Summary: While the markets seem to have been satisfied with the Fed’s decisions, the developing countries have once again started to feel the pressure of currency appreciation and the rapid capital inflows. In due course, Turkey continues to proceed with their plan to struggle amidst the new global economic backdrop and tries to intervene via new and old tools, where the constraint is the inflation outlook.
The long awaited decision by the FOMC has finally been revealed and the market reaction has so far been as expected. The Fed’s quantitative easing (QE) program has garnered almost all of the market attention that it even has taken the front seat to the U.S. midterm elections. Fed announced that they would purchase an additional $600bn of Treasury securities, with the overall purchases reaching $850mn-$900mn in 8 months, including some $250-300bn worth of reinvestments from the previous program. The assets purchased will have an average duration of between 5 and 6 years, which is the single feature of the program that may have created disappointment. Almost half of the assets will have a maturity of 5 to 10 years, while the 40% is planned to be of maturities between 2.5-5 years. Following the FOMC statement, the 2-year Treasury yield has slid to a historical low of 0.34% and the Fed funds futures indicate that no rate change is expected until the last quarter of 2012. Note that this is the case, despite the absence of any enhancement to the Fed’s phrase regarding the necessity of ‘low levels for the federal funds rate for an extended period’. Note also that ‘the Committee will regularly review the pace of its securities purchases and the overall size of the asset-purchase program in light of incoming information and will adjust the program as needed.’ This would leave the door open to changes in both directions. Moreover, just as the rate decisions are subject to growth and employment outlook, the above phrase assumes conditionality for the QE size and provides some flexibility to the Fed. As shall be recalled, the key properties of an ideal QE program mentioned in our comment published on October 12th listed exactly the same aspects. Therefore, the decisions did not come as a surprise. Accordingly, the financial markets have now returned to their positive trend and to the strong risk appetite environment. It seems that going forward, we will keep discussing about the appreciation pressure on TRY, as well as how further the country risk premiums and interest rates would fall, accompanied with the new record highs in the stock markets.
The Fed decisions would no doubt intensify the pressure on the emerging country central banks, which have already been dealing with the rapid capital inflows to their countries that result in appreciation of local currencies and has the risk of generating asset bubbles. Amidst this contentious environment, Turkey stands at a different point, being concerned with rapid domestic credit expansion and searching ways to suppress it, unlike the U.S. Turkish Central Bank Deputy Governor Basci told in a conference last week that Turkey should impede the credit expansion in its economy which has enjoyed a fast rebound after the global crisis and that new policy instruments may be required for that purpose. This was not much unexpected and the banking sector should be ready for creative and new tools, atop of the already introduced measures such as the increase in required reserves, abolishment of interest paid on reserves and the increase in the KKDF (Resource Utilization Support Fund) rate on consumer credits. The road-map regarding to these new instruments may be disclosed at the 2011 Foreign Exchange and Monetary Policy report due to be released at the beginning of the next month, the latest. However, the inflation pattern would play a critical role in order to give the Bank enough space to follow their plan.
Turkish Consumer Price Index rose by 1.83% m/m in October, overshooting the consensus, while the deviation from forecast was mostly due to the significant jump of 4.5% in food prices. Accordingly, the annual food inflation reached 17.1%, remaining above the Bank’s year-end assumption of 10.5%. The cumulative increase in food prices in the last two months of the last year was 7.7%, meaning that the prices should remain unchanged in the rest of this year in order to bring the annual inflation in line with the Bank’s forecast. Given the seasonal and other factors, this scenario seems quite unlikely. The unprocessed food prices that surged significantly over the last three months (from 8% to 31% y/y) have been the reason behind the elevated food component. In essence, the high level of volatility in food prices is one of the major obstacles against the process of disinflationary goals. A Central Bank study that covers the period between 2006-2009 shows that the volatility of monthly food price inflation in Turkey is 4 times of the EU-27, while this ratio goes up to 6 for the unprocessed food component, with Turkey having a higher volatility of monthly unprocessed food price inflation than each of the EU27 members. It should be noted that the volatility is two-sided and the inflation can fall as rapidly as it ascended. Nevertheless, recognizing that this would not happen all of a sudden, I revised my year-end CPI forecast to 7.7% from 7.2% due to the change in our food price assumptions. On the other hand, I continue to anticipate CPI easing to 6.0% by the end of 2011 with the help of the taming in food segment.
Contrary to the increase in the annual headline inflation, there were declines in the core indicators. The annual price change of the Central Bank’s favorite core indicator (excluding food, energy, gold, alcoholic beverages and tobacco), namely the “core-I” index, declined by a significant 1.2 pp m/m to 2.5%. While this is the sixth consecutive fall in annual core inflation, current level is its lowest level in the history of the series that started in 2003. Furthermore, the annual price change in services declined by 0.4 pp to 4.2%, again the lowest in the history of the series.
All in all, there is no doubt that the underlying inflation proceeds at a benign pace. Yet this does not change the fact that there is this disturbingly wide gap between the headline and the core. The Central Bank is also concerned with this issue by emphasizing the risk of jeopardy in pricing behavior. The Bank warns that they may hike earlier than planned, in case this risk materializes. On the other hand, the Central Bank seems quite comfortable here, as a recent CBRT working paper titled “A New Core Inflation Indicator for Turkey” concludes that ‘...when inflation deviates from core inflation, it converges back to the core inflation; but not the other way around.’ However, this does not necessarily mean that the headline CPI would converge to 2.5%. The empirical data show that even though there are cases where headline converges to the core, the two indices happen to meet somewhere in the middle following a significant decoupling.
Therefore, while the leading indicators warn against some revival in the economic activity going forward, it would unlikely ring any alarm bells in the Central Bank with such an encouraging underlying inflation trend. While this data is supportive of the already dovish stance of the Central Bank, we continue to expect the rate hikes to start in the last quarter of next year and amount to 100bps in 2011.
5 Kasım 2010 Cuma
25 Ekim 2010 Pazartesi
Rebalancing Bargain...
Summary: Whether you name it the “currency wars” or the war between Asian reflection and U.S. deflation, the implication would be intensified financial stability risk for Turkey, where growth is already constrained by the depressed external demand. Turkey is among the countries that exacerbate the global imbalances, which is seen as the culprits of the wars. Instead of pushing forward with the reforms to address the structural deficit, Turkey has so far been more engaged in reducing risks regarding the deficit financing. The Central Bank has taken such measures and they will likely continue doing so in the upcoming period to curtail these risks.
The surprise rate hike from the Central Bank of China last week has raised speculation regarding the G-20 decisions to be shaped at their weekend meeting. Moreover, this tightening move from China induced the markets to deviate from their current trend and exacerbate the market volatility. Basically, what we see was the softening of EUR/$, accompanied with the stock market sell-off. The mentioned speculation is about a “grand bargain between the U.S. and China.” The bargain assumes that the Federal Reserve to be less aggressive in an expected second round of quantitative easing when the FOMC meets on November 3rd in return for China tightening monetary policy and letting their currency Yuan to appreciate at a faster pace. On the other hand, Martin Wolf in example, from Financial Times is in the camp that perceives the recent developments in the context of a war between Asian reflation and U.S. deflation. Wolf says the U.S. would win the war thanks to their ability to print unlimited amount of dollar which is the reserve currency (either by pushing inflation higher or appreciating currencies against dollar in the rest of the World). The first rate hike from China since end-2007 is also interpreted to be a pre-emptive move, hinting that the monetary policy tools, aside from the F/X policy are part of the arsenal now. All in all, it is believed that the countries in Asia would guard against the ultra loose monetary policy objective of the U.S. which would export inflation to Asia through asset price bubbles. The market has perceived this new battle to be a risk against asset prices and the risk appetite has lost some ground. It is difficult to argue which of the above theses is true. However, there is one thing certain that the World continues to suffer from the lingering malaise in the post global crisis environment. Whether you name it the “currency wars” or the war between Asian reflation and U.S. deflation, the implication seems to be intensified financial stability risk for Turkey, where growth is already constrained by the depressed external demand. The good news is that the Central Bank has already been underscoring these risks for a while and acting fast in launching measures to combat these risks.
