-potential growth would be registered in the subsequent three quarters (0.5%, 0.9% and 0.8%); and that once again above-potential growth would be recorded in the remaining three quarters (1.8%, 2.1% and 1.2%) until YE12. In this respect, our GDP growth estimates for 2011 and 2012 are 6% and 4.5%, respectively.
Our more negative alternative scenarios include our estimates as to the values growth rate may take in case of a series of flat/declining seasonally-adjusted quarterly GDP readings. In both scenarios, while the 2011 growth rate does not change substantially with respect to the baseline scenario, the effect is evidenced most notably on the 2012 growth rate. Even in the soft landing scenario, annual GDP change becomes 2.5%, undershooting the 4.5-5.0% range considered as the potential growth rate for the Turkish economy. This notwithstanding, even in the worst-case scenario that we envisage at this point, we do not expect the Turkish economic growth to slip to negative territory; i.e. contract, on an annual basis in 2012, even though we do not rule out quarterly contractions (Table 1). Our opinion is underpinned by technical, as well as fundamental reasons. The technical reason is that, the slowdown, which has deepened due to negative shocks, is poised to show its impact as of the latter half of the year, and this factor will diffuse the deceleration in growth to a two-year time frame. The fundamental reasons, on the other hand, are key factors such as the absolute and comparative relief provided by Turkey’s indebtedness indicators, and the soundness of the banking system, as well as the ability of the Central Bank and the government to resort to counter-cyclical monetary and fiscal policy moves in case of necessity.
Moreover, the CBT’s guidance on growth was not very negative for 2H11. Governor Basci pointed out that qoq changes in seasonally-adjusted GDP would be flat in 2Q and would be slightly positive in the remaining quarters. In other words, the CBT’s projections were not much different from our base-case scenario. However, they probably see downside risk to their forecasts, especially for 3Q and 4Q, since the measures adopted on August 4 have been presented as a means of containing the downside risks for our economy. As technical recession occurs when the level of real gross domestic product (sa) declines over two successive quarters, the CBT will consider this risk seriously and act accordingly. Let us remind you that even in the Eurozone, the epicentre of global financial tensions, GDP growth showed a positive, albeit small, change in 2Q.
All in all, given the limited time frame since the interim meeting and the persisting uncertainties regarding global economic outlook, we think the CBT should return to a wait-and-see mode to monitor the critical events related to EU debt problems. Given that the President of the European Council is assigned to make concrete proposals (to improve working methods and enhance crisis management) by October the earliest, we do not expect any rapid solutions in the near future. Therefore, the CBT is likely to tend more towards the pessimistic scenario; thus looks set to maintain an “easing” bias. However, this does not necessarily mean an imminent further easing at the scheduled August meeting. Although, we do not rule out another measured (25bp) policy rate cut, this is not our central view. Nor do we expect an RRR cut on TRL liabilities for the time being. Please note that even in our base-case scenario, we foresee around 200bp cut in RRR on TRL liabilities till the year-end.
The TRL may benefit in the short-term from a pause in easing, but this would be temporary, since the “easing” bias appears poised to be maintained. Hence, there will be a need for further verbal interventions (Governor Basci said they reckon the TRL basket should be 5-10% lower) and prevailing facilities (regular FX selling auctions, decrease in RRR on FX liabilities, US$10.8bn CBT FX deposit facility to banks) providing FX liquidity. Furthermore, the CBT could leave its FX selling unsterilized, meaning not compensate for TRL liquidity withdrawal and let the secondary market repo rates climb to the upper (PD at 8 %) limit to support the TRL against hard currencies. Other key factors to support the TRL might be 1) The 27% depreciation of the TRL against EM averages (Graph 3) since the beginning of 2010 on the heels of the CBT’s new monetary policy implementation; 2) The CPI-based real effective exchange rate index slipping remarkably below its long term averages, and becoming only 10% overvalued against the index with base-year 2003 (Graph 4). (REER against EM countries 8.6% undervalued, REER against Developed countries 18% overvalued, PPI-based REER 6.8% overvalued and unit labour cost based REER 20% overvalued) You might notice that none of the official indexes other than the REER against EM supports the Governor’s argument about the TRL’s undervaluation.
On the rates, we still see a downside potential for the benchmark bond yield, despite around 1pp fall since the August 4 meeting. We expect bond yields to trade within the 7.0-8.0% range in the coming months, due to non-residents’ ongoing quest for higher yields. We reckon that the historic trough of 6.88% (Jan’11) could be tested again, but only in case of benign CPI prints.
18 Ağustos 2011 Perşembe
FX Risk of Corporates & Households....
An unintended consequence of a macro prudential warning… When CBT Governor Erdem Basci sounded a casual note of caution on the need to contain short FX positions in Turkey, at a presentation in Denizli on July 22, he probably did not anticipate such extensive media attention, or a reaction of such severity from the FX market. A few days later, at a meeting with the investor community in Istanbul, Mr Basci this time pointed out that there was no big FX short position in Turkey, an attempt that was seemingly intended to wipe away the impact of his previous remark. However, the damage was done; and the conundrum remains: Does Turkey indeed have a big FX short position or not?
Do we have a clue on FX positions in Turkey?... Management of risks associated with FX positions took on greater significance following the adoption of the floating exchange rate regime in Turkey. Moreover, increasingly volatile global capital movements in the recent period and accordingly, unanticipated changes in FX rates reinforced these risks. While the FX risk from the banks’ standpoint -- following the regulations adopted in 2001 and the measures consequently instituted -- stands remarkably low, for the corporates, which had been increasingly resorting to external borrowing facilities, the situation is not that clear. Besides, on the issue of FX positions, neither non-financial corporates are required to present additional reporting, nor are there any limits on capital adequacy ratios. Hence, while speculations on this area could arise quite easily, the extent of the related risks cannot be clearly fathomed. Obviously, any remarkable volatility in FX rates will have a significant impact on corporate profitability and capital. Besides, this situation also raises the spectre of additional risks for the banks, in the form of an increase in bad loans if the corporates fail to duly redeem their debt. In other words, although the banks had adopted the necessary measures to protect themselves from FX-related risks on their balance sheets, the situation is not all that secure from their perspective, as the FX risk assumed by the corporates could trigger credit risk. However, we are not completely clueless on this situation, either. The Central Bank of Turkey has been publishing the quarterly net FX positions of the corporates (Foreign Exchange Assets and Liabilities of Non-Financial Companies) based on Turkey’s International Investment Position (IIP) since 2006. According to these figures, the net open position of the corporates, after having surged to US$94.3bn as of end 2010, has increased further to US$111.7bn in 1Q11 (Graph 1). Within the 2006-08 period, the net open position increased rapidly to US$80.4bn from US$37.8bn, mainly due to a rise in the FX loans provided by domestic and external sources, thanks to favourable global economic conditions and ample global liquidity during that time. The global crisis in 2008-09 brought a temporary pause to the expansion of open positions, but did not change the trend; and the biggest ever quarterly increase was seen in 1Q11. However, the CBT data come with a significant lag (1Q figures in July) and do not reflect Turkey’s aggregate picture in terms of FX positions. This is because asset dollarization is still high in our economy, since households hold significant amounts of FX deposits in the banking system, whereas their FX liabilities are limited to FX-indexed consumer loans. Savings tends to be invested in FX-denominated assets, since households, having experienced chronic inflation for many years, consider these assets as more secure and expect to benefit from the movements in FX rates in periods of political uncertainty and unsteady economic growth. This means a massive long FX position in households, comparable to the corporate short FX position. Moreover, one should consider the similar long FX position of the Central Bank of Turkey when evaluating the FX risk in its entirety. Therefore, these major discrepancies prompt us to calculate Turkey’s net FX position -- and more importantly with less of a lag.
