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.
1 Temmuz 2011 Cuma
Hard Evidences of a Soft Patch?...
Global and local economic activity has been moderating in 2Q, but there is still a decent probability that this slowdown could prove temporary. July PMI data due for release on August 1 will be key in helping us discern the likely path of global economic activity. While the recent sharp reversal in energy and commodity prices should help to allay mounting concerns over the current account deficit and inflation pressure for a while, any relief appears unsustainable in the event of a global revival in economic activity.
The currently observed deceleration in economic activity is mainly a consequence of the weakness in external demand, while there has been no visible slowdown in domestic consumption. Therefore, we are still away from a soft landing. Moreover, this is certainly not the expected result of the implemented policy mix aimed at rebalancing external and domestic demand. However, 2H11 could turn out closer to the desired picture, with another round of consumer loan rate increases after the mid-June decisions by the BRSA on general provisions, and to some extent due to the favourable base effect from loan demand brought forward in anticipation of higher costs. Many banking analysts mentioned that the loan growth is seasonally the lowest in 3Q and tends to be roughly half that of 2Q, ceteris paribus. This would bode well for the CBT’s efforts to curb lending growth to 25%. However, recently the 4-week average trend growth in consumer loans has exceeded the 2006-2010 average. According to my calculation, weekly changes in line with the 2006-2010 average in the second half would imply around 35% loan growth at the year-end – not much different from the current trend. Therefore, the CBT and the economy administration would need to see a much sharper deceleration than the seasonal trends in 2H, to rule out the need for further measures.
Going forward, the data and news flow (inflation, loan growth, external balance and measures) until the July 21 MPC meeting will be crucial, since in the meantime the CBT will also have reviewed its stance and other projections for the preparation of the Quarterly Inflation Report, slated for release on July 28.
I reckon that RRR hikes are not on the table now and policy rate decisions will be linked to the core inflation outlook. Although the likely convergence of the headline CPI to the CBT’s projections in June would support the credibility of the Bank, I think core inflation does matter and recent TRL depreciation should warrant a cautious stance due to the potential pass-through effect on prices. Barring a further deterioration in the global economic outlook, I think the CBT will need to embark on a more orthodox policy mix, considering our above target core inflation (I) forecast. We continue to expect a 100bp policy rate hike in 4Q11.
The currently observed deceleration in economic activity is mainly a consequence of the weakness in external demand, while there has been no visible slowdown in domestic consumption. Therefore, we are still away from a soft landing. Moreover, this is certainly not the expected result of the implemented policy mix aimed at rebalancing external and domestic demand. However, 2H11 could turn out closer to the desired picture, with another round of consumer loan rate increases after the mid-June decisions by the BRSA on general provisions, and to some extent due to the favourable base effect from loan demand brought forward in anticipation of higher costs. Many banking analysts mentioned that the loan growth is seasonally the lowest in 3Q and tends to be roughly half that of 2Q, ceteris paribus. This would bode well for the CBT’s efforts to curb lending growth to 25%. However, recently the 4-week average trend growth in consumer loans has exceeded the 2006-2010 average. According to my calculation, weekly changes in line with the 2006-2010 average in the second half would imply around 35% loan growth at the year-end – not much different from the current trend. Therefore, the CBT and the economy administration would need to see a much sharper deceleration than the seasonal trends in 2H, to rule out the need for further measures.
Going forward, the data and news flow (inflation, loan growth, external balance and measures) until the July 21 MPC meeting will be crucial, since in the meantime the CBT will also have reviewed its stance and other projections for the preparation of the Quarterly Inflation Report, slated for release on July 28.
I reckon that RRR hikes are not on the table now and policy rate decisions will be linked to the core inflation outlook. Although the likely convergence of the headline CPI to the CBT’s projections in June would support the credibility of the Bank, I think core inflation does matter and recent TRL depreciation should warrant a cautious stance due to the potential pass-through effect on prices. Barring a further deterioration in the global economic outlook, I think the CBT will need to embark on a more orthodox policy mix, considering our above target core inflation (I) forecast. We continue to expect a 100bp policy rate hike in 4Q11.
17 Mayıs 2011 Salı
A Preview of 2011 Elections
The findings of the opinion polls published so far invariably show the incumbent AKP as the leading party. Most of them even indicate a higher voter support for the AKP at the 2011 elections with respect to 2007. However, this does not necessarily imply a higher number of seats in Parliament for the party, as the number of MPs could vary widely, based not only on the amount of votes garnered, but also on the distribution of votes across political parties; the number of parties exceeding the 10% threshold; and the number of independent MPs.
We estimated the critical level of votes for the AKP under different scenarios, in a bid to gauge the direction of the AKP’s policies post-2011 elections.
The first scenario shows the distribution of MPs based on the average of the most recent and reliable election polls. Accordingly, under the assumption of 32 independent MPs making it to Parliament and the AKP, the CHP and the MHP gaining 48%, 26% and 12% of the votes, respectively, we estimate the AKP winning 326 seats in Parliament, slightly lower than its current number of seats of 331. Moreover, in this eventuality, although it exceeds the requirement of 276 to form a single-party government, it fails to meet the requisite 330 seats to amend the constitution through a referendum.
The second scenario assumes the minor opposition party MHP remaining slightly below the country threshold of 10%, as some surveys have indicated. Under this scenario, the AKP wins 357 MPs with 48% of the votes, while CHP gets 161 seats with 26% of the votes. One interesting point to note is that even in a two-party Parliament with 32 independent MPs, the AKP may still fail to win a sufficient number of seats to amend the constitution without taking it to a referendum, unless it wins more than 52% of the votes.
Under the third and fourth scenarios, we estimated the minimum number of votes that would enable the AKP to pass a constitutional amendment with a referendum (min 330 MPs) or without a referendum (min 367 MPs). According to our simulations, in a three-party parliament with 32 independent MPs, the AKP would need to garner at least 45% of the votes to secure 330 MPs and at least 59.5% to secure 367 MPs, even if we assumed that the CHP and the MHP scored the worst results suggested by leading poll findings.
Hence, we conclude that
1- It seems almost impossible for the AKP to lose its single-party government status, i.e. fall below 276 MP
2- The AKP is likely to win around 330 MPs at the 2011 elections. If it exceeds 330, the AKP may amend the constitution to enable the adoption of the presidential system, and take it to a referendum. If it trails the 330 mark, we wouldn’t expect the AKP to go for a constitutional amendment.
3- The AKP is very unlikely to secure 367 seats, unless the MHP fails to pass the 10% threshold for representation in Parliament or the CHP’s voter support recedes back to its pre-Kilicdaroglu levels (around 20%). Therefore, it seems quite unlikely that the AKP will have the power to change the constitution by itself, i.e. without the support of other political parties or a referendum.
Having said that, it is not possible to derive reliable inferences regarding the outcome of the elections out of the current polls, due to the ambiguities related to the success of the election campaigns, parties’ candidates, as well as how voting decisions will be affected by the alliances and election agreements on the left and right. However, we expect the surveys to be conducted in the run up to the elections to yield more reliable findings, potentially enabling us to discern which of the aforementioned scenarios would be closer to the actual election outcome.