Behind the wars lie the global imbalances (high current account surplus in Asia, high C/A deficit in the U.S.) which failed to be corrected by the crisis, while the decoupling between countries during the recovery has made the situation even worse. In that context, the issue of maintaining a strong, balanced and sustainable growth has also been discussed by Oliver Blanchard, IMF Economic Counselor, who emphasized the difficulty of reaching this goal and outlined two complex global rebalancing acts that are required. First, internal rebalancing, that is based on the private demand taking the lead again in developed countries and on the consolidation of fiscal balances that were ruined during crisis. The second aspect of rebalancing is external rebalancing, which includes many advanced countries, most notably the U.S., relying more on net exports and many emerging countries, most notably China, turning more to domestic demand. Blanchard says both of these balancing acts have been proceeding, albeit at a very slow pace.
Turkey is also among the countries that inflate the global imbalances with an estimated current account deficit of above 5% this year. In essence, both cyclical and structural factors play role in rapid expansion of the current account deficit in Turkey, which in that sense does not match the emerging market prototype having external surpluses on the back of their commodity or industrial goods exports. Nevertheless, instead of pushing forward with the reforms to address the structural deficit, Turkey has so far been more engaged in reducing risks regarding the deficit financing that has become more vulnerable recently.
The Central Bank’s decisions announced from September onwards are also in this category. In our previous posts, we mentioned about how the Turkish Central Bank describes the new conjuncture. The Central Bank had warned that the intensive capital flows into trusted and dynamic emerging market economies during this period underscore the risk of overheating, excess borrowing and emergence of asset bubbles in these economies, eventually pushing the current account deficit to levels that may jeopardize the financial stability. The Bank had also said that the Bank’s latest decisions (about required reserves and F/X purchase auctions) should be seen as a preparation in advance of the new conjuncture. The Central Bank continued to stress these risks in the MPC meeting held afterwards. In the last meeting, the Bank said ‘While not yet a significant concern regarding financial stability, the Committee has indicated that these developments support the implementation of the “exit strategy” measures.’ As we noted many times before, we expect these measures to continue, while the pace of domestic demand, in particular the domestic loan growth rate of the banking system, would be the key criteria in determining how fast the Central Bank would act. The weekly data for domestic loans have so far implied no change in the rate of expansion since the measures were taken.
In the Inflation Report due October 26th or in the 2011 Monetary and Exchange Rate Policy due December, the latest, the Central Bank would likely outline in more detail the roadmap about required reserves, which have become a more effective tool in curtailing macroeconomic and financial stability risks. This would help the banking sector to better visualize the future and hence fulfill their intermediary role between the monetary authority and the household and real sector in a more stable way.
The surprise rate hike from the Central Bank of China last week has raised speculation regarding the G-20 decisions to be shaped at their weekend meeting. Moreover, this tightening move from China induced the markets to deviate from their current trend and exacerbate the market volatility. Basically, what we see was the softening of EUR/$, accompanied with the stock market sell-off. The mentioned speculation is about a “grand bargain between the U.S. and China.” The bargain assumes that the Federal Reserve to be less aggressive in an expected second round of quantitative easing when the FOMC meets on November 3rd in return for China tightening monetary policy and letting their currency Yuan to appreciate at a faster pace. On the other hand, Martin Wolf in example, from Financial Times is in the camp that perceives the recent developments in the context of a war between Asian reflation and U.S. deflation. Wolf says the U.S. would win the war thanks to their ability to print unlimited amount of dollar which is the reserve currency (either by pushing inflation higher or appreciating currencies against dollar in the rest of the World). The first rate hike from China since end-2007 is also interpreted to be a pre-emptive move, hinting that the monetary policy tools, aside from the F/X policy are part of the arsenal now. All in all, it is believed that the countries in Asia would guard against the ultra loose monetary policy objective of the U.S. which would export inflation to Asia through asset price bubbles. The market has perceived this new battle to be a risk against asset prices and the risk appetite has lost some ground. It is difficult to argue which of the above theses is true. However, there is one thing certain that the World continues to suffer from the lingering malaise in the post global crisis environment. Whether you name it the “currency wars” or the war between Asian reflation and U.S. deflation, the implication seems to be intensified financial stability risk for Turkey, where growth is already constrained by the depressed external demand. The good news is that the Central Bank has already been underscoring these risks for a while and acting fast in launching measures to combat these risks.
Behind the wars lie the global imbalances (high current account surplus in Asia, high C/A deficit in the U.S.) which failed to be corrected by the crisis, while the decoupling between countries during the recovery has made the situation even worse. In that context, the issue of maintaining a strong, balanced and sustainable growth has also been discussed by Oliver Blanchard, IMF Economic Counselor, who emphasized the difficulty of reaching this goal and outlined two complex global rebalancing acts that are required. First, internal rebalancing, that is based on the private demand taking the lead again in developed countries and on the consolidation of fiscal balances that were ruined during crisis. The second aspect of rebalancing is external rebalancing, which includes many advanced countries, most notably the U.S., relying more on net exports and many emerging countries, most notably China, turning more to domestic demand. Blanchard says both of these balancing acts have been proceeding, albeit at a very slow pace.
Turkey is also among the countries that inflate the global imbalances with an estimated current account deficit of above 5% this year. In essence, both cyclical and structural factors play role in rapid expansion of the current account deficit in Turkey, which in that sense does not match the emerging market prototype having external surpluses on the back of their commodity or industrial goods exports. Nevertheless, instead of pushing forward with the reforms to address the structural deficit, Turkey has so far been more engaged in reducing risks regarding the deficit financing that has become more vulnerable recently.
The Central Bank’s decisions announced from September onwards are also in this category. In our previous posts, we mentioned about how the Turkish Central Bank describes the new conjuncture. The Central Bank had warned that the intensive capital flows into trusted and dynamic emerging market economies during this period underscore the risk of overheating, excess borrowing and emergence of asset bubbles in these economies, eventually pushing the current account deficit to levels that may jeopardize the financial stability. The Bank had also said that the Bank’s latest decisions (about required reserves and F/X purchase auctions) should be seen as a preparation in advance of the new conjuncture. The Central Bank continued to stress these risks in the MPC meeting held afterwards. In the last meeting, the Bank said ‘While not yet a significant concern regarding financial stability, the Committee has indicated that these developments support the implementation of the “exit strategy” measures.’ As we noted many times before, we expect these measures to continue, while the pace of domestic demand, in particular the domestic loan growth rate of the banking system, would be the key criteria in determining how fast the Central Bank would act. The weekly data for domestic loans have so far implied no change in the rate of expansion since the measures were taken.
In the Inflation Report due October 26th or in the 2011 Monetary and Exchange Rate Policy due December, the latest, the Central Bank would likely outline in more detail the roadmap about required reserves, which have become a more effective tool in curtailing macroeconomic and financial stability risks. This would help the banking sector to better visualize the future and hence fulfill their intermediary role between the monetary authority and the household and real sector in a more stable way.
18 Ekim 2010 Pazartesi
Bernanke fed QE2 hopes...
Summary: The expectations regarding more accommodative monetary policies in developed markets have recently found further support, with the measures against deflation being discussed more intensely. Despite the decoupling between developed and developing countries, the ultra-loose monetary policies in the former limit the central banks’ maneuvers in the latter. Therefore, many central banks choose to rely on monetary policy tools other than interest rates, such as decisions to prevent currency appreciation or macro prudential tools. Turkey also follows suit.