Our methodology and approach in short… We used monthly IIP data available for May to calculate the FX position of the corporates generated from transactions with institutions abroad. To this figure, we added their local FX positions, which resulted from their transactions with the domestic banking system. In order to compute corporates’ local open positions, we extracted FX-denominated and FX-indexed loans and receivables entered to the records by the Savings Deposit Insurance Fund (SDIF) from legal entities’ FX deposits, Eurobonds and FX-denominated Government Domestic Debt Instruments (GDDIs). The merger of these two figures gives us the total FX open position of the corporates. To compute households’ FX assets, we summed up their investments in FX deposits, Eurobonds, FX-denominated GDDIs and FX-denominated participation accounts in special finance institutions. Subtracting FX-indexed consumer loans from this figure, we came up with the FX positions of the households.
Turkey’s net FX position slid to negative territory in 1Q11, with a US$8.4bn deficit as of May 2011, for the first time in its history… The difference between the CBT’s study and our analysis is that we exclude direct investments abroad, which, we reckon, should not be considered as part of FX assets from a liquidity perspective, since they do not result from financial transactions. Consequently, the CBT’s findings for 1Q11 remain around US$5bn lower than our computation. Despite this difference, for this time period our analysis reveals trends that are similar to the CBT’s study (Graph 2). Moreover, our analysis presents a comparable outlook from 2000 until the second half of 2011. For the FX positions of other segments included in our calculation, such as domestic banks and the Central Bank of Turkey, we took the figures directly from the BRSA’s and the CBT’s bulletins. We used net FX position calculations for the banks (On-Balance Sheet FX Position – Off-Balance Sheet FX Position) and for the CBT (Foreign Assets – Total FX Liabilities). Unfortunately, we do not have information about the FX assets and liabilities of the public sector; but we think, as a financial agent of the Turkish Treasury, the CBT’s FX position could represent the big picture -- more or less. All in all, we found that Turkey’s net FX position fell into negative territory in 1Q11, reaching a US$8.4bn deficit as of May 2011, for the first time in its history, when we combined all the segments of the economy (Graph 3). The previous low (US$2.3bn surplus) was recorded in October 2008, a few months prior to the global crisis and the rapid deterioration in FX net positions during the 2008 expansion was totally in line with the previous peak in the current account of the Turkish economy. Although the overall net FX position still looks roughly balanced, the sharp widening in the short corporate FX position since the end of 2010, in particular, appears worrisome.
However, there are some factors that could impart some comfort when evaluating the overall risk... First of all, the calculations are performed on the basis of a balance sheet approach. Therefore, the net FX position is a stock indicator and does not tell much about the maturity structure. When FX liquidity is a concern during hectic market conditions, the maturity of FX assets and liabilities does matter. As the CBT has been collecting this information for some time, they have been able to calculate the short-term net FX position of the corporates. According to these figures, the difference between the FX assets and liabilities of the corporate sector shorter than 1-year maturity is only US$9.1bn as of 1Q11. Generally, FX assets are in the form of deposits and look more liquid, while liabilities are in the form of long-term loans with less roll-over and re-pricing risk. Second, for small and medium-sized enterprises (SMEs), we think that the figures on their balance sheet do not exactly reflect their actual FX position. In our opinion, to assess the total effect of FX movements on the economy, elevated FX-denominated assets of real persons and FX open positions of legal entities should be considered together. In other words, especially as regards to SMEs, we cannot disregard the possibility that the personal FX positions of the owners might be counterbalancing the open positions of their companies. As of May 2009, our analysis on a volume basis indicates that 84% of the total FX deposits pertain to amounts higher than TRL50K, belonging to 1mn persons, who constitute only 1.5% of the total number of depositors (Table 1).
Bottom-line… As confirmed by our findings, the existence of over US$100bn in short FX position by the corporate sector sounds disconcerting. Even the CBT’s entire FX reserves (US$93bn as of end-July) would be short of covering this amount, in the event that they decided to close all their positions. However, we demonstrate in our study that there are similar big FX long positions elsewhere in Turkey to counterbalance this amount when needed, and that the short-term portion of corporate FX positions is limited. Moreover, the widening of FX short positions is totally related with the expansion of the C/A deficit and the availability of its financing. Therefore, the second half of this year could present a very different picture, with signs of further slowdown in economic activity and improvement in the C/A deficit. We admit that this is far from relieving, and trends in FX positioning should be followed closely. Moreover, the corporates need to prudently manage their FX risks. Accordingly, we will publish the findings of this study regularly with the issuance of new data, such as international investment position and foreign debt stock, released on a quarterly basis.
Do we have a clue on FX positions in Turkey?... Management of risks associated with FX positions took on greater significance following the adoption of the floating exchange rate regime in Turkey. Moreover, increasingly volatile global capital movements in the recent period and accordingly, unanticipated changes in FX rates reinforced these risks. While the FX risk from the banks’ standpoint -- following the regulations adopted in 2001 and the measures consequently instituted -- stands remarkably low, for the corporates, which had been increasingly resorting to external borrowing facilities, the situation is not that clear. Besides, on the issue of FX positions, neither non-financial corporates are required to present additional reporting, nor are there any limits on capital adequacy ratios. Hence, while speculations on this area could arise quite easily, the extent of the related risks cannot be clearly fathomed. Obviously, any remarkable volatility in FX rates will have a significant impact on corporate profitability and capital. Besides, this situation also raises the spectre of additional risks for the banks, in the form of an increase in bad loans if the corporates fail to duly redeem their debt. In other words, although the banks had adopted the necessary measures to protect themselves from FX-related risks on their balance sheets, the situation is not all that secure from their perspective, as the FX risk assumed by the corporates could trigger credit risk. However, we are not completely clueless on this situation, either. The Central Bank of Turkey has been publishing the quarterly net FX positions of the corporates (Foreign Exchange Assets and Liabilities of Non-Financial Companies) based on Turkey’s International Investment Position (IIP) since 2006. According to these figures, the net open position of the corporates, after having surged to US$94.3bn as of end 2010, has increased further to US$111.7bn in 1Q11 (Graph 1). Within the 2006-08 period, the net open position increased rapidly to US$80.4bn from US$37.8bn, mainly due to a rise in the FX loans provided by domestic and external sources, thanks to favourable global economic conditions and ample global liquidity during that time. The global crisis in 2008-09 brought a temporary pause to the expansion of open positions, but did not change the trend; and the biggest ever quarterly increase was seen in 1Q11. However, the CBT data come with a significant lag (1Q figures in July) and do not reflect Turkey’s aggregate picture in terms of FX positions. This is because asset dollarization is still high in our economy, since households hold significant amounts of FX deposits in the banking system, whereas their FX liabilities are limited to FX-indexed consumer loans. Savings tends to be invested in FX-denominated assets, since households, having experienced chronic inflation for many years, consider these assets as more secure and expect to benefit from the movements in FX rates in periods of political uncertainty and unsteady economic growth. This means a massive long FX position in households, comparable to the corporate short FX position. Moreover, one should consider the similar long FX position of the Central Bank of Turkey when evaluating the FX risk in its entirety. Therefore, these major discrepancies prompt us to calculate Turkey’s net FX position -- and more importantly with less of a lag.
Our methodology and approach in short… We used monthly IIP data available for May to calculate the FX position of the corporates generated from transactions with institutions abroad. To this figure, we added their local FX positions, which resulted from their transactions with the domestic banking system. In order to compute corporates’ local open positions, we extracted FX-denominated and FX-indexed loans and receivables entered to the records by the Savings Deposit Insurance Fund (SDIF) from legal entities’ FX deposits, Eurobonds and FX-denominated Government Domestic Debt Instruments (GDDIs). The merger of these two figures gives us the total FX open position of the corporates. To compute households’ FX assets, we summed up their investments in FX deposits, Eurobonds, FX-denominated GDDIs and FX-denominated participation accounts in special finance institutions. Subtracting FX-indexed consumer loans from this figure, we came up with the FX positions of the households.