The Day After
A solid victory on the part of the AKP would set the stage for a constitutional reform, as Prime Minister Erdogan, while launching his party manifesto on April 16 ahead of June elections, pledged to undertake a complete overhaul of the current
constitution after the elections. Also, it is no secret that Erdogan ultimately wants to become the President. Erdogan is thought to be interested in replacing the current Turkish parliamentary system -- which allocates all executive powers to the
Parliament and its chosen cabinet -- with a presidential system. Moreover, PM Erdogan, who is believed to covet the presidential post, has not mentioned any plans for a presidential system in the manifesto. However, based on various
statements to date by Erdogan, the most likely system seems to be the US-type presidential system. A presidential system is not a foregone conclusion, however, as there is likely to be a great deal of opposition from within the AKP to such a
radical change.
In 2007, the Turkish Parliament amended the Constitution to allow the Turkish people to elect the head of the state, in lieu of the Parliament appointing someone to this position. However, it took nearly four years to amend the related laws regulating the
presidential election process, due to the legal ambiguity surrounding the tenure of the current president. According to the Constitution, the people will elect a president for a five-year period with the right to run for a second term. The new bill, which allows prime ministers and other figures the right to remain in their electoral seats while they campaign for presidency, is being interpreted as the first sign by Erdogan that he will seek the position, though this does not clear all the obstacles on the way to his presidency. Since Erdogan has announced that this will be the last time he seeks deputyship, the result of the 2011 elections
should indicate whether or not Erdogan might run for president. Timing is also important in this case, as the duration of President Abdullah Gul’s tenure is not clear at this point. The new bill does not address the issues as to whether President
Gul will serve his current term of seven years or a new one of five years when the next presidential elections take place or if Gul could run for president again. Some political pundits have claimed that Gul’s tenure should not extend to beyond 2012, while others have suggested that the presidential elections should be held in 2014. Erdogan has previously implied that Gul’s term should be five years. The Supreme Election Board (YSK) will have the final word on the matter.
However, there are other interpretations... According to a prominent political analyst and researcher, Tarhan Erdem, from KONDA, the next presidential election will most likely be held in 2012 and the date is already set.
“When are the presidential elections to be held? Preparations for the constitution that are to begin post-elections, and PM Erdogan having expressed his “approval” of the presidential regime, further strengthened in recent months the preconception that Erdogan was coveting the presidential seat. No one seemed even willing to listen to the contrary! If the Constitution were completed on time, presidential elections would be held in 2012; if not presidential elections would be deferred to 2014 and Erdogan would become the President!... However, in recent days, the Parliament, while setting the MP election date, has also determined the presidential election date: Presidential elections will have been completed within the 60 days preceding August 28, 2012. It is stated that whether presidential elections will be held in 2012 or 2014 will be decided by the High Election Board (YSK). This view, however, contravenes both the law and precedents. The YSK does not determine the terms of the Turkish Grand National Assembly (TBMM), the President, or the provincial assemblies; these are decided by the Constitution, or by the Parliament, in conformity with the Constitution. The TBMM has designated how the constitutional amendment changing the presidential and parliamentary terms should be construed with its decision dated March 3, 2011, indicating that MP elections will be held prior to the completion of the 4-year period proceeding the 2007 elections. The term of the President, set as 5 years with the same law, will have expired on August 28, 2012.” (4 April 2011, Radikal)
Therefore, the distribution of seats at the next parliamentary elections is likely to be critical.
If the AKP secures 330-367 seats in Parliament in June 2011, it may have the power to change the constitution (with a referendum if it secures 330 seats - without a referendum if it secures 367 seats), which it will likely use to extend the power of the current president and introduce a presidential system. PM Erdogan could resign from the prime ministry and run for presidency in 2012 or 2014, depending on the YSK decision regarding the presidential election date.
If the AKP gets less than 330 seats, the presidential system may not come on the agenda, as the AKP would not have the power to change the constitution without the support of the opposition. Under this scenario, we think the odds of PM Erdogan
opting to abandon his powers as PM and run for presidency decrease substantially.
We estimated the critical level of votes for the AKP under different scenarios, in a bid to gauge the direction of the AKP’s policies post-2011 elections.
The first scenario shows the distribution of MPs based on the average of the most recent and reliable election polls. Accordingly, under the assumption of 32 independent MPs making it to Parliament and the AKP, the CHP and the MHP gaining 48%, 26% and 12% of the votes, respectively, we estimate the AKP winning 326 seats in Parliament, slightly lower than its current number of seats of 331. Moreover, in this eventuality, although it exceeds the requirement of 276 to form a single-party government, it fails to meet the requisite 330 seats to amend the constitution through a referendum.
The second scenario assumes the minor opposition party MHP remaining slightly below the country threshold of 10%, as some surveys have indicated. Under this scenario, the AKP wins 357 MPs with 48% of the votes, while CHP gets 161 seats with 26% of the votes. One interesting point to note is that even in a two-party Parliament with 32 independent MPs, the AKP may still fail to win a sufficient number of seats to amend the constitution without taking it to a referendum, unless it wins more than 52% of the votes.
Under the third and fourth scenarios, we estimated the minimum number of votes that would enable the AKP to pass a constitutional amendment with a referendum (min 330 MPs) or without a referendum (min 367 MPs). According to our simulations, in a three-party parliament with 32 independent MPs, the AKP would need to garner at least 45% of the votes to secure 330 MPs and at least 59.5% to secure 367 MPs, even if we assumed that the CHP and the MHP scored the worst results suggested by leading poll findings.
Hence, we conclude that
1- It seems almost impossible for the AKP to lose its single-party government status, i.e. fall below 276 MP
2- The AKP is likely to win around 330 MPs at the 2011 elections. If it exceeds 330, the AKP may amend the constitution to enable the adoption of the presidential system, and take it to a referendum. If it trails the 330 mark, we wouldn’t expect the AKP to go for a constitutional amendment.
3- The AKP is very unlikely to secure 367 seats, unless the MHP fails to pass the 10% threshold for representation in Parliament or the CHP’s voter support recedes back to its pre-Kilicdaroglu levels (around 20%). Therefore, it seems quite unlikely that the AKP will have the power to change the constitution by itself, i.e. without the support of other political parties or a referendum.
Having said that, it is not possible to derive reliable inferences regarding the outcome of the elections out of the current polls, due to the ambiguities related to the success of the election campaigns, parties’ candidates, as well as how voting decisions will be affected by the alliances and election agreements on the left and right. However, we expect the surveys to be conducted in the run up to the elections to yield more reliable findings, potentially enabling us to discern which of the aforementioned scenarios would be closer to the actual election outcome.