The news flow have continued to feed into the expectations that the Fed would start the second round of quantitative easing in November meeting and the anticipations of abundant global liquidity conditions have remained supportive of the financial markets. The FOMC minutes of the September 21st meeting was the last example. The FOMC members sounded very hopeless regarding the growth and inflation outlook, while most members favored more easing in monetary policy ‘before long’. Although the Committee members considered it unlikely that the economy would reenter a recession, many expressed concern that output growth, and the associated progress in reducing the level of unemployment, could be slow for some time. Participants noted a number of factors that were restraining growth, including low levels of household and business confidence, heightened risk aversion, and the still weak financial conditions of some households and small firms. Note that Fed has been uncomfortable with inflation being below levels consistent with the FOMC's dual mandate of maintaining full employment and price stability in the long run. While a minority in the Committee believes that additional accommodation would be warranted only if ‘the outlook worsened’ and ‘the odds of deflation increased materially’, many participants see a ‘too slow economic growth that would prevent satisfactory progress toward reducing the unemployment rate’ or ‘inflation surfacing below target levels’ as appropriate to provide additional monetary policy accommodation. In that context, a number of new alternative policy measures have been discussed at September FOMC meeting, as well. Among them ‘expanding long term bond purchases’ and ‘steps that would lift inflation expectations’ were the key focus areas. The minutes show that the members also discussed the best means to calibrate and implement additional asset purchases. Previously, we mentioned the key points of comments from New York Fed official Sack. Recall that his remarks hinted that the asset purchases would be in relatively continuous but smaller steps, rather than in infrequent but large increments.
Sack emphasized that asset purchases that would enlarge the balance sheet should be seen as a substitute for the changes in federal funds rate. The key points in Sacks speech were as follows: 1) the balance sheet should be adjusted in relatively continuous but smaller steps, rather than in infrequent but large increments. 2) The balance sheet decisions should be governed to a large extent by the evolution of the FOMC’s economic forecasts. 3) The movements in balance sheets should be stressed to have some persistency in order to make them more influential. 4) Providing information about the likely course of the balance sheet could be desirable. 5) Some flexibility should be incorporated into the program.
Last but not the least; we also want to touch on the monetary policy measures discussed by the Fed that would affect short term inflation expectations. As is known, real interest rate (that is the difference between nominal interest rates and expected inflation) is influential on total demand. Especially, the inflation expectations turn to be more important for monetary policy makers when policy rates are virtually zero. That is because; a decline in short-term inflation expectations increases short-term real interest rates, thereby damping aggregate demand. Conversely, in such circumstances, an increase in inflation expectations lowers short-term real interest rates, stimulating the economy. Therefore, Fed seems to have started mulling on alternative strategies that would lift short term inflation expectations higher, including providing more detailed information about the rates of inflation the Committee considered consistent with its dual mandate, targeting a path for the price level rather than the rate of inflation, and targeting a path for the level of nominal GDP. The last two strategies are new approaches for the central banking and there are no other countries that use them. Accordingly, these policy alternatives would unlikely be implemented in the short term.
While there are growing signs that the Fed would opt for more monetary easing, other Central Banks have also started to feel the pressure. Glancing at home, the outlook is quite mixed. The surprisingly strong industrial output in August triggered upgrades in growth forecasts, while the automotive sales and domestic demand in general have remained robust. These factors have the potential to put upward pressure on interest rates. On the other hand, the downside risk to external demand, the slowdown signals from leading economic activity indicators, TRY appreciation, the decline in bond yields and risk premiums, the impression of a tighter fiscal policy stance thanks to the Medium Term Program budget targets are all among the factors that would necessitate for lower policy rate or at least would urge for the maintenance of the current stance. The MPC meeting on October 14th was supposed to shed more light on how these developments would affect the Central Bank’s position. This meeting had an added importance since it was the last one to be held prior to the Inflation Report (where the Bank would update the inflation and output gap forecasts) due October 26th. The MPC decision did not involve much surprise and the statement indicated that the exit strategy would remain on course. After the meeting, the Central Bank also announced new decisions regarding the F/X market and open market operations. The Bank seemed to have slightly upgraded their assessment of the economic outlook in general. They said the economic activity continues to recover and domestic demand displays a relatively stronger outlook. In due course the Central Bank presumed headline inflation to be in a declining path, while core inflation was projected to remain consistent with medium term targets. From here, one may conclude that despite the decline in the core price inflation to as low as 3.7% in September, the Bank preferred to remain cautious due to the upside risks on headline CPI regarding the food price inflation. On the policy rate front, the Bank left their rhetoric untouched by reiterating that current levels would be maintained for some time and interest rate would remain low for a long period. The Bank seems to have preferred to wait for Inflation Report to describe the likely interest rate path more clearly. Meanwhile, the Bank also emphasized that the expectations of more accommodative monetary policies in developed economies which boost capital flows toward emerging markets and the accompanied decline in risk premiums, as well as the resulting appreciation of TRY and downside pressure on interest rates exacerbate upside risks to domestic demand and eventually underscore the threats against financial stability. In that concept, it is obvious that the Bank would continue relying on tools other than policy rate. The Bank continued to proceed with measures that would help normalization of the F/X, TRY and open market operations (the Bank abolished its intermediary function in the foreign exchange deposit market, ceased 3-month repo auctions, cut the O/N borrowing rates by an additional 50 bps and cancelled the provision of one-week funding to the primary dealers) and additional increase in TRY required reserve ratio should be expected soon.
The news flow have continued to feed into the expectations that the Fed would start the second round of quantitative easing in November meeting and the anticipations of abundant global liquidity conditions have remained supportive of the financial markets. The FOMC minutes of the September 21st meeting was the last example. The FOMC members sounded very hopeless regarding the growth and inflation outlook, while most members favored more easing in monetary policy ‘before long’. Although the Committee members considered it unlikely that the economy would reenter a recession, many expressed concern that output growth, and the associated progress in reducing the level of unemployment, could be slow for some time. Participants noted a number of factors that were restraining growth, including low levels of household and business confidence, heightened risk aversion, and the still weak financial conditions of some households and small firms. Note that Fed has been uncomfortable with inflation being below levels consistent with the FOMC's dual mandate of maintaining full employment and price stability in the long run. While a minority in the Committee believes that additional accommodation would be warranted only if ‘the outlook worsened’ and ‘the odds of deflation increased materially’, many participants see a ‘too slow economic growth that would prevent satisfactory progress toward reducing the unemployment rate’ or ‘inflation surfacing below target levels’ as appropriate to provide additional monetary policy accommodation. In that context, a number of new alternative policy measures have been discussed at September FOMC meeting, as well. Among them ‘expanding long term bond purchases’ and ‘steps that would lift inflation expectations’ were the key focus areas. The minutes show that the members also discussed the best means to calibrate and implement additional asset purchases. Previously, we mentioned the key points of comments from New York Fed official Sack. Recall that his remarks hinted that the asset purchases would be in relatively continuous but smaller steps, rather than in infrequent but large increments.
Sack emphasized that asset purchases that would enlarge the balance sheet should be seen as a substitute for the changes in federal funds rate. The key points in Sacks speech were as follows: 1) the balance sheet should be adjusted in relatively continuous but smaller steps, rather than in infrequent but large increments. 2) The balance sheet decisions should be governed to a large extent by the evolution of the FOMC’s economic forecasts. 3) The movements in balance sheets should be stressed to have some persistency in order to make them more influential. 4) Providing information about the likely course of the balance sheet could be desirable. 5) Some flexibility should be incorporated into the program.
Last but not the least; we also want to touch on the monetary policy measures discussed by the Fed that would affect short term inflation expectations. As is known, real interest rate (that is the difference between nominal interest rates and expected inflation) is influential on total demand. Especially, the inflation expectations turn to be more important for monetary policy makers when policy rates are virtually zero. That is because; a decline in short-term inflation expectations increases short-term real interest rates, thereby damping aggregate demand. Conversely, in such circumstances, an increase in inflation expectations lowers short-term real interest rates, stimulating the economy. Therefore, Fed seems to have started mulling on alternative strategies that would lift short term inflation expectations higher, including providing more detailed information about the rates of inflation the Committee considered consistent with its dual mandate, targeting a path for the price level rather than the rate of inflation, and targeting a path for the level of nominal GDP. The last two strategies are new approaches for the central banking and there are no other countries that use them. Accordingly, these policy alternatives would unlikely be implemented in the short term.