Turkey’s net FX position slid to negative territory in 1Q11, with a US$8.4bn deficit as of May 2011, for the first time in its history… The difference between the CBT’s study and our analysis is that we exclude direct investments abroad, which, we reckon, should not be considered as part of FX assets from a liquidity perspective, since they do not result from financial transactions. Consequently, the CBT’s findings for 1Q11 remain around US$5bn lower than our computation. Despite this difference, for this time period our analysis reveals trends that are similar to the CBT’s study (Graph 2). Moreover, our analysis presents a comparable outlook from 2000 until the second half of 2011. For the FX positions of other segments included in our calculation, such as domestic banks and the Central Bank of Turkey, we took the figures directly from the BRSA’s and the CBT’s bulletins. We used net FX position calculations for the banks (On-Balance Sheet FX Position – Off-Balance Sheet FX Position) and for the CBT (Foreign Assets – Total FX Liabilities). Unfortunately, we do not have information about the FX assets and liabilities of the public sector; but we think, as a financial agent of the Turkish Treasury, the CBT’s FX position could represent the big picture -- more or less. All in all, we found that Turkey’s net FX position fell into negative territory in 1Q11, reaching a US$8.4bn deficit as of May 2011, for the first time in its history, when we combined all the segments of the economy (Graph 3). The previous low (US$2.3bn surplus) was recorded in October 2008, a few months prior to the global crisis and the rapid deterioration in FX net positions during the 2008 expansion was totally in line with the previous peak in the current account of the Turkish economy. Although the overall net FX position still looks roughly balanced, the sharp widening in the short corporate FX position since the end of 2010, in particular, appears worrisome.
However, there are some factors that could impart some comfort when evaluating the overall risk... First of all, the calculations are performed on the basis of a balance sheet approach. Therefore, the net FX position is a stock indicator and does not tell much about the maturity structure. When FX liquidity is a concern during hectic market conditions, the maturity of FX assets and liabilities does matter. As the CBT has been collecting this information for some time, they have been able to calculate the short-term net FX position of the corporates. According to these figures, the difference between the FX assets and liabilities of the corporate sector shorter than 1-year maturity is only US$9.1bn as of 1Q11. Generally, FX assets are in the form of deposits and look more liquid, while liabilities are in the form of long-term loans with less roll-over and re-pricing risk. Second, for small and medium-sized enterprises (SMEs), we think that the figures on their balance sheet do not exactly reflect their actual FX position. In our opinion, to assess the total effect of FX movements on the economy, elevated FX-denominated assets of real persons and FX open positions of legal entities should be considered together. In other words, especially as regards to SMEs, we cannot disregard the possibility that the personal FX positions of the owners might be counterbalancing the open positions of their companies. As of May 2009, our analysis on a volume basis indicates that 84% of the total FX deposits pertain to amounts higher than TRL50K, belonging to 1mn persons, who constitute only 1.5% of the total number of depositors (Table 1).
Bottom-line… As confirmed by our findings, the existence of over US$100bn in short FX position by the corporate sector sounds disconcerting. Even the CBT’s entire FX reserves (US$93bn as of end-July) would be short of covering this amount, in the event that they decided to close all their positions. However, we demonstrate in our study that there are similar big FX long positions elsewhere in Turkey to counterbalance this amount when needed, and that the short-term portion of corporate FX positions is limited. Moreover, the widening of FX short positions is totally related with the expansion of the C/A deficit and the availability of its financing. Therefore, the second half of this year could present a very different picture, with signs of further slowdown in economic activity and improvement in the C/A deficit. We admit that this is far from relieving, and trends in FX positioning should be followed closely. Moreover, the corporates need to prudently manage their FX risks. Accordingly, we will publish the findings of this study regularly with the issuance of new data, such as international investment position and foreign debt stock, released on a quarterly basis.
3 Ağustos 2011 Çarşamba
Flexible Inflation Targeting...
MPC meeting (July 21st) is likely to bring some important changes to the current stance of the CBT which are signalled beforehand during the meeting with economists in Ankara on July 5th… One reason for this manoeuvre is simple. This is the month when the CBT publishes quarterly inflation report (July 28) and thereby review all of its macro projections that could have an impact on policy outlook. The message which was given for the likely path of the policy mix (limited additional tightening in 2H11 that will bring the loan growth to 20-25% by YE11) in the previous report is clearly outdated and has to be renewed in our view. The second and third reasons are related to the CBT’s assessment about the ongoing uncertainty regarding the global economy and the slowdown in domestic economic activity. The CBT had mentioned the risk scenario regarding a deterioration in global outlook (“should the problems in advanced economies intensify, leading to contraction in domestic economic activity, this may require an easing in all policy instruments”) at the July 5th meeting with economists, which a sign that it has more weight within the alternative scenarios. Therefore, it implies the reversal of the contractionary impact of policy mix --probably through lower RRR-- in the case of sequential contraction in the domestic economic activity. Note that the CBT anticipates GDP remaining flat in 2Q in seasonally adjusted terms as suggested by the charts presented at that meeting. Our preliminary estimate for 2Q also is inline with their forecast. We think the observed deceleration in economic activity was mainly a consequence of the weakness in external demand, while there has been no visible slowdown in domestic consumption. However, we would beg to disagree with the CBT if the above mentioned risk scenario soon becomes the base scenario, as we still do not see any hard evidences indicating that there is a permanent loss of momentum. On the contrary, all leading indicators (PMI, capacity utilisation, consumption index) for June are recovered from their troughs in May. Nevertheless, the fresh concerns about highly indebted countries of Eurozone, the ongoing weakness of job creation in the US and the Chinese inflation remain as obstacles to a visible acceleration in the global economy. All in all, it seems that the outlook for the domestic economic activity will not be changed significantly in the upcoming MPC statement and in the Inflation Report. Probably, the CBT will not change its output gap forecast notably either, despite higher than expected growth in 1Q. Therefore, the MPC is likely to continue to lean on weak external demand and might reiterate its view that the aggregate demand conditions do not indicate an overheating.
CBT will tolerate the core inflation increase… In due course, the CBT described the inflation outlook as benign at the July 5th meeting, despite the recent pickup in core inflation, hinting that there will be no noteworthy change in the CBT’s inflation forecasts. Note that, in the previous Inflation Report, the CBT revised up its inflation forecast to 6.9% for 2011, while keeping 2012 inflation forecast almost unchanged at 5.2%, under their main assumptions for average oil price ($115), annual import prices increase (16.2%) and food inflation (7.5%). This would imply a new year-end CPI forecast in the vicinity of 7% as these assumptions are still valid and annual CPI as of June converged again to the path foreseen in the April Inflation Report. We also project inflation will decelerate towards 5.5% in 3Q11 and re-accelerates to 7% by YE11, as food inflation tends to fluctuate massively throughout the year. However, we are more concerned about the upward trend in core inflation in the remainder of the year. Higher import prices, as well as strong domestic demand are expected to further lift the core inflation in the coming months. We foresee that the CBT’s favourite core indicator (I) would increase (from 5.27% in June) to 6% in 3Q, and 6.5% at the end of 2011.
Moreover, the CBT discloses its projection for one of the core inflation measures (CPI excluding unprocessed food, tobacco and alcoholic beverages) in the Inflation Report and we notice that this core inflation has already breached above the upper band of the forecast range as of June (Graph 1). Nevertheless, CBT still sees this increase as a relative price adjustment of tradable goods rather than deterioration in the overall pricing behaviour and it seems that the CBT attaches more importance to the trend of core indicators rather than the annual increase in those indicators that reflects unfavourable base effect. As a trend indicator, CBT uses the seasonally adjusted annualized 3-month averages of core-H and core-I, as well as services prices. As of June, which is the latest available data, all of those indicators are trending downwards and two of them are around 5.5% target for the headline CPI (Graph 2). Although, the recent TRL depreciation should warrant a cautious stance due to the potential pass-through effect on prices, the CBT is more inclined to tolerate further YoY increases in core indicators unless their trend turns north.