The Day After
A solid victory on the part of the AKP would set the stage for a constitutional reform, as Prime Minister Erdogan, while launching his party manifesto on April 16 ahead of June elections, pledged to undertake a complete overhaul of the current
constitution after the elections. Also, it is no secret that Erdogan ultimately wants to become the President. Erdogan is thought to be interested in replacing the current Turkish parliamentary system -- which allocates all executive powers to the
Parliament and its chosen cabinet -- with a presidential system. Moreover, PM Erdogan, who is believed to covet the presidential post, has not mentioned any plans for a presidential system in the manifesto. However, based on various
statements to date by Erdogan, the most likely system seems to be the US-type presidential system. A presidential system is not a foregone conclusion, however, as there is likely to be a great deal of opposition from within the AKP to such a
radical change.
In 2007, the Turkish Parliament amended the Constitution to allow the Turkish people to elect the head of the state, in lieu of the Parliament appointing someone to this position. However, it took nearly four years to amend the related laws regulating the
presidential election process, due to the legal ambiguity surrounding the tenure of the current president. According to the Constitution, the people will elect a president for a five-year period with the right to run for a second term. The new bill, which allows prime ministers and other figures the right to remain in their electoral seats while they campaign for presidency, is being interpreted as the first sign by Erdogan that he will seek the position, though this does not clear all the obstacles on the way to his presidency. Since Erdogan has announced that this will be the last time he seeks deputyship, the result of the 2011 elections
should indicate whether or not Erdogan might run for president. Timing is also important in this case, as the duration of President Abdullah Gul’s tenure is not clear at this point. The new bill does not address the issues as to whether President
Gul will serve his current term of seven years or a new one of five years when the next presidential elections take place or if Gul could run for president again. Some political pundits have claimed that Gul’s tenure should not extend to beyond 2012, while others have suggested that the presidential elections should be held in 2014. Erdogan has previously implied that Gul’s term should be five years. The Supreme Election Board (YSK) will have the final word on the matter.
However, there are other interpretations... According to a prominent political analyst and researcher, Tarhan Erdem, from KONDA, the next presidential election will most likely be held in 2012 and the date is already set.
“When are the presidential elections to be held? Preparations for the constitution that are to begin post-elections, and PM Erdogan having expressed his “approval” of the presidential regime, further strengthened in recent months the preconception that Erdogan was coveting the presidential seat. No one seemed even willing to listen to the contrary! If the Constitution were completed on time, presidential elections would be held in 2012; if not presidential elections would be deferred to 2014 and Erdogan would become the President!... However, in recent days, the Parliament, while setting the MP election date, has also determined the presidential election date: Presidential elections will have been completed within the 60 days preceding August 28, 2012. It is stated that whether presidential elections will be held in 2012 or 2014 will be decided by the High Election Board (YSK). This view, however, contravenes both the law and precedents. The YSK does not determine the terms of the Turkish Grand National Assembly (TBMM), the President, or the provincial assemblies; these are decided by the Constitution, or by the Parliament, in conformity with the Constitution. The TBMM has designated how the constitutional amendment changing the presidential and parliamentary terms should be construed with its decision dated March 3, 2011, indicating that MP elections will be held prior to the completion of the 4-year period proceeding the 2007 elections. The term of the President, set as 5 years with the same law, will have expired on August 28, 2012.” (4 April 2011, Radikal)
Therefore, the distribution of seats at the next parliamentary elections is likely to be critical.
If the AKP secures 330-367 seats in Parliament in June 2011, it may have the power to change the constitution (with a referendum if it secures 330 seats - without a referendum if it secures 367 seats), which it will likely use to extend the power of the current president and introduce a presidential system. PM Erdogan could resign from the prime ministry and run for presidency in 2012 or 2014, depending on the YSK decision regarding the presidential election date.
If the AKP gets less than 330 seats, the presidential system may not come on the agenda, as the AKP would not have the power to change the constitution without the support of the opposition. Under this scenario, we think the odds of PM Erdogan
opting to abandon his powers as PM and run for presidency decrease substantially.
19 Nisan 2011 Salı
Taking Stock of the CBT’s Policy Mix
ACHIEVEMENTS
Volatile money market rates and intentional ambiguity on policy stance As a result of the policy rate cuts and widening interest rate corridor, rates in the secondary market for repos fluctuated intensely and deviated from the policy rate for a longer period of time. Within November-December 2010, the 10-day average of the O/N repo and 1m swap rates hovered below the policy rate. Meanwhile, the CBT left the door open for additional rate cuts, a move that we feel was intended to impede a clear understanding of the Bank’s policy stance, hence to make any positioning more difficult.
Heavy outflows from short-term bets; partial shift to longer maturities Based on the BRSA’s off-balance sheet data for the banks, cumulative outflows from Turkish markets have reached US$11.5bn in between the MPC meeting held in November and the end of February. Short-term fund outflows are noted to be mainly the result of the closure of money market positions of the non-residents, in the form of swaps, deposits, repos and credit transactions. A partial return of these flows caused a shift in non-residents’ positions within November 2010 – February 2011 in favour of longer maturities, mainly through accumulation of domestic debt instruments.
Banks’ reliance on short-term funds is on the rise; so is the interest rate risk... Before the recent agressive hike, the CBT increased TRL reserve requirement ratio (RRR) gradually three times and withdrew TL19.5bn cumulatively. This has brought the CBT funding through 1w repo auctions to the TL25-30bn range recently. Since the March RRR hike will have taken effect on April 15, 2011, liquidity to the tune of about TL19.1bn will be withdrawn from the market and will pull the total funding from the CBT up to the TL45-50bn range. Contrary to speculations about insufficient liquidity injections by the CBT, we think the monetary authority needs to provide the liquidity demanded in the market, to
maintain money market rates close to the policy rate. However, banks will become more dependent on very short-term Central Bank resources despite additional funding. Hence, even when banks’ loan levels remain unchanged, their maturity mismatch
will increase. Banks will have to reflect the additional interest rate risk to their loan rates and/or scale back their loan portfolios.
FAILURES
Decline in TRL deposit rates; no increase in TRL loan rates...Banks had the chance to scale down the interest rate of the deposit whose cost had increased, given full substitutability of short-term Central Bank funds with deposits. Thus, the rise in the cost reflected more on deposit rates than on loan rates, at least before the latest hike in RRR.
Although this 400bp increase may be a game changer, the data on the average interest rate on loans for the March 25 week, when the MPC meeting took place, are not promising. Only the interest rate on commercial loans increased by a considerable
37bp to 8.78%. While the cash and vehicle loan interest rates even declined by 7bp and 5bp to 11.97% and 10.51%, respectively, the interest rate on housing loans increased by an insignificant 3bp to 9.76%.
Loan growth is still strong on all metrics...
Despite all the measures adopted, the slowdown in loan growth is still not significant, as total loans are increasing at an annual rate of 41% and consumer loans at 35% as of March 25. We also think the exchange rate effect on FX loans should be neutralised by using fixed FX rates against the TRL and a fixed
currency (60% US$-40% €) composition. We took the last 22 business days’ average of total loans (fixed FX rates and fixed FX composition) to represent the monthly outlook and compared it with the average of the same period a year ago. The annual
increase in our indicator is still high at 34.7% as of end-March.
Where to henceforth?