While there are growing signs that the Fed would opt for more monetary easing, other Central Banks have also started to feel the pressure. Glancing at home, the outlook is quite mixed. The surprisingly strong industrial output in August triggered upgrades in growth forecasts, while the automotive sales and domestic demand in general have remained robust. These factors have the potential to put upward pressure on interest rates. On the other hand, the downside risk to external demand, the slowdown signals from leading economic activity indicators, TRY appreciation, the decline in bond yields and risk premiums, the impression of a tighter fiscal policy stance thanks to the Medium Term Program budget targets are all among the factors that would necessitate for lower policy rate or at least would urge for the maintenance of the current stance. The MPC meeting on October 14th was supposed to shed more light on how these developments would affect the Central Bank’s position. This meeting had an added importance since it was the last one to be held prior to the Inflation Report (where the Bank would update the inflation and output gap forecasts) due October 26th. The MPC decision did not involve much surprise and the statement indicated that the exit strategy would remain on course. After the meeting, the Central Bank also announced new decisions regarding the F/X market and open market operations. The Bank seemed to have slightly upgraded their assessment of the economic outlook in general. They said the economic activity continues to recover and domestic demand displays a relatively stronger outlook. In due course the Central Bank presumed headline inflation to be in a declining path, while core inflation was projected to remain consistent with medium term targets. From here, one may conclude that despite the decline in the core price inflation to as low as 3.7% in September, the Bank preferred to remain cautious due to the upside risks on headline CPI regarding the food price inflation. On the policy rate front, the Bank left their rhetoric untouched by reiterating that current levels would be maintained for some time and interest rate would remain low for a long period. The Bank seems to have preferred to wait for Inflation Report to describe the likely interest rate path more clearly. Meanwhile, the Bank also emphasized that the expectations of more accommodative monetary policies in developed economies which boost capital flows toward emerging markets and the accompanied decline in risk premiums, as well as the resulting appreciation of TRY and downside pressure on interest rates exacerbate upside risks to domestic demand and eventually underscore the threats against financial stability. In that concept, it is obvious that the Bank would continue relying on tools other than policy rate. The Bank continued to proceed with measures that would help normalization of the F/X, TRY and open market operations (the Bank abolished its intermediary function in the foreign exchange deposit market, ceased 3-month repo auctions, cut the O/N borrowing rates by an additional 50 bps and cancelled the provision of one-week funding to the primary dealers) and additional increase in TRY required reserve ratio should be expected soon.
12 Ekim 2010 Salı
Bartenders Refill Punchbowl…
Summary: The financial markets, being convinced that a new phase of quantitative easing would be launched, have started to search for a new equilibrium. The ultra loose monetary policies in developed countries triggered intervention in F/X markets and other measures to discourage capital inflows in many countries, giving the impression of currency wars across the globe. The Central Bank has been prepared to take action to secure financial stability, bearing in mind that this new conjuncture may result in volatility in financial markets. It remains to be seen whether new measures for price stability would also be introduced.
The post-crisis economic backdrop seems to have entered into a new phase of unconventional monetary easing, or more specifically the second round of quantitative easing (QE2). This tool has been especially preferred by developed countries which experience slow economic recovery after the recession and who have already cut policy rates to rock-bottom levels. In September meeting, Fed put greater emphasis on deflation risk and has become the first Central Bank that signaled for expansion in its balance sheet. Moreover, the remarks by a number of Fed officials since then have further fueled into the expectations that Fed would launch QE2 as early as the November 3rd meeting. Japan also joined this camp by lowering the policy rate to 0.0-0.1% range, accompanied with additional asset purchase program. These decisions that would further boost already abundant global liquidity have started to drive the financial markets to a new equilibrium. The Fed’s relative position in terms of monetary policy stance has deteriorated due to their bias for ultra loose monetary policy, consequentially dragging US$ lower across all currencies. The 2-year U.S. Treasury yield slumped to a record low of 0.4%, with the market seeming more deeply convinced that the interest rates would remain low for an extended period. This has also formed the basis for growing appetite for riskier assets. Especially the stock markets across the globe and the emerging market assets in general have become the beneficiaries of this new environment, with the repercussions in Turkey being lower F/X basket and $/TRY, as well as tighter yields along the curve and record highs in stock market. The Central Bank names the key features of this new economic conjuncture as the ‘occurrence of the risks of overheating, excessive indebtness and emergence of asset bubbles as a result of intensive capital inflows towards reliable and dynamic emerging market economies, and the probability of elevated levels of current account deficit threatening financial stability.’ The Bank also says that the additional measures they have taken recently are preparation for the new economic situation, which would dominate the whole world in the upcoming period.
Note that the markets have got very much accustomed to the idea of additional expansion in Fed’s balance sheet (which has expanded to $2.3trn from $860bn prior to the crisis) so that they were not surprised to hear some Fed officials giving details regarding how QE2 would operate. A good example was the speech by Brian Sack from the NY Fed about “Managing the Federal Reserve's Balance Sheet" where he outlined five policy questions that could be considered in designing a purchase program. Sack emphasized that asset purchases that would enlarge the balance sheet should be seen as a substitute for the changes in federal funds rate. The key points in Sacks speech were:
1) Similar to the manner in which the FOMC has historically adjusted the federal funds rate, the balance sheet should be adjusted in relatively continuous but smaller steps, rather than in infrequent but large increments.
2) The balance sheet decisions should be governed to a large extent by the evolution of the FOMC’s economic forecasts just was the case for the decisions regarding the federal funds target rate.
3) The movements in balance sheets should be stressed to have some persistency in order to make them more influential.
4) Providing information about the likely course of the balance sheet could be desirable, similar to the case for federal funds rate.
5) Some flexibility should be incorporated into the program, providing some discretion to change course as market conditions evolve and as more is learned about the instrument.
Note that the ultimate goal of the QE2 is to change the yield curve and revive the economic activity through the banking sector. While doing this, Fed is likely to expand the balance sheet gradually and in small amounts, rather than a substantial and front-loaded approach of the earlier round of asset purchases. While the BoE is foreseen to mirror the steps of its peers BoJ and Fed, the implications of this new round of monetary easing on other Central Banks should be discussed as well. This may urge those Central Banks who have already moved forward with some tightening to give a second thought to their decisions. Moreover, the appreciation of emerging market currencies would potentially have favorable repercussions on inflation with some lag and that could create room for monetary easing maneuvers in some countries, considering also that the risk premiums would remain low in such environments. Ironically, going forward, macroprudential tools may be used more intensively for the sake of financial stability while at the same time a loose monetary policy stance may be adopted to address the price stability objective.
The key question would be whether Turkish Central Bank would also join this camp. Despite the jump in the headline CPI in September, core indices remained below the medium term targets. Moreover, the leading economic activity indicators hinted at some slowdown going forward. These were the developments that supported the Central Bank to at east keep the current monetary policy stance for a longer time. However, it is yet early to conclude whether the fresh developments would be enough to induce the Central Bank for a remarkably change in their baseline scenario that includes limited rate hikes in 2011. We will keep monitoring the signals regarding such a change.
The post-crisis economic backdrop seems to have entered into a new phase of unconventional monetary easing, or more specifically the second round of quantitative easing (QE2). This tool has been especially preferred by developed countries which experience slow economic recovery after the recession and who have already cut policy rates to rock-bottom levels. In September meeting, Fed put greater emphasis on deflation risk and has become the first Central Bank that signaled for expansion in its balance sheet. Moreover, the remarks by a number of Fed officials since then have further fueled into the expectations that Fed would launch QE2 as early as the November 3rd meeting. Japan also joined this camp by lowering the policy rate to 0.0-0.1% range, accompanied with additional asset purchase program. These decisions that would further boost already abundant global liquidity have started to drive the financial markets to a new equilibrium. The Fed’s relative position in terms of monetary policy stance has deteriorated due to their bias for ultra loose monetary policy, consequentially dragging US$ lower across all currencies. The 2-year U.S. Treasury yield slumped to a record low of 0.4%, with the market seeming more deeply convinced that the interest rates would remain low for an extended period. This has also formed the basis for growing appetite for riskier assets. Especially the stock markets across the globe and the emerging market assets in general have become the beneficiaries of this new environment, with the repercussions in Turkey being lower F/X basket and $/TRY, as well as tighter yields along the curve and record highs in stock market. The Central Bank names the key features of this new economic conjuncture as the ‘occurrence of the risks of overheating, excessive indebtness and emergence of asset bubbles as a result of intensive capital inflows towards reliable and dynamic emerging market economies, and the probability of elevated levels of current account deficit threatening financial stability.’ The Bank also says that the additional measures they have taken recently are preparation for the new economic situation, which would dominate the whole world in the upcoming period.