Loan growth could slowdown, but not to 25% without further BRSA measures... For the other important issues like loan growth and current account, the Bank remains confident by reiterating that the loan growth rate will be observed to fall to 25% in the last quarter of 2011 and the current account deficit will start improving from 4Q11 onwards. Indeed, at first sight, it seems that 2H11 could turn out closer to the desired picture, with another round of increase (240 bps) in consumer loan rate (Graph 3) after the mid-June decisions by the BRSA on general provisions and to some extent due to the favourable base effect originated by the loan demand brought forward in anticipation of higher costs. Moreover, the loan growth is seasonally the lowest in 3Q and tends to be roughly half that of 2Q. However, the trend indicator that the CBT follows (the 4-week average trend growth in consumer loans) remained above the 2006-2010 average in the last couple of weeks (Graph 4). According to our calculations, the weekly changes in line with the 2006-2010 average in the second half would imply around 35% loan growth at the year-end --not much different from the current trend. We think, the year-end target will unlikely to be within reach, without further measures from the BRSA.
C/A deficit could get worse before it stabilises… Elsewhere, on the back of the strong recovery in domestic demand and higher commodity prices, 12-m rolling CA deficit hit a record high US$68.2bn as of May’11, corresponding to 8.8% of the GDP. Similar to some other macro indicators, there are sings of moderation in imports recently. Based on our calculations, non-energy imports have been declining in seasonally-adjusted terms during the last two months. However, this evidence neither guarantees a steady downward trend, nor seems sufficient to allay concerns over current account balances. Moreover, exports also declined in seasonally-adjusted terms due to slowdown in 2Q in the global economy. We expect the 12-m cumulative CA deficit to GDP ratio to peak around 9.5 - 10% in 4Q11. This would keep Turkey vulnerable to sudden stop risks in the capital flows on the back of rising concerns about Eurozone. However, the financing of the deficit will not be a problem with the current status of global liquidity amidst the revival of QE3 discussions after FOMC minutes.
Can TRL make the necessary adjustment?.. The current monetary policy stance, deteriorating C/A deficit and lower global risk appetite will certainly keep depreciation pressure on TRL. In the absence of measures --including fiscal ones-- from other institutions, weaker TRL would help the adjustment process of macroeconomic imbalances (wide difference between the growth rates of domestic and external demand) to the extent that CBT can tolerate the overshooting of CPI target. That means, in case of excessive depreciation, i.e. above 2.0 basket (0.5$+0.5€) level, CBT may further lower the daily FX purchases, suspend FX auctions or narrow the interest rate corridor by increasing the O/N borrowing rate from 1.5% in a bid to make TRL attractive for carry trades.
No significant help from fiscal side… Last but not the least, the CBT continues to see the fiscal discipline as essential to control the C/A deficit but it looks like they do not pencil tax hikes on consumer goods and they are probably contented with governments’ saving the extra revenues from stronger economic activity and debt restructuring. Therefore, we have to keep a close eye on central government primary expenditures as % of GDP from now on, to evaluate the fiscal discipline.
To conclude, the CBT is still far away from returning to orthodox policies and more importantly they are inclined to tolerate further increases in annual core inflation indicators unless their trend turns north. For the moment, this means the maintenance of current policy stance. However, if the risk scenario related to global economy becomes the base scenario soon, then there is a significant probability of dropping the “tightening” bias in the monetary policy stance. Although we acknowledge that the global and local economic activity has been moderating in 2Q, we think there is still a decent probability that this slowdown could prove temporary. In that context, we decided to wait for the new Inflation Report to revisit our call for 100 bps hike in 4Q, although we are aware of the fact that the consensus perception from the meeting in Ankara is geared towards “no rate hike this year”. In any case, we do not expect RRR hikes in TRL or FX liabilities in 2011.
CBT will tolerate the core inflation increase… In due course, the CBT described the inflation outlook as benign at the July 5th meeting, despite the recent pickup in core inflation, hinting that there will be no noteworthy change in the CBT’s inflation forecasts. Note that, in the previous Inflation Report, the CBT revised up its inflation forecast to 6.9% for 2011, while keeping 2012 inflation forecast almost unchanged at 5.2%, under their main assumptions for average oil price ($115), annual import prices increase (16.2%) and food inflation (7.5%). This would imply a new year-end CPI forecast in the vicinity of 7% as these assumptions are still valid and annual CPI as of June converged again to the path foreseen in the April Inflation Report. We also project inflation will decelerate towards 5.5% in 3Q11 and re-accelerates to 7% by YE11, as food inflation tends to fluctuate massively throughout the year. However, we are more concerned about the upward trend in core inflation in the remainder of the year. Higher import prices, as well as strong domestic demand are expected to further lift the core inflation in the coming months. We foresee that the CBT’s favourite core indicator (I) would increase (from 5.27% in June) to 6% in 3Q, and 6.5% at the end of 2011.
Moreover, the CBT discloses its projection for one of the core inflation measures (CPI excluding unprocessed food, tobacco and alcoholic beverages) in the Inflation Report and we notice that this core inflation has already breached above the upper band of the forecast range as of June (Graph 1). Nevertheless, CBT still sees this increase as a relative price adjustment of tradable goods rather than deterioration in the overall pricing behaviour and it seems that the CBT attaches more importance to the trend of core indicators rather than the annual increase in those indicators that reflects unfavourable base effect. As a trend indicator, CBT uses the seasonally adjusted annualized 3-month averages of core-H and core-I, as well as services prices. As of June, which is the latest available data, all of those indicators are trending downwards and two of them are around 5.5% target for the headline CPI (Graph 2). Although, the recent TRL depreciation should warrant a cautious stance due to the potential pass-through effect on prices, the CBT is more inclined to tolerate further YoY increases in core indicators unless their trend turns north.
Loan growth could slowdown, but not to 25% without further BRSA measures... For the other important issues like loan growth and current account, the Bank remains confident by reiterating that the loan growth rate will be observed to fall to 25% in the last quarter of 2011 and the current account deficit will start improving from 4Q11 onwards. Indeed, at first sight, it seems that 2H11 could turn out closer to the desired picture, with another round of increase (240 bps) in consumer loan rate (Graph 3) after the mid-June decisions by the BRSA on general provisions and to some extent due to the favourable base effect originated by the loan demand brought forward in anticipation of higher costs. Moreover, the loan growth is seasonally the lowest in 3Q and tends to be roughly half that of 2Q. However, the trend indicator that the CBT follows (the 4-week average trend growth in consumer loans) remained above the 2006-2010 average in the last couple of weeks (Graph 4). According to our calculations, the weekly changes in line with the 2006-2010 average in the second half would imply around 35% loan growth at the year-end --not much different from the current trend. We think, the year-end target will unlikely to be within reach, without further measures from the BRSA.
C/A deficit could get worse before it stabilises… Elsewhere, on the back of the strong recovery in domestic demand and higher commodity prices, 12-m rolling CA deficit hit a record high US$68.2bn as of May’11, corresponding to 8.8% of the GDP. Similar to some other macro indicators, there are sings of moderation in imports recently. Based on our calculations, non-energy imports have been declining in seasonally-adjusted terms during the last two months. However, this evidence neither guarantees a steady downward trend, nor seems sufficient to allay concerns over current account balances. Moreover, exports also declined in seasonally-adjusted terms due to slowdown in 2Q in the global economy. We expect the 12-m cumulative CA deficit to GDP ratio to peak around 9.5 - 10% in 4Q11. This would keep Turkey vulnerable to sudden stop risks in the capital flows on the back of rising concerns about Eurozone. However, the financing of the deficit will not be a problem with the current status of global liquidity amidst the revival of QE3 discussions after FOMC minutes.
Can TRL make the necessary adjustment?.. The current monetary policy stance, deteriorating C/A deficit and lower global risk appetite will certainly keep depreciation pressure on TRL. In the absence of measures --including fiscal ones-- from other institutions, weaker TRL would help the adjustment process of macroeconomic imbalances (wide difference between the growth rates of domestic and external demand) to the extent that CBT can tolerate the overshooting of CPI target. That means, in case of excessive depreciation, i.e. above 2.0 basket (0.5$+0.5€) level, CBT may further lower the daily FX purchases, suspend FX auctions or narrow the interest rate corridor by increasing the O/N borrowing rate from 1.5% in a bid to make TRL attractive for carry trades.