Too early to call a cease-fire... Considering the achievements versus failures of the CBT’s policy mix, it would be somewhat premature, in our view, to expect the monetary authority to refrain from adopting further tightening measures, until there is conclusive evidence of a slowdown in loan volume and domestic demand.
The Central Bank bought time; but the window of opportunity is a narrow one... The CBT expects the restrictive effects of these policy measures to be observed with a lag, possibly starting with the second quarter. The monetary authority also bought time by launching front-loaded RRR hikes with its recent move. Moreover, it called for supplementary macro-prudential measures targeting credit supply from other institutions (read as BRSA) to extend the wait-and-see period. However, this window of opportunity is not wide open: now is the time to observe more concrete developments (rise in deposit and loan rates) -- even before the major liquidity withdrawal takes place.
CBT drives short-term rates up; pressures the banks... As one of the channels (cost) for transmission of RR is not working, the CBT relied heavily on the other (liquidity) channel. Further liquidity withdrawal on April 15 and a wider interest rate corridor provide the CBT with the opportunity to drive O/N rates wherever it wants them to be. Within November-December, the CBT’s aim was to discourage portfolio inflows; hence, O/N rates fell sharply. But now, the main concern is relentless loan growth; so the CBT is driving the rates to the upper limit (Primary Dealers Facility, which is at 8% vs. policy rate of 6.25%) of the interest rate corridor. However, we need to acknowledge that this cannot be a permanent strategy in an Inflation Targeting regime, where the Central Bank has to provide the liquidity demanded in the market, to maintain money market rates close to the policy rate. Otherwise, the policy rate will lose its significance as a reference rate.
Is it early for FX RR hike?... Up until now, the CBT used TRL RRR as its main policy tool. However, now the average weighted RRR stands at 13.4%, higher than the uniform FX RRR of 11%. Meanwhile, banks increased their FX deposit rates and were granted permission to issue FX bonds. This creates the perception that RRR hikes in FX deposits might be in the pipeline. Also as expected, the coverage of the liabilities subject to RRR may be expanded and the RRRs may be differentiated according to the nature and maturity of liabilities, including the off-balance sheet liabilities (mainly swaps) of the banking system. We do not
think we are there yet, especially in terms of RRR hikes that withdraw FX liquidity, since banks are still not comfortable, as the “claims from abroad” account has halved to US$12.5bn during the hot money outflows and remained at that level since then.
Swap RR also likely... On the other hand, we have been observing inflows through swap transactions since the start of March, due to attractive money market rates. Over the last four weeks, cumulative inflows have amounted to US$8.8bn, corresponding to almost 70% of the outflows within November-March. Since March 4, the TRL has appreciated by 5.7% against the US$. This picture could compel the CBT to act by broadening the coverage of liabilities subject to RR to include off-balance sheet items.
New Governor, Old Bank... As the quarterly inflation report will be published in April, the MPC meeting on 21 April, under the presidency of the new governor, has become more crucial. As a reminder, the CBT’s baseline scenario in the previous report envisaged a gradual tightening this year by changing the mix of the policy rate and RRRs. According to the CBT, monetary tightening could be implemented either through RRRs or policy rates, or a combination of both. Until now, the RRR leg of the policy mix has been used and its impact through the liquidity channel has been relied upon. Although we do not expect further TRL RR hikes in the short-term, we see some room if necessary and expect the usage of untapped FX related measures
including FX buying auctions. However, in the absence of any meaningful slowdown in loan growth and domestic demand, despite all the measures taken to date and discussed above, the recent positive inflation outlook could only delay an inevitable
policy rate increase by a few months.
Volatile money market rates and intentional ambiguity on policy stance As a result of the policy rate cuts and widening interest rate corridor, rates in the secondary market for repos fluctuated intensely and deviated from the policy rate for a longer period of time. Within November-December 2010, the 10-day average of the O/N repo and 1m swap rates hovered below the policy rate. Meanwhile, the CBT left the door open for additional rate cuts, a move that we feel was intended to impede a clear understanding of the Bank’s policy stance, hence to make any positioning more difficult.
Heavy outflows from short-term bets; partial shift to longer maturities Based on the BRSA’s off-balance sheet data for the banks, cumulative outflows from Turkish markets have reached US$11.5bn in between the MPC meeting held in November and the end of February. Short-term fund outflows are noted to be mainly the result of the closure of money market positions of the non-residents, in the form of swaps, deposits, repos and credit transactions. A partial return of these flows caused a shift in non-residents’ positions within November 2010 – February 2011 in favour of longer maturities, mainly through accumulation of domestic debt instruments.
Banks’ reliance on short-term funds is on the rise; so is the interest rate risk... Before the recent agressive hike, the CBT increased TRL reserve requirement ratio (RRR) gradually three times and withdrew TL19.5bn cumulatively. This has brought the CBT funding through 1w repo auctions to the TL25-30bn range recently. Since the March RRR hike will have taken effect on April 15, 2011, liquidity to the tune of about TL19.1bn will be withdrawn from the market and will pull the total funding from the CBT up to the TL45-50bn range. Contrary to speculations about insufficient liquidity injections by the CBT, we think the monetary authority needs to provide the liquidity demanded in the market, to
maintain money market rates close to the policy rate. However, banks will become more dependent on very short-term Central Bank resources despite additional funding. Hence, even when banks’ loan levels remain unchanged, their maturity mismatch
will increase. Banks will have to reflect the additional interest rate risk to their loan rates and/or scale back their loan portfolios.
FAILURES
Decline in TRL deposit rates; no increase in TRL loan rates...Banks had the chance to scale down the interest rate of the deposit whose cost had increased, given full substitutability of short-term Central Bank funds with deposits. Thus, the rise in the cost reflected more on deposit rates than on loan rates, at least before the latest hike in RRR.
Although this 400bp increase may be a game changer, the data on the average interest rate on loans for the March 25 week, when the MPC meeting took place, are not promising. Only the interest rate on commercial loans increased by a considerable
37bp to 8.78%. While the cash and vehicle loan interest rates even declined by 7bp and 5bp to 11.97% and 10.51%, respectively, the interest rate on housing loans increased by an insignificant 3bp to 9.76%.
Loan growth is still strong on all metrics...
Despite all the measures adopted, the slowdown in loan growth is still not significant, as total loans are increasing at an annual rate of 41% and consumer loans at 35% as of March 25. We also think the exchange rate effect on FX loans should be neutralised by using fixed FX rates against the TRL and a fixed
currency (60% US$-40% €) composition. We took the last 22 business days’ average of total loans (fixed FX rates and fixed FX composition) to represent the monthly outlook and compared it with the average of the same period a year ago. The annual
increase in our indicator is still high at 34.7% as of end-March.
Where to henceforth?
Too early to call a cease-fire... Considering the achievements versus failures of the CBT’s policy mix, it would be somewhat premature, in our view, to expect the monetary authority to refrain from adopting further tightening measures, until there is conclusive evidence of a slowdown in loan volume and domestic demand.