Note that the markets have got very much accustomed to the idea of additional expansion in Fed’s balance sheet (which has expanded to $2.3trn from $860bn prior to the crisis) so that they were not surprised to hear some Fed officials giving details regarding how QE2 would operate. A good example was the speech by Brian Sack from the NY Fed about “Managing the Federal Reserve's Balance Sheet" where he outlined five policy questions that could be considered in designing a purchase program. Sack emphasized that asset purchases that would enlarge the balance sheet should be seen as a substitute for the changes in federal funds rate. The key points in Sacks speech were:
1) Similar to the manner in which the FOMC has historically adjusted the federal funds rate, the balance sheet should be adjusted in relatively continuous but smaller steps, rather than in infrequent but large increments.
2) The balance sheet decisions should be governed to a large extent by the evolution of the FOMC’s economic forecasts just was the case for the decisions regarding the federal funds target rate.
3) The movements in balance sheets should be stressed to have some persistency in order to make them more influential.
4) Providing information about the likely course of the balance sheet could be desirable, similar to the case for federal funds rate.
5) Some flexibility should be incorporated into the program, providing some discretion to change course as market conditions evolve and as more is learned about the instrument.
Note that the ultimate goal of the QE2 is to change the yield curve and revive the economic activity through the banking sector. While doing this, Fed is likely to expand the balance sheet gradually and in small amounts, rather than a substantial and front-loaded approach of the earlier round of asset purchases. While the BoE is foreseen to mirror the steps of its peers BoJ and Fed, the implications of this new round of monetary easing on other Central Banks should be discussed as well. This may urge those Central Banks who have already moved forward with some tightening to give a second thought to their decisions. Moreover, the appreciation of emerging market currencies would potentially have favorable repercussions on inflation with some lag and that could create room for monetary easing maneuvers in some countries, considering also that the risk premiums would remain low in such environments. Ironically, going forward, macroprudential tools may be used more intensively for the sake of financial stability while at the same time a loose monetary policy stance may be adopted to address the price stability objective.
The key question would be whether Turkish Central Bank would also join this camp. Despite the jump in the headline CPI in September, core indices remained below the medium term targets. Moreover, the leading economic activity indicators hinted at some slowdown going forward. These were the developments that supported the Central Bank to at east keep the current monetary policy stance for a longer time. However, it is yet early to conclude whether the fresh developments would be enough to induce the Central Bank for a remarkably change in their baseline scenario that includes limited rate hikes in 2011. We will keep monitoring the signals regarding such a change.
4 Ekim 2010 Pazartesi
New Mission of CBT: Financial Stability
Summary: Lately the Central Bank has been putting a greater emphasis on financial stability. In order to fulfill this goal, they have started using the alternative monetary policy tools other than interest rate more effectively. Having already made some revisions about the RR, the Bank signals that the RR may also be employed as a tool to extend the maturities of deposits. The Central Bank also underlines that the cost associated with the accumulation of financial risks would be higher level of interest rates and therefore a more limited interest rate hike than normally expected may suffice provided that the macroprudential tools are put into force.
The repercussions of the alternative monetary policy tools started to be used by the Central Bank continue to be felt in the markets. Among last week’s decisions launched by the Central Bank, the removal of the interest paid on required reserves (RR) was the major shock to the markets, rather than the increase in the RR ratios. The Central Bank’s exit strategy had not mentioned such a change in regulation and therefore the decision should be considered as a surprise. The Central Bank said their aim is to use RR ratios more actively as a policy tool to mitigate the macroeconomic and financial risks. After all, it was obvious that the increase in the RR by itself would not be enough to limit the credit expansion, given the interest paid on TRY RR which is 80% of the Central Bank’s O/N borrowing rate. Moreover, the news that in order to extend the maturities of deposits the Central Bank may apply varying RR ratios depending on their maturities is a sign that the Central Bank would continue using this alternative policy tool more actively. In the meantime, the Central Bank’s emphasis on further possible reduction in the O/N borrowing rates hints that the Bank would keep utilizing liquidity management facilities more effectively. Having summarized the fresh developments regarding the monetary policy framework, we will now have a closer look into the “financial stability” concept that appears to be the reason behind the regeneration of alternative monetary policy tools, as well as the implications of this concept for the Central Bank’s monetary policy. The financial stability can be defined as avoiding or dispelling the financial system inadequacies and disruptions that could potentially have major distortions on the real economy. Recently, the Central Bank has been putting a special emphasis on this concept, as should be understood from the latest MPC meeting summary where the Bank said that “….global crisis has demonstrated the importance of central banks having an auxiliary financial stability mandate as well as the objective of price stability.” Accordingly, this adds another objective to the Bank’s current obligations of fighting inflation, as well as supporting growth and employment. It at the same time hints that the Central Bank anticipates this objective to become more widespread going forward. The CBRT Law says: “The primary objective of the Bank shall be to achieve and maintain price stability. The Bank shall determine on its own discretion the monetary policy that it shall implement and the monetary policy instruments that it is going to use in order to achieve and maintain price stability.“ Whereas, via the presentations recently made by Central Bank Governor, another mandate has been added and the Bank’s primary roles have been defined as follows: 1. To achieve price stability; 2. To take measures to enhance stability in the financial system; 3. To support the growth and employment policies of the government provided that it shall not be in confliction with the objective of price stability.
This new mandate would likely be included in the Central Bank Law as soon as there is a chance for such an amendment. On the other hand, there is another independent entity in Turkey, namely BRSA that has the responsibility of supervision of the financial system. Therefore, it seems that there may be problems associated with enlarging the authorization of the Central Bank, as was understood from BRSA Governor’s comments that came after the Central Bank’s decision to raise the RR.
Returning to the Central Bank’s financial stability mandate, the Bank defines primary objectives as given in the following lines. Therefore, following the Bank’s plans about applying varying RR ratios for deposits depending on their maturities, other steps associated with either of these items may also be expected going forward.
1. Debt Ratios: Use of more equity, less debt
2. Debt Maturities: Extending maturities of external borrowing and domestic deposits
3. FX Positions: Strengthening FX position of the public and the private sectors
4. Risk management practices: More effective management of financial risks by all agents in the economy
In another presentation, the Bank lists the macroprudential tools that can be used to achieve these objectives as follows: Reserve Requirements, Central Bank’s Liquidity Provision, Bank’s Capital Requirements, Banks’ Liquidity Requirements and Taxes.
The first two of these are the Central Bank’s responsibility, while the BRSA is authorized for the following two and the Finance Ministry has the control over the last tool. Therefore, institutions must cooperate in order to use these tools efficiently.
The graphs in the Central Bank’s mentioned presentation suggest that, financial stability curve would urge for a higher interest rate if there is positive output gap, while a lower interest rate would be implied by the curve when output gap turns negative. On the other hand, if macroprudential tools are employed to meet the financial stability objective, then the Taylor rule, which is the most common approach to determine the policy rate, would suggest lower interest rate when output gap is positive and higher interest rate when output gap is negative. A straightforward interpretation of this might be that in the period ahead when the output gap would be closed and eventually turn positive, the Central Bank is likely to keep the interest rate at a lower level than would be suggested by Taylor rule under normal circumstances, thanks to the macroprudential tools.