No significant help from fiscal side… Last but not the least, the CBT continues to see the fiscal discipline as essential to control the C/A deficit but it looks like they do not pencil tax hikes on consumer goods and they are probably contented with governments’ saving the extra revenues from stronger economic activity and debt restructuring. Therefore, we have to keep a close eye on central government primary expenditures as % of GDP from now on, to evaluate the fiscal discipline.
To conclude, the CBT is still far away from returning to orthodox policies and more importantly they are inclined to tolerate further increases in annual core inflation indicators unless their trend turns north. For the moment, this means the maintenance of current policy stance. However, if the risk scenario related to global economy becomes the base scenario soon, then there is a significant probability of dropping the “tightening” bias in the monetary policy stance. Although we acknowledge that the global and local economic activity has been moderating in 2Q, we think there is still a decent probability that this slowdown could prove temporary. In that context, we decided to wait for the new Inflation Report to revisit our call for 100 bps hike in 4Q, although we are aware of the fact that the consensus perception from the meeting in Ankara is geared towards “no rate hike this year”. In any case, we do not expect RRR hikes in TRL or FX liabilities in 2011.
1 Temmuz 2011 Cuma
Hard Evidences of a Soft Patch?...
Global and local economic activity has been moderating in 2Q, but there is still a decent probability that this slowdown could prove temporary. July PMI data due for release on August 1 will be key in helping us discern the likely path of global economic activity. While the recent sharp reversal in energy and commodity prices should help to allay mounting concerns over the current account deficit and inflation pressure for a while, any relief appears unsustainable in the event of a global revival in economic activity.
The currently observed deceleration in economic activity is mainly a consequence of the weakness in external demand, while there has been no visible slowdown in domestic consumption. Therefore, we are still away from a soft landing. Moreover, this is certainly not the expected result of the implemented policy mix aimed at rebalancing external and domestic demand. However, 2H11 could turn out closer to the desired picture, with another round of consumer loan rate increases after the mid-June decisions by the BRSA on general provisions, and to some extent due to the favourable base effect from loan demand brought forward in anticipation of higher costs. Many banking analysts mentioned that the loan growth is seasonally the lowest in 3Q and tends to be roughly half that of 2Q, ceteris paribus. This would bode well for the CBT’s efforts to curb lending growth to 25%. However, recently the 4-week average trend growth in consumer loans has exceeded the 2006-2010 average. According to my calculation, weekly changes in line with the 2006-2010 average in the second half would imply around 35% loan growth at the year-end – not much different from the current trend. Therefore, the CBT and the economy administration would need to see a much sharper deceleration than the seasonal trends in 2H, to rule out the need for further measures.
Going forward, the data and news flow (inflation, loan growth, external balance and measures) until the July 21 MPC meeting will be crucial, since in the meantime the CBT will also have reviewed its stance and other projections for the preparation of the Quarterly Inflation Report, slated for release on July 28.
I reckon that RRR hikes are not on the table now and policy rate decisions will be linked to the core inflation outlook. Although the likely convergence of the headline CPI to the CBT’s projections in June would support the credibility of the Bank, I think core inflation does matter and recent TRL depreciation should warrant a cautious stance due to the potential pass-through effect on prices. Barring a further deterioration in the global economic outlook, I think the CBT will need to embark on a more orthodox policy mix, considering our above target core inflation (I) forecast. We continue to expect a 100bp policy rate hike in 4Q11.
The currently observed deceleration in economic activity is mainly a consequence of the weakness in external demand, while there has been no visible slowdown in domestic consumption. Therefore, we are still away from a soft landing. Moreover, this is certainly not the expected result of the implemented policy mix aimed at rebalancing external and domestic demand. However, 2H11 could turn out closer to the desired picture, with another round of consumer loan rate increases after the mid-June decisions by the BRSA on general provisions, and to some extent due to the favourable base effect from loan demand brought forward in anticipation of higher costs. Many banking analysts mentioned that the loan growth is seasonally the lowest in 3Q and tends to be roughly half that of 2Q, ceteris paribus. This would bode well for the CBT’s efforts to curb lending growth to 25%. However, recently the 4-week average trend growth in consumer loans has exceeded the 2006-2010 average. According to my calculation, weekly changes in line with the 2006-2010 average in the second half would imply around 35% loan growth at the year-end – not much different from the current trend. Therefore, the CBT and the economy administration would need to see a much sharper deceleration than the seasonal trends in 2H, to rule out the need for further measures.
Going forward, the data and news flow (inflation, loan growth, external balance and measures) until the July 21 MPC meeting will be crucial, since in the meantime the CBT will also have reviewed its stance and other projections for the preparation of the Quarterly Inflation Report, slated for release on July 28.
I reckon that RRR hikes are not on the table now and policy rate decisions will be linked to the core inflation outlook. Although the likely convergence of the headline CPI to the CBT’s projections in June would support the credibility of the Bank, I think core inflation does matter and recent TRL depreciation should warrant a cautious stance due to the potential pass-through effect on prices. Barring a further deterioration in the global economic outlook, I think the CBT will need to embark on a more orthodox policy mix, considering our above target core inflation (I) forecast. We continue to expect a 100bp policy rate hike in 4Q11.
17 Mayıs 2011 Salı
A Preview of 2011 Elections
The findings of the opinion polls published so far invariably show the incumbent AKP as the leading party. Most of them even indicate a higher voter support for the AKP at the 2011 elections with respect to 2007. However, this does not necessarily imply a higher number of seats in Parliament for the party, as the number of MPs could vary widely, based not only on the amount of votes garnered, but also on the distribution of votes across political parties; the number of parties exceeding the 10% threshold; and the number of independent MPs.
We estimated the critical level of votes for the AKP under different scenarios, in a bid to gauge the direction of the AKP’s policies post-2011 elections.
The first scenario shows the distribution of MPs based on the average of the most recent and reliable election polls. Accordingly, under the assumption of 32 independent MPs making it to Parliament and the AKP, the CHP and the MHP gaining 48%, 26% and 12% of the votes, respectively, we estimate the AKP winning 326 seats in Parliament, slightly lower than its current number of seats of 331. Moreover, in this eventuality, although it exceeds the requirement of 276 to form a single-party government, it fails to meet the requisite 330 seats to amend the constitution through a referendum.
The second scenario assumes the minor opposition party MHP remaining slightly below the country threshold of 10%, as some surveys have indicated. Under this scenario, the AKP wins 357 MPs with 48% of the votes, while CHP gets 161 seats with 26% of the votes. One interesting point to note is that even in a two-party Parliament with 32 independent MPs, the AKP may still fail to win a sufficient number of seats to amend the constitution without taking it to a referendum, unless it wins more than 52% of the votes.
Under the third and fourth scenarios, we estimated the minimum number of votes that would enable the AKP to pass a constitutional amendment with a referendum (min 330 MPs) or without a referendum (min 367 MPs). According to our simulations, in a three-party parliament with 32 independent MPs, the AKP would need to garner at least 45% of the votes to secure 330 MPs and at least 59.5% to secure 367 MPs, even if we assumed that the CHP and the MHP scored the worst results suggested by leading poll findings.
Hence, we conclude that
1- It seems almost impossible for the AKP to lose its single-party government status, i.e. fall below 276 MP
2- The AKP is likely to win around 330 MPs at the 2011 elections. If it exceeds 330, the AKP may amend the constitution to enable the adoption of the presidential system, and take it to a referendum. If it trails the 330 mark, we wouldn’t expect the AKP to go for a constitutional amendment.
3- The AKP is very unlikely to secure 367 seats, unless the MHP fails to pass the 10% threshold for representation in Parliament or the CHP’s voter support recedes back to its pre-Kilicdaroglu levels (around 20%). Therefore, it seems quite unlikely that the AKP will have the power to change the constitution by itself, i.e. without the support of other political parties or a referendum.
Having said that, it is not possible to derive reliable inferences regarding the outcome of the elections out of the current polls, due to the ambiguities related to the success of the election campaigns, parties’ candidates, as well as how voting decisions will be affected by the alliances and election agreements on the left and right. However, we expect the surveys to be conducted in the run up to the elections to yield more reliable findings, potentially enabling us to discern which of the aforementioned scenarios would be closer to the actual election outcome.