The Central Bank bought time; but the window of opportunity is a narrow one... The CBT expects the restrictive effects of these policy measures to be observed with a lag, possibly starting with the second quarter. The monetary authority also bought time by launching front-loaded RRR hikes with its recent move. Moreover, it called for supplementary macro-prudential measures targeting credit supply from other institutions (read as BRSA) to extend the wait-and-see period. However, this window of opportunity is not wide open: now is the time to observe more concrete developments (rise in deposit and loan rates) -- even before the major liquidity withdrawal takes place.
CBT drives short-term rates up; pressures the banks... As one of the channels (cost) for transmission of RR is not working, the CBT relied heavily on the other (liquidity) channel. Further liquidity withdrawal on April 15 and a wider interest rate corridor provide the CBT with the opportunity to drive O/N rates wherever it wants them to be. Within November-December, the CBT’s aim was to discourage portfolio inflows; hence, O/N rates fell sharply. But now, the main concern is relentless loan growth; so the CBT is driving the rates to the upper limit (Primary Dealers Facility, which is at 8% vs. policy rate of 6.25%) of the interest rate corridor. However, we need to acknowledge that this cannot be a permanent strategy in an Inflation Targeting regime, where the Central Bank has to provide the liquidity demanded in the market, to maintain money market rates close to the policy rate. Otherwise, the policy rate will lose its significance as a reference rate.
Is it early for FX RR hike?... Up until now, the CBT used TRL RRR as its main policy tool. However, now the average weighted RRR stands at 13.4%, higher than the uniform FX RRR of 11%. Meanwhile, banks increased their FX deposit rates and were granted permission to issue FX bonds. This creates the perception that RRR hikes in FX deposits might be in the pipeline. Also as expected, the coverage of the liabilities subject to RRR may be expanded and the RRRs may be differentiated according to the nature and maturity of liabilities, including the off-balance sheet liabilities (mainly swaps) of the banking system. We do not
think we are there yet, especially in terms of RRR hikes that withdraw FX liquidity, since banks are still not comfortable, as the “claims from abroad” account has halved to US$12.5bn during the hot money outflows and remained at that level since then.
Swap RR also likely... On the other hand, we have been observing inflows through swap transactions since the start of March, due to attractive money market rates. Over the last four weeks, cumulative inflows have amounted to US$8.8bn, corresponding to almost 70% of the outflows within November-March. Since March 4, the TRL has appreciated by 5.7% against the US$. This picture could compel the CBT to act by broadening the coverage of liabilities subject to RR to include off-balance sheet items.
New Governor, Old Bank... As the quarterly inflation report will be published in April, the MPC meeting on 21 April, under the presidency of the new governor, has become more crucial. As a reminder, the CBT’s baseline scenario in the previous report envisaged a gradual tightening this year by changing the mix of the policy rate and RRRs. According to the CBT, monetary tightening could be implemented either through RRRs or policy rates, or a combination of both. Until now, the RRR leg of the policy mix has been used and its impact through the liquidity channel has been relied upon. Although we do not expect further TRL RR hikes in the short-term, we see some room if necessary and expect the usage of untapped FX related measures
including FX buying auctions. However, in the absence of any meaningful slowdown in loan growth and domestic demand, despite all the measures taken to date and discussed above, the recent positive inflation outlook could only delay an inevitable
policy rate increase by a few months.
16 Mart 2011 Çarşamba
A US$10bn Question...
CBT expounds on fund flows; this time in greater detail... Data flow regarding the financing of the current account deficit within Nov’10-Jan’11 was not consistent with the trend in the TRL, which in the same period remained under heavy pressure against major currencies, depreciating almost 12%. Indeed, there were no significant outflows from the conventional portfolio channels that the balance of payments could cover. Furthermore, net errors & omissions item showed US$5.7bn inflow over the last three months. Although this item represents flows that cannot be recorded in finance accounts and is calculated as a residual, it is usually considered hot money. Consequently, several articles appeared in the local press, claiming that the Central Bank of Turkey’s new policy mix that was aimed at deterring short-term capital flows to Turkey had proved ineffective, defying claims by the Bank. The CBT promptly responded in a press statement: “...Following resolutions adopted by the Central Bank of Turkey Monetary Policy Committee during and after the November 2010 meeting, such as widening of the interest rate corridor and cuts in policy rates, some outflows of short-term funds have been noted. Based on the CBT’s calculations, cumulative outflows from Turkish markets have exceeded US$10bn in between the MPC meeting held in November and the end of December. Short-term fund outflows are noted to be mainly the result of the closure of money market positions of the non-residents, in the form of swaps, deposits, repos and credit transactions. Although these transactions are reflected to balance of payment (BoP) statistics, swap transactions in particular, which constitute the bulk of the money market positions, cannot be monitored via BoP statistics. On the other hand, since the beginning of 2011, the CBT has been observing daily fluctuations in non-resident portfolio volumes, driven by global risk perceptions and international developments. The CBT has also acknowledged a shift in non-residents’ positions within November 2010 – Feb 2011 in favour of longer maturities, mainly through accumulation of domestic debt instruments...” However, this explanation apparently failed to convincingly rebut the counter-arguments, as the CBT had not backed its statement with concrete evidence on money market positions. As such, a few days later, the monetary authority had to elaborate on fund flows in more detail and to support its case this time with figures.
Where are hot money flows headed to and how to monitor them? -- First, the CBT specified three channels for non-residents’ portfolio flows: equities, debt instruments, and money market transactions. As we all know, the first two channels can be easily monitored from the CBT’s database (Non-residents' Holdings of Securities) on a weekly basis and from BoP statistics on a monthly basis. However, as mentioned in the above statement as well, swap transactions in particular, which constitute the bulk -- and are the most volatile component -- of the money market positions, cannot be monitored via BoP statistics. Secondly, a major difference from the previous statement was the indication provided by the CBT to monitor such flows. The CBT pointed out that the off-balance sheet FX position of the banking system could be an important indicator of the magnitude of these transactions. Developments on the off-balance sheet FX position of the banking system can be monitored through the weekly bulletins of the Banking Regulation and Supervision Agency. Unlike many others, we have been aware of these figures and have been following their evolution for many years now to better comprehend the TRL’s performance amid hectic market conditions. Let us explain here what off-balance sheet FX position stands for and what its implications are for the TRL.
As is known, since Turkey switched to the floating exchange rate regime in 2001, the banking sector’s net open F/X position has been close to zero, while there is even a surplus, according to the latest data. On the other hand, banks are offsetting their on-balance sheet open position at US$12.3bn as of March 4, by taking long positions via off-balance sheet transactions (derivatives) of similar amounts. Swaps with foreign residents are known to be making up a major portion (60%) of the off-balance-sheet transactions and 75% of these derivative transactions were on currency, according to the September 2010 issue of the FX Risk Evaluation Report of the BRSA. Currency swaps include the exchange of the TRL and major currencies between domestic banks and foreign investors. It provides foreign investors the opportunity to take TRL positions without assuming the country risk. Especially, long term swaps had been used to hedge long-term domestic housing loans during 2005-06 by our local banks.
