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.
18 Ağustos 2011 Perşembe
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.
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