The Day After
A solid victory on the part of the AKP would set the stage for a constitutional reform, as Prime Minister Erdogan, while launching his party manifesto on April 16 ahead of June elections, pledged to undertake a complete overhaul of the current
constitution after the elections. Also, it is no secret that Erdogan ultimately wants to become the President. Erdogan is thought to be interested in replacing the current Turkish parliamentary system -- which allocates all executive powers to the
Parliament and its chosen cabinet -- with a presidential system. Moreover, PM Erdogan, who is believed to covet the presidential post, has not mentioned any plans for a presidential system in the manifesto. However, based on various
statements to date by Erdogan, the most likely system seems to be the US-type presidential system. A presidential system is not a foregone conclusion, however, as there is likely to be a great deal of opposition from within the AKP to such a
radical change.
In 2007, the Turkish Parliament amended the Constitution to allow the Turkish people to elect the head of the state, in lieu of the Parliament appointing someone to this position. However, it took nearly four years to amend the related laws regulating the
presidential election process, due to the legal ambiguity surrounding the tenure of the current president. According to the Constitution, the people will elect a president for a five-year period with the right to run for a second term. The new bill, which allows prime ministers and other figures the right to remain in their electoral seats while they campaign for presidency, is being interpreted as the first sign by Erdogan that he will seek the position, though this does not clear all the obstacles on the way to his presidency. Since Erdogan has announced that this will be the last time he seeks deputyship, the result of the 2011 elections
should indicate whether or not Erdogan might run for president. Timing is also important in this case, as the duration of President Abdullah Gul’s tenure is not clear at this point. The new bill does not address the issues as to whether President
Gul will serve his current term of seven years or a new one of five years when the next presidential elections take place or if Gul could run for president again. Some political pundits have claimed that Gul’s tenure should not extend to beyond 2012, while others have suggested that the presidential elections should be held in 2014. Erdogan has previously implied that Gul’s term should be five years. The Supreme Election Board (YSK) will have the final word on the matter.
However, there are other interpretations... According to a prominent political analyst and researcher, Tarhan Erdem, from KONDA, the next presidential election will most likely be held in 2012 and the date is already set.
“When are the presidential elections to be held? Preparations for the constitution that are to begin post-elections, and PM Erdogan having expressed his “approval” of the presidential regime, further strengthened in recent months the preconception that Erdogan was coveting the presidential seat. No one seemed even willing to listen to the contrary! If the Constitution were completed on time, presidential elections would be held in 2012; if not presidential elections would be deferred to 2014 and Erdogan would become the President!... However, in recent days, the Parliament, while setting the MP election date, has also determined the presidential election date: Presidential elections will have been completed within the 60 days preceding August 28, 2012. It is stated that whether presidential elections will be held in 2012 or 2014 will be decided by the High Election Board (YSK). This view, however, contravenes both the law and precedents. The YSK does not determine the terms of the Turkish Grand National Assembly (TBMM), the President, or the provincial assemblies; these are decided by the Constitution, or by the Parliament, in conformity with the Constitution. The TBMM has designated how the constitutional amendment changing the presidential and parliamentary terms should be construed with its decision dated March 3, 2011, indicating that MP elections will be held prior to the completion of the 4-year period proceeding the 2007 elections. The term of the President, set as 5 years with the same law, will have expired on August 28, 2012.” (4 April 2011, Radikal)
Therefore, the distribution of seats at the next parliamentary elections is likely to be critical.
If the AKP secures 330-367 seats in Parliament in June 2011, it may have the power to change the constitution (with a referendum if it secures 330 seats - without a referendum if it secures 367 seats), which it will likely use to extend the power of the current president and introduce a presidential system. PM Erdogan could resign from the prime ministry and run for presidency in 2012 or 2014, depending on the YSK decision regarding the presidential election date.
If the AKP gets less than 330 seats, the presidential system may not come on the agenda, as the AKP would not have the power to change the constitution without the support of the opposition. Under this scenario, we think the odds of PM Erdogan
opting to abandon his powers as PM and run for presidency decrease substantially.
We estimated the critical level of votes for the AKP under different scenarios, in a bid to gauge the direction of the AKP’s policies post-2011 elections.
The first scenario shows the distribution of MPs based on the average of the most recent and reliable election polls. Accordingly, under the assumption of 32 independent MPs making it to Parliament and the AKP, the CHP and the MHP gaining 48%, 26% and 12% of the votes, respectively, we estimate the AKP winning 326 seats in Parliament, slightly lower than its current number of seats of 331. Moreover, in this eventuality, although it exceeds the requirement of 276 to form a single-party government, it fails to meet the requisite 330 seats to amend the constitution through a referendum.
The second scenario assumes the minor opposition party MHP remaining slightly below the country threshold of 10%, as some surveys have indicated. Under this scenario, the AKP wins 357 MPs with 48% of the votes, while CHP gets 161 seats with 26% of the votes. One interesting point to note is that even in a two-party Parliament with 32 independent MPs, the AKP may still fail to win a sufficient number of seats to amend the constitution without taking it to a referendum, unless it wins more than 52% of the votes.
Under the third and fourth scenarios, we estimated the minimum number of votes that would enable the AKP to pass a constitutional amendment with a referendum (min 330 MPs) or without a referendum (min 367 MPs). According to our simulations, in a three-party parliament with 32 independent MPs, the AKP would need to garner at least 45% of the votes to secure 330 MPs and at least 59.5% to secure 367 MPs, even if we assumed that the CHP and the MHP scored the worst results suggested by leading poll findings.
Hence, we conclude that
1- It seems almost impossible for the AKP to lose its single-party government status, i.e. fall below 276 MP
2- The AKP is likely to win around 330 MPs at the 2011 elections. If it exceeds 330, the AKP may amend the constitution to enable the adoption of the presidential system, and take it to a referendum. If it trails the 330 mark, we wouldn’t expect the AKP to go for a constitutional amendment.
3- The AKP is very unlikely to secure 367 seats, unless the MHP fails to pass the 10% threshold for representation in Parliament or the CHP’s voter support recedes back to its pre-Kilicdaroglu levels (around 20%). Therefore, it seems quite unlikely that the AKP will have the power to change the constitution by itself, i.e. without the support of other political parties or a referendum.
Having said that, it is not possible to derive reliable inferences regarding the outcome of the elections out of the current polls, due to the ambiguities related to the success of the election campaigns, parties’ candidates, as well as how voting decisions will be affected by the alliances and election agreements on the left and right. However, we expect the surveys to be conducted in the run up to the elections to yield more reliable findings, potentially enabling us to discern which of the aforementioned scenarios would be closer to the actual election outcome.
The Day After
A solid victory on the part of the AKP would set the stage for a constitutional reform, as Prime Minister Erdogan, while launching his party manifesto on April 16 ahead of June elections, pledged to undertake a complete overhaul of the current
constitution after the elections. Also, it is no secret that Erdogan ultimately wants to become the President. Erdogan is thought to be interested in replacing the current Turkish parliamentary system -- which allocates all executive powers to the
Parliament and its chosen cabinet -- with a presidential system. Moreover, PM Erdogan, who is believed to covet the presidential post, has not mentioned any plans for a presidential system in the manifesto. However, based on various
statements to date by Erdogan, the most likely system seems to be the US-type presidential system. A presidential system is not a foregone conclusion, however, as there is likely to be a great deal of opposition from within the AKP to such a
radical change.
In 2007, the Turkish Parliament amended the Constitution to allow the Turkish people to elect the head of the state, in lieu of the Parliament appointing someone to this position. However, it took nearly four years to amend the related laws regulating the
presidential election process, due to the legal ambiguity surrounding the tenure of the current president. According to the Constitution, the people will elect a president for a five-year period with the right to run for a second term. The new bill, which allows prime ministers and other figures the right to remain in their electoral seats while they campaign for presidency, is being interpreted as the first sign by Erdogan that he will seek the position, though this does not clear all the obstacles on the way to his presidency. Since Erdogan has announced that this will be the last time he seeks deputyship, the result of the 2011 elections
should indicate whether or not Erdogan might run for president. Timing is also important in this case, as the duration of President Abdullah Gul’s tenure is not clear at this point. The new bill does not address the issues as to whether President
Gul will serve his current term of seven years or a new one of five years when the next presidential elections take place or if Gul could run for president again. Some political pundits have claimed that Gul’s tenure should not extend to beyond 2012, while others have suggested that the presidential elections should be held in 2014. Erdogan has previously implied that Gul’s term should be five years. The Supreme Election Board (YSK) will have the final word on the matter.