Implications for the TRL -- So how can we interpret a change in the off-balance sheet FX position? Simple… When there is an increase (decrease) in the off-balance position, it eventually means a rise (fall) in money market positions in the TRL by foreigners. It also places appreciation (depreciation) pressure on the domestic currency.
Let us continue with the November-December evolution of these figures. Moreover, we will be looking at recent numbers to evaluate the current outlook of short-term capital flows. According to the BRSA’s weekly data, off-balance sheet FX position fell by US$10.5bn within the Nov 12 – Dec 31, 2010 period, lending support to the CBT’s argument on hot money outflows and the effectiveness of the decisions.
Although the direction of the flows has changed more often year-to-date in 2011, there have still been outflows of around US$1.3bn cumulatively as of March 4. As a result, total money market outflows have reached US$11.5bn since the beginning of November. However, there have been US$7.2bn inflows to domestic debt instruments in the same period, mostly during the first months of 2011, and US$1.9bn outflows from equity portfolios. Central Bank Governor Yilmaz also acknowledged this, saying that following their statement concerning “US$10 billion worth of outflows”, "a majority" of those positions had returned. But much of the returning money appeared to be invested in longer term instruments, which was their main goal.
Note that the above analysis has a certain margin of error, since the data are not compiled through conventional investment channels. Nevertheless, we think it is a valuable exercise to understand the recent trends.
Where are hot money flows headed to and how to monitor them? -- First, the CBT specified three channels for non-residents’ portfolio flows: equities, debt instruments, and money market transactions. As we all know, the first two channels can be easily monitored from the CBT’s database (Non-residents' Holdings of Securities) on a weekly basis and from BoP statistics on a monthly basis. However, as mentioned in the above statement as well, swap transactions in particular, which constitute the bulk -- and are the most volatile component -- of the money market positions, cannot be monitored via BoP statistics. Secondly, a major difference from the previous statement was the indication provided by the CBT to monitor such flows. The CBT pointed out that the off-balance sheet FX position of the banking system could be an important indicator of the magnitude of these transactions. Developments on the off-balance sheet FX position of the banking system can be monitored through the weekly bulletins of the Banking Regulation and Supervision Agency. Unlike many others, we have been aware of these figures and have been following their evolution for many years now to better comprehend the TRL’s performance amid hectic market conditions. Let us explain here what off-balance sheet FX position stands for and what its implications are for the TRL.
As is known, since Turkey switched to the floating exchange rate regime in 2001, the banking sector’s net open F/X position has been close to zero, while there is even a surplus, according to the latest data. On the other hand, banks are offsetting their on-balance sheet open position at US$12.3bn as of March 4, by taking long positions via off-balance sheet transactions (derivatives) of similar amounts. Swaps with foreign residents are known to be making up a major portion (60%) of the off-balance-sheet transactions and 75% of these derivative transactions were on currency, according to the September 2010 issue of the FX Risk Evaluation Report of the BRSA. Currency swaps include the exchange of the TRL and major currencies between domestic banks and foreign investors. It provides foreign investors the opportunity to take TRL positions without assuming the country risk. Especially, long term swaps had been used to hedge long-term domestic housing loans during 2005-06 by our local banks.
Implications for the TRL -- So how can we interpret a change in the off-balance sheet FX position? Simple… When there is an increase (decrease) in the off-balance position, it eventually means a rise (fall) in money market positions in the TRL by foreigners. It also places appreciation (depreciation) pressure on the domestic currency.
Let us continue with the November-December evolution of these figures. Moreover, we will be looking at recent numbers to evaluate the current outlook of short-term capital flows. According to the BRSA’s weekly data, off-balance sheet FX position fell by US$10.5bn within the Nov 12 – Dec 31, 2010 period, lending support to the CBT’s argument on hot money outflows and the effectiveness of the decisions.
Although the direction of the flows has changed more often year-to-date in 2011, there have still been outflows of around US$1.3bn cumulatively as of March 4. As a result, total money market outflows have reached US$11.5bn since the beginning of November. However, there have been US$7.2bn inflows to domestic debt instruments in the same period, mostly during the first months of 2011, and US$1.9bn outflows from equity portfolios. Central Bank Governor Yilmaz also acknowledged this, saying that following their statement concerning “US$10 billion worth of outflows”, "a majority" of those positions had returned. But much of the returning money appeared to be invested in longer term instruments, which was their main goal.
Note that the above analysis has a certain margin of error, since the data are not compiled through conventional investment channels. Nevertheless, we think it is a valuable exercise to understand the recent trends.
25 Şubat 2011 Cuma
Is the CBT done, or yet to start?...
Turkey needs a re-coupling of growth drivers - After an impressive growth performance in 2010, thanks mainly to a robust recovery in domestic demand, it is clear that Turkey needs to rebalance its growth drivers in the face of mounting risks threatening the sustainability of this outperformance. Our C/A deficit, the speed limit of the economy, has widened rapidly, while the recent trend in oil and other commodity prices has definitely not been of any help in terms of stemming this rise. Luckily, the government and the CBT seem cognisant of the situation and have taken certain measures to restrain the pace of the recovery in loans and eventually domestic demand over the coming period, while hoping that the role to be played by the banking system in the monetary transmission mechanism would be supportive. Moreover, in order to quantify and commit these targets, the CBT has assumed a limited monetary tightening to bring loan growth down to 20-25% in 2011, which supports its YE11 CPI forecast (5.9%), as stipulated in its Jan’11 Inflation Report.
Government keen to restrain loan growth - Deputy PM Babacan also cautioned further measures were to follow in case of no slowdown in credit growth within 1Q11, as he stated that additional measures should be expected if loan growth persisted at 35-40% annually within January-March. He reiterated that a loan growth rate of 20-25% would be reasonable and in line with the government’s GDP growth target of 4.5-5.0% for 2011. He further noted that some bank-specific measures could also be applied, if necessary. Such a strong degree of commitment to limit loan growth renders this indicator even more critical than usual. Hence, it is essential for economists and analysts to gauge whether there is a slowdown in loan growth or not.
Are inferences of “no slowdown in loan growth” well-founded? Unfortunately, there are different sources (BRSA, CBT) and definitions (bank-only, consolidated) for loan figures and market players do not know exactly on which parameters the CBT or other authorities are basing their assessments, in the absence of an official announcement. Experts inferring that there is “no slowdown in loan growth” are usually predicating this conclusion on the BRSA’s weekly figures on an annual basis, but without making the necessary adjustments. Indeed, as of Feb 11, on a year-on-year basis, total loans outstanding were up 36%, while consumer loans were higher by 40%, showing no signs of a deceleration. However, first of all, a direct comparison with the year ago could be misleading due to the weak base. Secondly, the exchange rate effect on FX loans should be neutralised by using fixed FX rates against the TRL and a fixed currency (60% US$-40% €) composition. Last but not least, short term changes are more descriptive in terms of detecting trend changes. We have tried to refrain from those mistakes and used the BRSA’s loan figures from its daily bulletin, which come with less of a lag. We took the last 22 business days’ average of total loans (fixed FX rates and fixed FX composition) to represent the monthly outlook and compared it with the same period’s average of a year ago. The annual increase in our indicator is still high at 33.7% as of February 17, but it signifies a slight deceleration in the trend towards 33.6% as of mid-February, after having peaked at 33.8% within January. The CBT also acknowledged this, noting that there was a slight deceleration in the pace of credit growth at the beginning of 2011 in the summary of the MPC meeting notes. It also pointed to a slowdown in consumer loans, given sluggish auto loans, in another paragraph of the report.
