The mood in the financial markets has turned decidedly sour over the last few weeks amid a welter of disappointing economic news from around the world. The U.S. is in the center of this pessimism – first the home sales data and then the non-farm payrolls surprised on the downside and erased hopes for an early recovery in the U.S.
In the EU, weak growth outlook persists, accompanied by debates over the feasibility of a credible post-crisis mechanism. It seems that the volatility in the markets would likely remain high or even get higher due to both global and local developments. Globally, the weak recovery pace in developed markets would likely be of main concern. Locally, the Central Bank of Turkey’s new monetary policy toolbox to fulfill the dual mandate of low inflation and financial stability would add to the short-term uncertainty and thus the general volatility. For instance, currently the market is mostly expecting a 50 basis point cut at the next meeting of the Monetary Policy Committee, or MPC, on Jan. 20. However, it doesn’t seem to be a done deal, bearing in mind the currency depreciation recently.
As I’ve mentioned here before, policy rates currently appear to be a function of the short-term fund flows, thus the fluctuations in the level of currency should also be considered. The portfolio inflows have slowed down in December and there seems to be a global risk aversion tendency, which is pushing the currency rates higher in Turkey, beyond some very important technical resistance levels. If this tendency is to be preserved till the next Monetary Policy Committee meeting, then the Central Bank may opt to wait a bit longer before cutting rates further. If really it is the case, the Central Bank may preserve this tool for the times when the portfolio inflows intensify and lead to sharp currency appreciation.
On the other ingredient of policy mix, namely the reserve requirement ratio, the Central Bank relies on this old-fashioned tool to slow down the credit growth, which is considered to be highly correlated with the current account deficit. While the consensus expectation for the deficit points to 6.2 percent of GDP in 2010, the Central Bank says that the credit growth should be limited to 25 percent in order to attain a current account deficit level of 5.4 percent of GDP in 2011. The current trend of credit growth is at 40 percent and it would definitely necessitate more reserve requirement rises in order to attain such a slowdown. So I expect the Central Bank to hike the reserve requirement of foreign exchange liabilities this month (more on short-term liabilities again), but also consider more rises on Turkish Lira liabilities in the following months.
Permanent bears
In November, the current account deficit hit a record $5.9 billion. Also, the 12-month cumulative deficit increased to $44.9 billion, from $40.8 billion in the previous month. I expect that the deficit will continue to expand, reaching $46.6 billion in 2010 (6.2 percent of GDP). In my opinion, for an energy-hungry country the deficit is structural and Turkey is no stranger to large current account deficits. However, although I have been following the Turkish economy for many years, I still do not understand the real cause of concern of some market pundits. Is it the deficit, its financing or the quality of financing? This time they put forward the dominance of short-term portfolio inflows in the financing of the current account deficit as a cause of concern. But I remember very well that the same pundits were worried in 2008 as well when the financing was coming from long-term items such as foreign direct investment and long-term loans. Now I understand that there is no way to dispel all worries of some pundits because they are permanent bears.
Early signs of pre-election spending?
Early indicator of the budget performance, The Treasury’s cash-based budget produced a bulky 11.2 billion-lira non-interest deficit in December. The surge in the non-interest expenditures was the key reason behind the weak performance. However, this was not uncommon, as every December points to similar expansion in expenditures. Besides, based on these cash figures, the central government budget deficit to GDP ratio would be slightly above 3 percent in 2010, much below the revised official estimate at 4 percent in the Medium Term Fiscal Program.
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