However, there are other interpretations... According to a prominent political analyst and researcher, Tarhan Erdem, from KONDA, the next presidential election will most likely be held in 2012 and the date is already set.
“When are the presidential elections to be held? Preparations for the constitution that are to begin post-elections, and PM Erdogan having expressed his “approval” of the presidential regime, further strengthened in recent months the preconception that Erdogan was coveting the presidential seat. No one seemed even willing to listen to the contrary! If the Constitution were completed on time, presidential elections would be held in 2012; if not presidential elections would be deferred to 2014 and Erdogan would become the President!... However, in recent days, the Parliament, while setting the MP election date, has also determined the presidential election date: Presidential elections will have been completed within the 60 days preceding August 28, 2012. It is stated that whether presidential elections will be held in 2012 or 2014 will be decided by the High Election Board (YSK). This view, however, contravenes both the law and precedents. The YSK does not determine the terms of the Turkish Grand National Assembly (TBMM), the President, or the provincial assemblies; these are decided by the Constitution, or by the Parliament, in conformity with the Constitution. The TBMM has designated how the constitutional amendment changing the presidential and parliamentary terms should be construed with its decision dated March 3, 2011, indicating that MP elections will be held prior to the completion of the 4-year period proceeding the 2007 elections. The term of the President, set as 5 years with the same law, will have expired on August 28, 2012.” (4 April 2011, Radikal)
Therefore, the distribution of seats at the next parliamentary elections is likely to be critical.
If the AKP secures 330-367 seats in Parliament in June 2011, it may have the power to change the constitution (with a referendum if it secures 330 seats - without a referendum if it secures 367 seats), which it will likely use to extend the power of the current president and introduce a presidential system. PM Erdogan could resign from the prime ministry and run for presidency in 2012 or 2014, depending on the YSK decision regarding the presidential election date.
If the AKP gets less than 330 seats, the presidential system may not come on the agenda, as the AKP would not have the power to change the constitution without the support of the opposition. Under this scenario, we think the odds of PM Erdogan
opting to abandon his powers as PM and run for presidency decrease substantially.
19 Nisan 2011 Salı
Taking Stock of the CBT’s Policy Mix
ACHIEVEMENTS
Volatile money market rates and intentional ambiguity on policy stance As a result of the policy rate cuts and widening interest rate corridor, rates in the secondary market for repos fluctuated intensely and deviated from the policy rate for a longer period of time. Within November-December 2010, the 10-day average of the O/N repo and 1m swap rates hovered below the policy rate. Meanwhile, the CBT left the door open for additional rate cuts, a move that we feel was intended to impede a clear understanding of the Bank’s policy stance, hence to make any positioning more difficult.
Heavy outflows from short-term bets; partial shift to longer maturities Based on the BRSA’s off-balance sheet data for the banks, cumulative outflows from Turkish markets have reached US$11.5bn in between the MPC meeting held in November and the end of February. Short-term fund outflows are noted to be mainly the result of the closure of money market positions of the non-residents, in the form of swaps, deposits, repos and credit transactions. A partial return of these flows caused a shift in non-residents’ positions within November 2010 – February 2011 in favour of longer maturities, mainly through accumulation of domestic debt instruments.
Banks’ reliance on short-term funds is on the rise; so is the interest rate risk... Before the recent agressive hike, the CBT increased TRL reserve requirement ratio (RRR) gradually three times and withdrew TL19.5bn cumulatively. This has brought the CBT funding through 1w repo auctions to the TL25-30bn range recently. Since the March RRR hike will have taken effect on April 15, 2011, liquidity to the tune of about TL19.1bn will be withdrawn from the market and will pull the total funding from the CBT up to the TL45-50bn range. Contrary to speculations about insufficient liquidity injections by the CBT, we think the monetary authority needs to provide the liquidity demanded in the market, to
maintain money market rates close to the policy rate. However, banks will become more dependent on very short-term Central Bank resources despite additional funding. Hence, even when banks’ loan levels remain unchanged, their maturity mismatch
will increase. Banks will have to reflect the additional interest rate risk to their loan rates and/or scale back their loan portfolios.
FAILURES
Decline in TRL deposit rates; no increase in TRL loan rates...Banks had the chance to scale down the interest rate of the deposit whose cost had increased, given full substitutability of short-term Central Bank funds with deposits. Thus, the rise in the cost reflected more on deposit rates than on loan rates, at least before the latest hike in RRR.
Although this 400bp increase may be a game changer, the data on the average interest rate on loans for the March 25 week, when the MPC meeting took place, are not promising. Only the interest rate on commercial loans increased by a considerable
37bp to 8.78%. While the cash and vehicle loan interest rates even declined by 7bp and 5bp to 11.97% and 10.51%, respectively, the interest rate on housing loans increased by an insignificant 3bp to 9.76%.
Loan growth is still strong on all metrics...
Despite all the measures adopted, the slowdown in loan growth is still not significant, as total loans are increasing at an annual rate of 41% and consumer loans at 35% as of March 25. We also think the exchange rate effect on FX loans should be neutralised by using fixed FX rates against the TRL and a fixed
currency (60% US$-40% €) composition. We took the last 22 business days’ average of total loans (fixed FX rates and fixed FX composition) to represent the monthly outlook and compared it with the average of the same period a year ago. The annual
increase in our indicator is still high at 34.7% as of end-March.
Where to henceforth?
Too early to call a cease-fire... Considering the achievements versus failures of the CBT’s policy mix, it would be somewhat premature, in our view, to expect the monetary authority to refrain from adopting further tightening measures, until there is conclusive evidence of a slowdown in loan volume and domestic demand.
The Central Bank bought time; but the window of opportunity is a narrow one... The CBT expects the restrictive effects of these policy measures to be observed with a lag, possibly starting with the second quarter. The monetary authority also bought time by launching front-loaded RRR hikes with its recent move. Moreover, it called for supplementary macro-prudential measures targeting credit supply from other institutions (read as BRSA) to extend the wait-and-see period. However, this window of opportunity is not wide open: now is the time to observe more concrete developments (rise in deposit and loan rates) -- even before the major liquidity withdrawal takes place.
CBT drives short-term rates up; pressures the banks... As one of the channels (cost) for transmission of RR is not working, the CBT relied heavily on the other (liquidity) channel. Further liquidity withdrawal on April 15 and a wider interest rate corridor provide the CBT with the opportunity to drive O/N rates wherever it wants them to be. Within November-December, the CBT’s aim was to discourage portfolio inflows; hence, O/N rates fell sharply. But now, the main concern is relentless loan growth; so the CBT is driving the rates to the upper limit (Primary Dealers Facility, which is at 8% vs. policy rate of 6.25%) of the interest rate corridor. However, we need to acknowledge that this cannot be a permanent strategy in an Inflation Targeting regime, where the Central Bank has to provide the liquidity demanded in the market, to maintain money market rates close to the policy rate. Otherwise, the policy rate will lose its significance as a reference rate.
Is it early for FX RR hike?... Up until now, the CBT used TRL RRR as its main policy tool. However, now the average weighted RRR stands at 13.4%, higher than the uniform FX RRR of 11%. Meanwhile, banks increased their FX deposit rates and were granted permission to issue FX bonds. This creates the perception that RRR hikes in FX deposits might be in the pipeline. Also as expected, the coverage of the liabilities subject to RRR may be expanded and the RRRs may be differentiated according to the nature and maturity of liabilities, including the off-balance sheet liabilities (mainly swaps) of the banking system. We do not
think we are there yet, especially in terms of RRR hikes that withdraw FX liquidity, since banks are still not comfortable, as the “claims from abroad” account has halved to US$12.5bn during the hot money outflows and remained at that level since then.