There are other signs pointing to a deceleration in economic activity, which make our observation of a slowdown in the pace of credit growth more meaningful. First of all, seasonally-adjusted imports fell by 6.4% m/m in December. Moreover, VAT on imports item in the central government budget signified some deceleration in the pace of import growth in January. VAT on imports dropped by 5% yoy in TRL terms, corresponding to a 10% yoy decline in US$ terms. According to our calculations, this implies an import level of around US$14bn for Jan’11, reducing the annual growth of imports down to 15-20% from 37% in Dec’10. In that case, the trade deficit and hence the C/A deficit would continue to widen in annualised terms, but at a decelerating pace. Second, two of the most important leading indicators of economic activity showed some weakness in February. Capacity utilisation rate (CUR) fell further to 73.0%, while the Business Confidence Index of the CBT retreated after the impressive improvement of a month ago. CUR declined to 73.0% in Feb’11, the lowest level registered since Aug’10. Feb’11 CUR reading fell short of both the expectations and the average CUR (75.6%) of 4Q10. However, the seasonally-adjusted CUR of 76.1% indicated a more limited deterioration than what the headline figures suggested. Business Confidence Index slipped to 111.0 in Feb’11 from 113.6 in Jan’11, on the back of the fall in total orders in the last three months and that in export orders for the next three months. Yet, the current level is still much higher than the critical threshold of 100 -- which separates the expansion and contraction periods in the economy -- thereby attesting to the ongoing economic growth. While being a negative surprise for growth outlook, it was definitely another source of relief for recent overheating concerns. CUR turned out much weaker than expected, driven by lower CUR in consumption and capital goods. Despite its being still relatively stronger on a seasonally-adjusted basis, weak CUR supports the CBT’s stance on the existence of a negative output gap (around 1% of GDP) in the economy. Business confidence index implies that the growth momentum is also losing some steam, probably reflecting the measures taken by the Central Bank and other authorities.
On the consumer side, available leading indicators of domestic demand (domestic car sales and white goods sales) were strong in January. However, more forward-looking indicators such as consumer confidence have somewhat weakened, due to a deterioration in expectations. Recognising the above-mentioned developments, the CBT also acknowledged early signs of a slowdown that are discernible through various channels. The CBT sees an improvement in the current account deficit in December in seasonally-adjusted terms, as well as a slight deceleration in the pace of credit growth at the beginning of 2011. The monetary authority also indicates that monetary tightening would restrain demand side pressures on inflation, by citing that domestic orders have moderated during the first quarter compared to the previous quarter, according to leading indicators (business confidence sub index).
For the time being, the final supporting factor is the favourable performance of the central government budget in January. The budget posted a TRL4.81bn primary surplus in Jan’11, compared to a TRL2.97bn primary surplus in Jan’10, up 62% yoy. Similarly, a TRL1bn budget surplus was recorded in Jan’11, versus TRL3.1bn deficit in the same month last year. Budget revenues rose by 20.4% yoy, thanks to solid performances in both tax and non-tax revenues. On the other hand, budget expenditures declined by 0.7% yoy, thanks to lower interest expenses in Jan’11. Otherwise, non-interest expenditures rose by 12.9% yoy, at a slightly slower pace than the tax revenues. It was really a good start to 2011 in terms of fiscal discipline ahead of the parliamentary election scheduled for June’11. 12-month rolling budget figures imply that the primary balance improved slightly to 1% of the GDP from 0.8% of the GDP, while the budget deficit declined from 3.6% of the GDP to 3.2% of the GDP. Excluding one-off factors such as privatisation revenues, the primary balance also shows about 0.1pp improvement as a percentage of the GDP.
All in all, these signals bode well for the success of the CBT’s recent strategy. However, we agree with the CBT that the available data are not long enough to make a healthy assessment, as the effects of the measures would be observed more significantly with some lag.
Therefore, we think the CBT is seemingly trying to buy time before making any adjustments to the policy mix. However, the CBT also sees early signs of a slowdown and expects a further deceleration in economic activity. This should suggest that the CBT would be in no hurry to further increase the reserve requirement ratios (RRRs) or would be even more likely to hold them at current levels for a longer period, in case the impact of the measures became more visible. We maintain our expectation of a 100bp policy rate hike in 4Q and a 150bp RRR hike (weighted average) in the first half of the year. However, if the “slowdown” scenario pans out, this would lessen the chances of further RRR hikes and render the policy rate decision dependent more on inflation outlook than before.
On the other hand, we see a slight downside risk (*) to our GDP growth forecast of 6%for 2011, to which the current weakness in leading indicators would pose a threat should it evolve into a trend. We also see a limited upside risk to our CPI forecast of 6.2% for 2011, as oil prices are hovering about US$10-15 above our assumption. Our back of the envelope calculations suggest that the direct impact of every US$5 increase in average oil prices would be a 0.2pp rise in annual inflation. It would also mean a US$4.8-7.2bn (**) addition to our C/A deficit forecast of US$57.0bn, if the recent elevated oil price levels are sustained.
(*) In 2011, we assume seasonally-adjusted m/m changes in industrial production (IP) as 0.3% on average after a likely retreat of 2-3% m/m in January due to the sharp improvement in December. We think our assumption is very conservative, since average m/m changes were 0.8% and 1.4% in 2009 and 2010, respectively. Based on our calculations, even with this moderate improvement in industrial production, GDP growth could easily reach or even slightly exceed 6% in 2011.
(**) Oil and derivatives imports (US$21bn) constitute 54.5% of total energy imports (US$38.5bn) in 2010. Natural gas and solid fuels comprise the remainder. For simplicity, we assumed similar price increases in those segments. Oil and derivatives imports rise by around US$1.3bn in every US$10 increase in average oil prices
Government keen to restrain loan growth - Deputy PM Babacan also cautioned further measures were to follow in case of no slowdown in credit growth within 1Q11, as he stated that additional measures should be expected if loan growth persisted at 35-40% annually within January-March. He reiterated that a loan growth rate of 20-25% would be reasonable and in line with the government’s GDP growth target of 4.5-5.0% for 2011. He further noted that some bank-specific measures could also be applied, if necessary. Such a strong degree of commitment to limit loan growth renders this indicator even more critical than usual. Hence, it is essential for economists and analysts to gauge whether there is a slowdown in loan growth or not.