The repercussions of the alternative monetary policy tools started to be used by the Central Bank continue to be felt in the markets. Among last week’s decisions launched by the Central Bank, the removal of the interest paid on required reserves (RR) was the major shock to the markets, rather than the increase in the RR ratios. The Central Bank’s exit strategy had not mentioned such a change in regulation and therefore the decision should be considered as a surprise. The Central Bank said their aim is to use RR ratios more actively as a policy tool to mitigate the macroeconomic and financial risks. After all, it was obvious that the increase in the RR by itself would not be enough to limit the credit expansion, given the interest paid on TRY RR which is 80% of the Central Bank’s O/N borrowing rate. Moreover, the news that in order to extend the maturities of deposits the Central Bank may apply varying RR ratios depending on their maturities is a sign that the Central Bank would continue using this alternative policy tool more actively. In the meantime, the Central Bank’s emphasis on further possible reduction in the O/N borrowing rates hints that the Bank would keep utilizing liquidity management facilities more effectively. Having summarized the fresh developments regarding the monetary policy framework, we will now have a closer look into the “financial stability” concept that appears to be the reason behind the regeneration of alternative monetary policy tools, as well as the implications of this concept for the Central Bank’s monetary policy. The financial stability can be defined as avoiding or dispelling the financial system inadequacies and disruptions that could potentially have major distortions on the real economy. Recently, the Central Bank has been putting a special emphasis on this concept, as should be understood from the latest MPC meeting summary where the Bank said that “….global crisis has demonstrated the importance of central banks having an auxiliary financial stability mandate as well as the objective of price stability.” Accordingly, this adds another objective to the Bank’s current obligations of fighting inflation, as well as supporting growth and employment. It at the same time hints that the Central Bank anticipates this objective to become more widespread going forward. The CBRT Law says: “The primary objective of the Bank shall be to achieve and maintain price stability. The Bank shall determine on its own discretion the monetary policy that it shall implement and the monetary policy instruments that it is going to use in order to achieve and maintain price stability.“ Whereas, via the presentations recently made by Central Bank Governor, another mandate has been added and the Bank’s primary roles have been defined as follows: 1. To achieve price stability; 2. To take measures to enhance stability in the financial system; 3. To support the growth and employment policies of the government provided that it shall not be in confliction with the objective of price stability.
This new mandate would likely be included in the Central Bank Law as soon as there is a chance for such an amendment. On the other hand, there is another independent entity in Turkey, namely BRSA that has the responsibility of supervision of the financial system. Therefore, it seems that there may be problems associated with enlarging the authorization of the Central Bank, as was understood from BRSA Governor’s comments that came after the Central Bank’s decision to raise the RR.
Returning to the Central Bank’s financial stability mandate, the Bank defines primary objectives as given in the following lines. Therefore, following the Bank’s plans about applying varying RR ratios for deposits depending on their maturities, other steps associated with either of these items may also be expected going forward.
1. Debt Ratios: Use of more equity, less debt
2. Debt Maturities: Extending maturities of external borrowing and domestic deposits
3. FX Positions: Strengthening FX position of the public and the private sectors
4. Risk management practices: More effective management of financial risks by all agents in the economy
In another presentation, the Bank lists the macroprudential tools that can be used to achieve these objectives as follows: Reserve Requirements, Central Bank’s Liquidity Provision, Bank’s Capital Requirements, Banks’ Liquidity Requirements and Taxes.
The first two of these are the Central Bank’s responsibility, while the BRSA is authorized for the following two and the Finance Ministry has the control over the last tool. Therefore, institutions must cooperate in order to use these tools efficiently.
The graphs in the Central Bank’s mentioned presentation suggest that, financial stability curve would urge for a higher interest rate if there is positive output gap, while a lower interest rate would be implied by the curve when output gap turns negative. On the other hand, if macroprudential tools are employed to meet the financial stability objective, then the Taylor rule, which is the most common approach to determine the policy rate, would suggest lower interest rate when output gap is positive and higher interest rate when output gap is negative. A straightforward interpretation of this might be that in the period ahead when the output gap would be closed and eventually turn positive, the Central Bank is likely to keep the interest rate at a lower level than would be suggested by Taylor rule under normal circumstances, thanks to the macroprudential tools.
20 Eylül 2010 Pazartesi
Two Sides of The Economy…
Summary: The latest data disclosures support our long-held view for a high growth rate for this year, while we also realize that the divergence between domestic and external demand has turned more visible. This outlook would unlikely change the monetary stance of the Central Bank, but ease the downside risks on the policy rates. The Bank is more likely to respond via instruments other than interest rate in case this divergence continues. Separately, the fresh budget figures seem to be relieving for the Bank, who emphasized that they would be monitoring the implementation at the absence of fiscal rule.
The data disclosures over the recent term suggest that divergence between growth rates of domestic and external demand has turned more apparent in Turkey. The Consumption Index reached all time high in August, posting around 20% y/y gains in each of the last two months, while the annual expansion in the domestic loans climbed above 35%. Meanwhile, the unemployment rate remained on a steep decline pattern and more importantly the seasonally adjusted rate receded to its lowest level since October 2008. Also, after the limited drop in May, the economy continued to generate jobs in June, as was valid in the m/m increase of 161K in the total payrolls (the average increase in the first five months was 100K). The consumption and investment contribitued above-expected 4.5 pp and 5.9 pp to the overall GDP growth in Q2. Despite this healthy domestic demand outlook, the industrial output has lost pace over the last months due to the slowdown in exports. The seasonally adjusted industrial output could only recoup by 0.3% m/m in June atop of the sharp 2.2% slump in June. Note also that the net exports erased some 1.6 pp off the GDP in Q2. Nevertheless, Q2 GDP came better than expected; posting a seasonally adjusted quarterly growth rate of 3.7% and GDP level has reached mildly above its pre-crisis peak. The fresh data disclosures such as the increase in current account deficit, improvement in labor market and budget performance, suggest a slightly better economic outlook. On the contrary, the leading indicators of economic activity indicate that economy would enter to a somewhat slower pace in the third quarter and display a flattish trend. Separately, as we approach to a period where the weak base effect would fade off, the Turkish economy is likely to post more conservative single-digit growth rates in the following quarters (we expect around 6% growth in Q3, followed by 4% in the following quarters). In other words, we stick to our baseline scenario that includes below-potential growth rate and slow recovery.
While the growth outlook is a bit stronger than what the market expected, we stick to our above-consensus GDP growth forecast of 7.0% for 2010. Note that the risks now are upside on this forecast. However, we reckon the growth rate would decelerate to 4.0% vicinity in 2011, due to the weak global backdrop, unfavorable base effect linked to this year’s strong performance and likely deterioration in confidence in the election year. Thus, the fresh data would unlikely change the monetary stance of the Central Bank, but ease the downside risks on the policy rates. Recall that in the August MPC meeting summary, the Bank mentioned the ‘Economic Contraction At Home’ scenario whereby global economic problems intensify and contribute to a contraction of domestic economic activity, consequently triggering a new easing cycle. Back then, the Bank had also said “If this [exacerbating pattern of the divergence between the pace of recovery in the domestic demand and external demand] pattern of growth coexists with rapid credit expansion and a deterioration in the current account balance, consequently leading to financial stability concerns, it would be necessary to utilize other policy instruments such as reserve requirement ratios and liquidity tools more effectively.” In this context, the Bank introduced the technical rate cut in September MPC meeting, while also noting that it would be appropriate to proceed with the other measures outlined in the exit strategy. We expect soon there will be increase in F/X and TRY reserve requirements and anticipate the Bank resuming rate hikes by May next year reaching 200 bps in end-2011.
On the other hand, the Central Bank frequently signals that they keep a close eye on the fiscal policies while forming their monetary policy strategy. Recalling from the August meeting summary, the Bank had noted that “…the delay in the enactment of the fiscal rule has increased the importance of current fiscal policy implementation.” In that context, the July-August budget realizations that were disclosed a month later than normal timing due to fiscal holiday would probably give some relief to the Bank. The Bank’s assessment regarding the 1H performance was positive and the Bank had said “… the better-than-expected performance in budget revenues, due to stronger economic activity than envisaged in the Medium Term Program (MTP), is largely being used to reduce government debt,” signaling that they do not see any problem with the fiscal discipline. We think that July-August budget performance is likely to deserve a similar assessment.