Swap RR also likely... On the other hand, we have been observing inflows through swap transactions since the start of March, due to attractive money market rates. Over the last four weeks, cumulative inflows have amounted to US$8.8bn, corresponding to almost 70% of the outflows within November-March. Since March 4, the TRL has appreciated by 5.7% against the US$. This picture could compel the CBT to act by broadening the coverage of liabilities subject to RR to include off-balance sheet items.
New Governor, Old Bank... As the quarterly inflation report will be published in April, the MPC meeting on 21 April, under the presidency of the new governor, has become more crucial. As a reminder, the CBT’s baseline scenario in the previous report envisaged a gradual tightening this year by changing the mix of the policy rate and RRRs. According to the CBT, monetary tightening could be implemented either through RRRs or policy rates, or a combination of both. Until now, the RRR leg of the policy mix has been used and its impact through the liquidity channel has been relied upon. Although we do not expect further TRL RR hikes in the short-term, we see some room if necessary and expect the usage of untapped FX related measures
including FX buying auctions. However, in the absence of any meaningful slowdown in loan growth and domestic demand, despite all the measures taken to date and discussed above, the recent positive inflation outlook could only delay an inevitable
policy rate increase by a few months.
Volatile money market rates and intentional ambiguity on policy stance As a result of the policy rate cuts and widening interest rate corridor, rates in the secondary market for repos fluctuated intensely and deviated from the policy rate for a longer period of time. Within November-December 2010, the 10-day average of the O/N repo and 1m swap rates hovered below the policy rate. Meanwhile, the CBT left the door open for additional rate cuts, a move that we feel was intended to impede a clear understanding of the Bank’s policy stance, hence to make any positioning more difficult.
Heavy outflows from short-term bets; partial shift to longer maturities Based on the BRSA’s off-balance sheet data for the banks, cumulative outflows from Turkish markets have reached US$11.5bn in between the MPC meeting held in November and the end of February. Short-term fund outflows are noted to be mainly the result of the closure of money market positions of the non-residents, in the form of swaps, deposits, repos and credit transactions. A partial return of these flows caused a shift in non-residents’ positions within November 2010 – February 2011 in favour of longer maturities, mainly through accumulation of domestic debt instruments.
Banks’ reliance on short-term funds is on the rise; so is the interest rate risk... Before the recent agressive hike, the CBT increased TRL reserve requirement ratio (RRR) gradually three times and withdrew TL19.5bn cumulatively. This has brought the CBT funding through 1w repo auctions to the TL25-30bn range recently. Since the March RRR hike will have taken effect on April 15, 2011, liquidity to the tune of about TL19.1bn will be withdrawn from the market and will pull the total funding from the CBT up to the TL45-50bn range. Contrary to speculations about insufficient liquidity injections by the CBT, we think the monetary authority needs to provide the liquidity demanded in the market, to
maintain money market rates close to the policy rate. However, banks will become more dependent on very short-term Central Bank resources despite additional funding. Hence, even when banks’ loan levels remain unchanged, their maturity mismatch
will increase. Banks will have to reflect the additional interest rate risk to their loan rates and/or scale back their loan portfolios.
FAILURES
Decline in TRL deposit rates; no increase in TRL loan rates...Banks had the chance to scale down the interest rate of the deposit whose cost had increased, given full substitutability of short-term Central Bank funds with deposits. Thus, the rise in the cost reflected more on deposit rates than on loan rates, at least before the latest hike in RRR.
Although this 400bp increase may be a game changer, the data on the average interest rate on loans for the March 25 week, when the MPC meeting took place, are not promising. Only the interest rate on commercial loans increased by a considerable
37bp to 8.78%. While the cash and vehicle loan interest rates even declined by 7bp and 5bp to 11.97% and 10.51%, respectively, the interest rate on housing loans increased by an insignificant 3bp to 9.76%.
Loan growth is still strong on all metrics...
Despite all the measures adopted, the slowdown in loan growth is still not significant, as total loans are increasing at an annual rate of 41% and consumer loans at 35% as of March 25. We also think the exchange rate effect on FX loans should be neutralised by using fixed FX rates against the TRL and a fixed
currency (60% US$-40% €) composition. We took the last 22 business days’ average of total loans (fixed FX rates and fixed FX composition) to represent the monthly outlook and compared it with the average of the same period a year ago. The annual
increase in our indicator is still high at 34.7% as of end-March.
Where to henceforth?
Too early to call a cease-fire... Considering the achievements versus failures of the CBT’s policy mix, it would be somewhat premature, in our view, to expect the monetary authority to refrain from adopting further tightening measures, until there is conclusive evidence of a slowdown in loan volume and domestic demand.
The Central Bank bought time; but the window of opportunity is a narrow one... The CBT expects the restrictive effects of these policy measures to be observed with a lag, possibly starting with the second quarter. The monetary authority also bought time by launching front-loaded RRR hikes with its recent move. Moreover, it called for supplementary macro-prudential measures targeting credit supply from other institutions (read as BRSA) to extend the wait-and-see period. However, this window of opportunity is not wide open: now is the time to observe more concrete developments (rise in deposit and loan rates) -- even before the major liquidity withdrawal takes place.
CBT drives short-term rates up; pressures the banks... As one of the channels (cost) for transmission of RR is not working, the CBT relied heavily on the other (liquidity) channel. Further liquidity withdrawal on April 15 and a wider interest rate corridor provide the CBT with the opportunity to drive O/N rates wherever it wants them to be. Within November-December, the CBT’s aim was to discourage portfolio inflows; hence, O/N rates fell sharply. But now, the main concern is relentless loan growth; so the CBT is driving the rates to the upper limit (Primary Dealers Facility, which is at 8% vs. policy rate of 6.25%) of the interest rate corridor. However, we need to acknowledge that this cannot be a permanent strategy in an Inflation Targeting regime, where the Central Bank has to provide the liquidity demanded in the market, to maintain money market rates close to the policy rate. Otherwise, the policy rate will lose its significance as a reference rate.
Is it early for FX RR hike?... Up until now, the CBT used TRL RRR as its main policy tool. However, now the average weighted RRR stands at 13.4%, higher than the uniform FX RRR of 11%. Meanwhile, banks increased their FX deposit rates and were granted permission to issue FX bonds. This creates the perception that RRR hikes in FX deposits might be in the pipeline. Also as expected, the coverage of the liabilities subject to RRR may be expanded and the RRRs may be differentiated according to the nature and maturity of liabilities, including the off-balance sheet liabilities (mainly swaps) of the banking system. We do not
think we are there yet, especially in terms of RRR hikes that withdraw FX liquidity, since banks are still not comfortable, as the “claims from abroad” account has halved to US$12.5bn during the hot money outflows and remained at that level since then.
Swap RR also likely... On the other hand, we have been observing inflows through swap transactions since the start of March, due to attractive money market rates. Over the last four weeks, cumulative inflows have amounted to US$8.8bn, corresponding to almost 70% of the outflows within November-March. Since March 4, the TRL has appreciated by 5.7% against the US$. This picture could compel the CBT to act by broadening the coverage of liabilities subject to RR to include off-balance sheet items.
New Governor, Old Bank... As the quarterly inflation report will be published in April, the MPC meeting on 21 April, under the presidency of the new governor, has become more crucial. As a reminder, the CBT’s baseline scenario in the previous report envisaged a gradual tightening this year by changing the mix of the policy rate and RRRs. According to the CBT, monetary tightening could be implemented either through RRRs or policy rates, or a combination of both. Until now, the RRR leg of the policy mix has been used and its impact through the liquidity channel has been relied upon. Although we do not expect further TRL RR hikes in the short-term, we see some room if necessary and expect the usage of untapped FX related measures
including FX buying auctions. However, in the absence of any meaningful slowdown in loan growth and domestic demand, despite all the measures taken to date and discussed above, the recent positive inflation outlook could only delay an inevitable
policy rate increase by a few months.
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