Are inferences of “no slowdown in loan growth” well-founded? Unfortunately, there are different sources (BRSA, CBT) and definitions (bank-only, consolidated) for loan figures and market players do not know exactly on which parameters the CBT or other authorities are basing their assessments, in the absence of an official announcement. Experts inferring that there is “no slowdown in loan growth” are usually predicating this conclusion on the BRSA’s weekly figures on an annual basis, but without making the necessary adjustments. Indeed, as of Feb 11, on a year-on-year basis, total loans outstanding were up 36%, while consumer loans were higher by 40%, showing no signs of a deceleration. However, first of all, a direct comparison with the year ago could be misleading due to the weak base. Secondly, the exchange rate effect on FX loans should be neutralised by using fixed FX rates against the TRL and a fixed currency (60% US$-40% €) composition. Last but not least, short term changes are more descriptive in terms of detecting trend changes. We have tried to refrain from those mistakes and used the BRSA’s loan figures from its daily bulletin, which come with less of a lag. We took the last 22 business days’ average of total loans (fixed FX rates and fixed FX composition) to represent the monthly outlook and compared it with the same period’s average of a year ago. The annual increase in our indicator is still high at 33.7% as of February 17, but it signifies a slight deceleration in the trend towards 33.6% as of mid-February, after having peaked at 33.8% within January. The CBT also acknowledged this, noting that there was a slight deceleration in the pace of credit growth at the beginning of 2011 in the summary of the MPC meeting notes. It also pointed to a slowdown in consumer loans, given sluggish auto loans, in another paragraph of the report.
There are other signs pointing to a deceleration in economic activity, which make our observation of a slowdown in the pace of credit growth more meaningful. First of all, seasonally-adjusted imports fell by 6.4% m/m in December. Moreover, VAT on imports item in the central government budget signified some deceleration in the pace of import growth in January. VAT on imports dropped by 5% yoy in TRL terms, corresponding to a 10% yoy decline in US$ terms. According to our calculations, this implies an import level of around US$14bn for Jan’11, reducing the annual growth of imports down to 15-20% from 37% in Dec’10. In that case, the trade deficit and hence the C/A deficit would continue to widen in annualised terms, but at a decelerating pace. Second, two of the most important leading indicators of economic activity showed some weakness in February. Capacity utilisation rate (CUR) fell further to 73.0%, while the Business Confidence Index of the CBT retreated after the impressive improvement of a month ago. CUR declined to 73.0% in Feb’11, the lowest level registered since Aug’10. Feb’11 CUR reading fell short of both the expectations and the average CUR (75.6%) of 4Q10. However, the seasonally-adjusted CUR of 76.1% indicated a more limited deterioration than what the headline figures suggested. Business Confidence Index slipped to 111.0 in Feb’11 from 113.6 in Jan’11, on the back of the fall in total orders in the last three months and that in export orders for the next three months. Yet, the current level is still much higher than the critical threshold of 100 -- which separates the expansion and contraction periods in the economy -- thereby attesting to the ongoing economic growth. While being a negative surprise for growth outlook, it was definitely another source of relief for recent overheating concerns. CUR turned out much weaker than expected, driven by lower CUR in consumption and capital goods. Despite its being still relatively stronger on a seasonally-adjusted basis, weak CUR supports the CBT’s stance on the existence of a negative output gap (around 1% of GDP) in the economy. Business confidence index implies that the growth momentum is also losing some steam, probably reflecting the measures taken by the Central Bank and other authorities.
On the consumer side, available leading indicators of domestic demand (domestic car sales and white goods sales) were strong in January. However, more forward-looking indicators such as consumer confidence have somewhat weakened, due to a deterioration in expectations. Recognising the above-mentioned developments, the CBT also acknowledged early signs of a slowdown that are discernible through various channels. The CBT sees an improvement in the current account deficit in December in seasonally-adjusted terms, as well as a slight deceleration in the pace of credit growth at the beginning of 2011. The monetary authority also indicates that monetary tightening would restrain demand side pressures on inflation, by citing that domestic orders have moderated during the first quarter compared to the previous quarter, according to leading indicators (business confidence sub index).
For the time being, the final supporting factor is the favourable performance of the central government budget in January. The budget posted a TRL4.81bn primary surplus in Jan’11, compared to a TRL2.97bn primary surplus in Jan’10, up 62% yoy. Similarly, a TRL1bn budget surplus was recorded in Jan’11, versus TRL3.1bn deficit in the same month last year. Budget revenues rose by 20.4% yoy, thanks to solid performances in both tax and non-tax revenues. On the other hand, budget expenditures declined by 0.7% yoy, thanks to lower interest expenses in Jan’11. Otherwise, non-interest expenditures rose by 12.9% yoy, at a slightly slower pace than the tax revenues. It was really a good start to 2011 in terms of fiscal discipline ahead of the parliamentary election scheduled for June’11. 12-month rolling budget figures imply that the primary balance improved slightly to 1% of the GDP from 0.8% of the GDP, while the budget deficit declined from 3.6% of the GDP to 3.2% of the GDP. Excluding one-off factors such as privatisation revenues, the primary balance also shows about 0.1pp improvement as a percentage of the GDP.
All in all, these signals bode well for the success of the CBT’s recent strategy. However, we agree with the CBT that the available data are not long enough to make a healthy assessment, as the effects of the measures would be observed more significantly with some lag.
Therefore, we think the CBT is seemingly trying to buy time before making any adjustments to the policy mix. However, the CBT also sees early signs of a slowdown and expects a further deceleration in economic activity. This should suggest that the CBT would be in no hurry to further increase the reserve requirement ratios (RRRs) or would be even more likely to hold them at current levels for a longer period, in case the impact of the measures became more visible. We maintain our expectation of a 100bp policy rate hike in 4Q and a 150bp RRR hike (weighted average) in the first half of the year. However, if the “slowdown” scenario pans out, this would lessen the chances of further RRR hikes and render the policy rate decision dependent more on inflation outlook than before.
On the other hand, we see a slight downside risk (*) to our GDP growth forecast of 6%for 2011, to which the current weakness in leading indicators would pose a threat should it evolve into a trend. We also see a limited upside risk to our CPI forecast of 6.2% for 2011, as oil prices are hovering about US$10-15 above our assumption. Our back of the envelope calculations suggest that the direct impact of every US$5 increase in average oil prices would be a 0.2pp rise in annual inflation. It would also mean a US$4.8-7.2bn (**) addition to our C/A deficit forecast of US$57.0bn, if the recent elevated oil price levels are sustained.
(*) In 2011, we assume seasonally-adjusted m/m changes in industrial production (IP) as 0.3% on average after a likely retreat of 2-3% m/m in January due to the sharp improvement in December. We think our assumption is very conservative, since average m/m changes were 0.8% and 1.4% in 2009 and 2010, respectively. Based on our calculations, even with this moderate improvement in industrial production, GDP growth could easily reach or even slightly exceed 6% in 2011.
(**) Oil and derivatives imports (US$21bn) constitute 54.5% of total energy imports (US$38.5bn) in 2010. Natural gas and solid fuels comprise the remainder. For simplicity, we assumed similar price increases in those segments. Oil and derivatives imports rise by around US$1.3bn in every US$10 increase in average oil prices
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