Having a closer look at the fiscal outlook, the central government budget produced TRY8.8bn primary surplus in July-August period, much better than the TRY5.1bn surplus in the look-alike slice of last year. There is substantial improvement in revenues on the back of strong tax proceeds that is more than enough to counterbalance the increase in primary expenditures, while around TRY2.0bn transfers from unemployment insurance fund and privatization revenues also helped the revenue performance. Adding the visible decline in interest payments, the budget balance improved at an even greater pace as the two-month budget produced a surplus of TRY1.0bn vs. last year’s TRY8.1bn deficit. All in all, the 12-month central government budget deficit to GDP declined to 3.4% vs. the year-end target of 4.9% in the Medium Term Program (MTP). This improvement is in line with our estimates disclosed in the ‘Fiscal Outlook’ report published on Monday. This may indicate that there is an extra room for 1.5 pp more (TRY15.8bn) for expenditures boosting or revenue-damping policies. In other words, extra improvement in July-August budget implies that the fiscal area that can be turned into higher expenditures is enlarged and both Finance Minister Simsek’s words that “we will be loyal to our targets” and Economy Minister Babacan’s emphasis that the year-end budget deficit will be in line with MTP targets are consistent with deterioration vs. the current point. Along with the Central Bank, we will continue to monitor how this fiscal area will be used in the following period. However, even if budget performance deteriorates somewhat in the period ahead, we do not anticipate the Bank would react unless this deterioration yields upward pressure on inflation via for example indirect tax hikes.
The data disclosures over the recent term suggest that divergence between growth rates of domestic and external demand has turned more apparent in Turkey. The Consumption Index reached all time high in August, posting around 20% y/y gains in each of the last two months, while the annual expansion in the domestic loans climbed above 35%. Meanwhile, the unemployment rate remained on a steep decline pattern and more importantly the seasonally adjusted rate receded to its lowest level since October 2008. Also, after the limited drop in May, the economy continued to generate jobs in June, as was valid in the m/m increase of 161K in the total payrolls (the average increase in the first five months was 100K). The consumption and investment contribitued above-expected 4.5 pp and 5.9 pp to the overall GDP growth in Q2. Despite this healthy domestic demand outlook, the industrial output has lost pace over the last months due to the slowdown in exports. The seasonally adjusted industrial output could only recoup by 0.3% m/m in June atop of the sharp 2.2% slump in June. Note also that the net exports erased some 1.6 pp off the GDP in Q2. Nevertheless, Q2 GDP came better than expected; posting a seasonally adjusted quarterly growth rate of 3.7% and GDP level has reached mildly above its pre-crisis peak. The fresh data disclosures such as the increase in current account deficit, improvement in labor market and budget performance, suggest a slightly better economic outlook. On the contrary, the leading indicators of economic activity indicate that economy would enter to a somewhat slower pace in the third quarter and display a flattish trend. Separately, as we approach to a period where the weak base effect would fade off, the Turkish economy is likely to post more conservative single-digit growth rates in the following quarters (we expect around 6% growth in Q3, followed by 4% in the following quarters). In other words, we stick to our baseline scenario that includes below-potential growth rate and slow recovery.
While the growth outlook is a bit stronger than what the market expected, we stick to our above-consensus GDP growth forecast of 7.0% for 2010. Note that the risks now are upside on this forecast. However, we reckon the growth rate would decelerate to 4.0% vicinity in 2011, due to the weak global backdrop, unfavorable base effect linked to this year’s strong performance and likely deterioration in confidence in the election year. Thus, the fresh data would unlikely change the monetary stance of the Central Bank, but ease the downside risks on the policy rates. Recall that in the August MPC meeting summary, the Bank mentioned the ‘Economic Contraction At Home’ scenario whereby global economic problems intensify and contribute to a contraction of domestic economic activity, consequently triggering a new easing cycle. Back then, the Bank had also said “If this [exacerbating pattern of the divergence between the pace of recovery in the domestic demand and external demand] pattern of growth coexists with rapid credit expansion and a deterioration in the current account balance, consequently leading to financial stability concerns, it would be necessary to utilize other policy instruments such as reserve requirement ratios and liquidity tools more effectively.” In this context, the Bank introduced the technical rate cut in September MPC meeting, while also noting that it would be appropriate to proceed with the other measures outlined in the exit strategy. We expect soon there will be increase in F/X and TRY reserve requirements and anticipate the Bank resuming rate hikes by May next year reaching 200 bps in end-2011.
On the other hand, the Central Bank frequently signals that they keep a close eye on the fiscal policies while forming their monetary policy strategy. Recalling from the August meeting summary, the Bank had noted that “…the delay in the enactment of the fiscal rule has increased the importance of current fiscal policy implementation.” In that context, the July-August budget realizations that were disclosed a month later than normal timing due to fiscal holiday would probably give some relief to the Bank. The Bank’s assessment regarding the 1H performance was positive and the Bank had said “… the better-than-expected performance in budget revenues, due to stronger economic activity than envisaged in the Medium Term Program (MTP), is largely being used to reduce government debt,” signaling that they do not see any problem with the fiscal discipline. We think that July-August budget performance is likely to deserve a similar assessment.
Having a closer look at the fiscal outlook, the central government budget produced TRY8.8bn primary surplus in July-August period, much better than the TRY5.1bn surplus in the look-alike slice of last year. There is substantial improvement in revenues on the back of strong tax proceeds that is more than enough to counterbalance the increase in primary expenditures, while around TRY2.0bn transfers from unemployment insurance fund and privatization revenues also helped the revenue performance. Adding the visible decline in interest payments, the budget balance improved at an even greater pace as the two-month budget produced a surplus of TRY1.0bn vs. last year’s TRY8.1bn deficit. All in all, the 12-month central government budget deficit to GDP declined to 3.4% vs. the year-end target of 4.9% in the Medium Term Program (MTP). This improvement is in line with our estimates disclosed in the ‘Fiscal Outlook’ report published on Monday. This may indicate that there is an extra room for 1.5 pp more (TRY15.8bn) for expenditures boosting or revenue-damping policies. In other words, extra improvement in July-August budget implies that the fiscal area that can be turned into higher expenditures is enlarged and both Finance Minister Simsek’s words that “we will be loyal to our targets” and Economy Minister Babacan’s emphasis that the year-end budget deficit will be in line with MTP targets are consistent with deterioration vs. the current point. Along with the Central Bank, we will continue to monitor how this fiscal area will be used in the following period. However, even if budget performance deteriorates somewhat in the period ahead, we do not anticipate the Bank would react unless this deterioration yields upward pressure on inflation via for example indirect tax hikes.
6 Eylül 2010 Pazartesi
Global Real-ISM…
The Purchasing Managers Index (PMI) that is disclosed in the first day of every month and is followed as the most important leading indicator for economic activity showed that the World economy remained in a weakening trend in August. The Global PMI that is the average of the country PMIs across the World took the value of 53.8 and held above the 50 threshold that demarcates the expansion and contraction periods. Nevertheless, this was the lowest print over the last 1 year. Contrary to the surprising jump in the U.S., the index in China (51.7) and Japan (50.1), which are the engines of global growth, dropped below this average. No doubt, the growth implication of a PMI that is slightly above the threshold would not be the same for developing countries, with high potential growth rate like China, and developed countries. However, what is certain is that in both country groups the PMI levels imply a near potential at best and most probably a weaker growth rate. In due course, the downtrend in the leading indicators also suggests that the most robust phase of the post-recession recovery has been over. Obviously, the extent that the countries could benefit from this fast rebound period differed depending on the initial shape of the economy prior to the recession. The countries which performed poorly in that respect would also be most vulnerable to a new slowdown cycle. Glancing at home, the leading indicators (Real Sector Confidence Index (RCSI), Turkish PMI and Central Bank Composite Leading Indicator) indicate that Turkey stands at a similar point in terms of the economic cycle. Tracking the global trends, the PMI and RSCI started to fall after peaking in April-May period, hinting that the robust growth performance in H1 would not be extended into H2. Meanwhile, the Central Bank’s Composite Leading Indicator signaled for the turning point of the industrial production two-three months ahead, as usual and the annual expansion of the industrial output eased to around 3% from around 10% after that point. This is a very weak recovery pace and let alone narrowing, the output gap would widen further in these circumstances.
Now, the question is whether this is an irreversible trend? How does the Central Bank perceive these developments and what are the measures they plan? We will be seeking answers to these questions in this weekly.
In order to have a better view of the picture above, the economy needs to be cleared from last year’s weak base effect. In essence it seems that the weak economic outlook that is described above may be undermined due to a number of reasons. For instance we expect 9.2% annual GDP growth in Q2 and 9.5% annual expansion in July industrial output both due to be released in the following weeks. Moreover, the domestic demand depicts a relatively better picture, thanks to the support from monetary policy. What then is going to be our benchmark? The rate of growth in the consecutive periods… A slowdown in GDP to 5-6% in Q3 and to 3-4% in Q4 would be acceptable, while growth rates below these intervals would be alarming.
The Central Banks are always concerned with the growth-inflation balance, while growth outlook outweighs in their monetary policy response function during crisis periods. The CBRT adopted countercyclical monetary policy strategy during and post recession period as much as the inflation outlook allowed them to do so. The Bank still sticks to this approach, as implied by the latest MPC meeting summary. Recall that in April the Bank had announced an exit strategy and pointed at Q4 this year as the start of the rate hikes, while coming to July, the risks associated with the global economy and the accompanying slowdown in the domestic economic activity urged the Bank to postpone rate hikes to an uncertain date next year, together with a delay in the exit strategy towards the end of this year. The Bank’s rhetoric seems to have changed a little bit since then as well. Among the alternative scenarios to the baseline described in the July Inflation Report, the Bank picked the one that we name as “economic contraction at home” and emphasized it in the latest MPC meeting summary. This has given the impression that they may be closer to this scenario than other alternatives (Pls. see below the Box for Central Bank Scenarios). In this scenario the Bank says should problems in the global economy further intensify, thereby increasing the possibility of a domestic recession, a new easing cycle may be considered. Even though in the meeting summary the Bank hints that they stick to the baseline scenario by saying that the outlook is in line with the July Inflation Report, the Bank only underlined the “economic contraction at home” scenario, without mentioning of “delayed recovery at home” scenario. This may be a sign that the alternative scenario that assumes first rate hike through the end of 2011 is now the Bank’s baseline scenario.
Against this backdrop, the Central Bank underlines that there is no change in the presumed timing of the steps in exit strategy (gradual increase in the TRY-FX reserve requirement rate and technical rate cut), which are planned to be introduced this year. Nevertheless, the Bank leaves the door open to different cases, mentioning of the risks that would either cause those steps to be brought forward or delayed. For instance, in the “economic contraction at home” scenario, the exit strategy was assumed to be delayed. Therefore, if this scenario is to be priced, that should consider both rate cuts and not implementing exit strategy. Needless to say, the above conclusions do depend on the domestic and foreign data disclosures more than ever.
In summary, the global economy remains in a slowdown trend, making it clearer that the strongest phase of recovery has been left behind. However, the uncertainties regarding the pace of recovery feed into double dip fears. Despite the support from monetary policy in Turkey, there is a significant deceleration in industrial output, while the leading indicators suggest deepening of this slowdown going forward. It is relieving to see that the Bank would keep the countercyclical monetary policy to combat this threat, which is not fully acknowledged by public opinion yet.
Central Bank Scenarios
Baseline: No important change in the recovery pace of economic activity is foreseen, with limited rate hikes starting sometime in 2011.
Delayed Recovery At Home: Should the global economy face a longer-than-anticipated period of anemic growth, which would consequently delay the domestic recovery significantly, the monetary tightening envisaged in 2011 under the baseline scenario may be postponed towards the end of 2011.
Economic Contraction At Home: An outcome whereby global economic problems intensify and contribute to a contraction of domestic economic activity may trigger a new easing cycle.
Faster Global Recovery: Monetary tightening may be implemented in an earlier period during 2011, should the recovery in economic activity turns out to be faster than expected.
Now, the question is whether this is an irreversible trend? How does the Central Bank perceive these developments and what are the measures they plan? We will be seeking answers to these questions in this weekly.
In order to have a better view of the picture above, the economy needs to be cleared from last year’s weak base effect. In essence it seems that the weak economic outlook that is described above may be undermined due to a number of reasons. For instance we expect 9.2% annual GDP growth in Q2 and 9.5% annual expansion in July industrial output both due to be released in the following weeks. Moreover, the domestic demand depicts a relatively better picture, thanks to the support from monetary policy. What then is going to be our benchmark? The rate of growth in the consecutive periods… A slowdown in GDP to 5-6% in Q3 and to 3-4% in Q4 would be acceptable, while growth rates below these intervals would be alarming.
The Central Banks are always concerned with the growth-inflation balance, while growth outlook outweighs in their monetary policy response function during crisis periods. The CBRT adopted countercyclical monetary policy strategy during and post recession period as much as the inflation outlook allowed them to do so. The Bank still sticks to this approach, as implied by the latest MPC meeting summary. Recall that in April the Bank had announced an exit strategy and pointed at Q4 this year as the start of the rate hikes, while coming to July, the risks associated with the global economy and the accompanying slowdown in the domestic economic activity urged the Bank to postpone rate hikes to an uncertain date next year, together with a delay in the exit strategy towards the end of this year. The Bank’s rhetoric seems to have changed a little bit since then as well. Among the alternative scenarios to the baseline described in the July Inflation Report, the Bank picked the one that we name as “economic contraction at home” and emphasized it in the latest MPC meeting summary. This has given the impression that they may be closer to this scenario than other alternatives (Pls. see below the Box for Central Bank Scenarios). In this scenario the Bank says should problems in the global economy further intensify, thereby increasing the possibility of a domestic recession, a new easing cycle may be considered. Even though in the meeting summary the Bank hints that they stick to the baseline scenario by saying that the outlook is in line with the July Inflation Report, the Bank only underlined the “economic contraction at home” scenario, without mentioning of “delayed recovery at home” scenario. This may be a sign that the alternative scenario that assumes first rate hike through the end of 2011 is now the Bank’s baseline scenario.
Against this backdrop, the Central Bank underlines that there is no change in the presumed timing of the steps in exit strategy (gradual increase in the TRY-FX reserve requirement rate and technical rate cut), which are planned to be introduced this year. Nevertheless, the Bank leaves the door open to different cases, mentioning of the risks that would either cause those steps to be brought forward or delayed. For instance, in the “economic contraction at home” scenario, the exit strategy was assumed to be delayed. Therefore, if this scenario is to be priced, that should consider both rate cuts and not implementing exit strategy. Needless to say, the above conclusions do depend on the domestic and foreign data disclosures more than ever.
In summary, the global economy remains in a slowdown trend, making it clearer that the strongest phase of recovery has been left behind. However, the uncertainties regarding the pace of recovery feed into double dip fears. Despite the support from monetary policy in Turkey, there is a significant deceleration in industrial output, while the leading indicators suggest deepening of this slowdown going forward. It is relieving to see that the Bank would keep the countercyclical monetary policy to combat this threat, which is not fully acknowledged by public opinion yet.
Central Bank Scenarios
Baseline: No important change in the recovery pace of economic activity is foreseen, with limited rate hikes starting sometime in 2011.
Delayed Recovery At Home: Should the global economy face a longer-than-anticipated period of anemic growth, which would consequently delay the domestic recovery significantly, the monetary tightening envisaged in 2011 under the baseline scenario may be postponed towards the end of 2011.
Economic Contraction At Home: An outcome whereby global economic problems intensify and contribute to a contraction of domestic economic activity may trigger a new easing cycle.
Faster Global Recovery: Monetary tightening may be implemented in an earlier period during 2011, should the recovery in economic activity turns out to be faster than expected.
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