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Central Bank of the Republic of Turkey I. Macroeconomic Outlook The global economy displayed a moderate growth in 2014 while the discrepancies continue between recovery trends of countries. Inflation in advanced economies hovers below the target rates owing to the fall in commodity prices, especially oil prices. In emerging markets, however, inflation rates display an uptrend due to the depreciation in national currencies. The discrepancies between growth and the inflation outlook are reflected in national monetary policies of advanced economies. Global markets remain highly sensitive to data flows due to these developments coupled with low predictability in global economy and elevated uncertainties. Consequently, the volatility in risk perceptions and capital flows persists. The global economic developments offer both opportunities and challenges to emerging economies. The low oil prices are positively affecting the inflation, current account deficit and growth outlook of emerging economies that import commodities. Meanwhile, subdued global economic activity poses a downside risk to the growth prospects of the emerging economies via the foreign trade channel. The significant appreciation of the US dollar against all other currencies on the global foreign exchange market stands out as a risk factor for those emerging economies running a high level of FX indebtedness. In Turkey, economic activity remains moderate. Weak export trend is the main factor decelerating growth. While aggregate demand conditions are underpinning disinflation; food prices and the lagged effects of exchange rate developments curb improvement in the inflation outlook. While portfolio flows to Turkey remain weak, there are fluctuations in the risk premium and the value of the Turkish lira. The CBRT sustains its cautious monetary policy stance and maintains a tight monetary policy to curb the impact of the volatility in the global markets on Turkey's inflation outlook and inflation expectations. While the current account deficit is improving on the back of the cautious monetary stance coupled with the sustained macroprudential measures, the risk premia remains low thanks to the fiscal discipline and the banking sector's strong position. In the upcoming period, the course of economic activity and Financial Stability Report- May 2015 3 Central Bank of the Republic of Turkey the volatility in the markets will be the factors affecting financial Chart I.1.1 Global and Advanced Economies’ Growth Rates1 stability. While the CBRT maintains its cautious monetary stance (Percent, Annual) Advanced Countries on one hand, on the other it aims to mitigate macro-financial Developing Countries Developing Countries excluding China and India 10 8 risks by introducing measures supporting foreign exchange liquidity, core liabilities and long-term borrowing. 6 4 2 I.1. International Developments 0 -2 -4 Global growth realized at moderate levels in 2014 and -6 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 2008 2009 2010 2011 2012 2013 2014 has continued to diverge. The USA enjoys a stronger growth (1) Weighted by each country's share in global GDP. Source: Bloomberg, CBRT. performance compared to other advanced economies. Chart I.1.2 Manufacturing Industry PMI Indices Despite signs of recovery, growth in the euro area is still subdued. The growth pace of advanced economies, which comprises EMEs AEs US EU 58 56 the recovery trends in the economic activity of countries 75 percent of global growth, is slowing down (Chart I.1.1). The 04.15 02.15 12.14 10.14 08.14 06.14 04.14 the economic outlook in the euro area may improve whereas 02.14 industry PMI indices for advanced economies suggest that 46 12.13 48 10.13 likely continue throughout 2015. However, the manufacturing 08.13 50 06.13 slowdown in the growth pace of the emerging economies will 04.13 52 02.13 manufacturing industry PMI indices exhibit signals that the 12.12 54 recovery in the USA will likely lose some pace (Chart I.1.2). Source: Bloomberg Chart I.1.3 Inflation in Advanced and Emerging Economies and Crude Oil Prices (Percent, Annual, USD) economies diverge significantly. The decline in commodity AEs EMEs Crude Oil- (RHA) 6 160 140 5 120 4 100 3 80 60 2 40 1 02.15 12.14 10.14 08.14 06.14 04.14 02.14 12.13 10.13 08.13 06.13 04.13 12.12 02.13 20 0 Inflation outlook in advanced economies and emerging 0 prices, particularly in oil prices, reduces inflationary pressures. Moreover, inflation rates in advanced economies remain below targets due to weak demand in countries like the euro area and Japan. However, inflation rates in emerging economies, display an uptrend due to the depreciation in national currencies (Chart I.1.3). The monetary policies of advanced economies diverge Source: Bloomberg due to the discrepancies in the growth and the inflation outlook. Chart I.1.4 US and Germany Treasury Bond Yields (Percent) The ECB drove lending rates down to negative and expanded US 10-Year Germany 10-Year US 2-Year (RHA) Germany 2-Year (RHA) the asset purchase program that it initiated in October 2014 by -0.3 improvement in the US economy. Overall, these developments 0,0 -0.6 have led to the appreciation of US dollar against the euro 11.13 09.13 07.13 05.13 03.13 01.13 05.15 Fed is giving signals of a start of an interest rate hike with the 0,6 03.15 0 01.15 in inflation expectations (Chart I.1.4). On the other hand, the 1,2 11.14 0.3 09.14 falling rapidly on the back of monetary expansion and the fall 1,8 07.14 0.6 05.14 2,4 03.14 including public sector bonds. Interest rates in the euro area are 01.14 0.9 3,0 Source: Bloomberg 4 Financial Stability Report- May 2015 Central Bank of the Republic of Turkey (Chart I.1.5). Even though the change in the euro / US dollar parity is welcomed as this will support recovery in the euro area, Chart I.1.5 EUR/USD Parity and DXY Index DXY Index there is not a noteworthy improvement in credit supply yet. The 100 high NPL ratios in the balance sheets of the banks in the euro 95 1.4 90 1.3 85 1.2 strategy by the Fed regarding its monetary policy is of 80 1.1 crucial importance. The low inflation trend coupled with 75 1 the normalization process of the US monetary policy. These uncertainties lead to a discrepancy between the expectations 04.15 01.15 10.14 07.14 04.14 01.14 10.13 Source: Bloomberg Chart I.1.6 Expectations of the FOMC Members and the Market (End-year, percent) Market of the Federal Open Market Committee members and those of the market. Market participants are expecting a smoother 07.13 04.13 01.13 10.12 07.12 lower-than-expected US data is elevating uncertainties over 04.12 The implementation of an effective communication 01.12 area prevents effective operating of the credit market. 1.5 Euro-USD Parity (RHA) Projection FOMC Members 4.5 3.5 4.0 3.0 increase in the Federal funds rate than the FOMC members 3.5 (Chart I.1.6). An earlier and faster than expected rise in the rate 2.5 2.0 2.0 1.5 1.5 1.0 1.0 -4 -6 Financial Stability Report- May 2015 02.15 12.14 10.14 95 200 90 175 85 150 80 125 03.15 70 01.15 75 75 11.14 100 09.14 the current global low interest rate environment, extending 100 225 07.14 roll-over of especially short-term debts. In this framework, amid JP Morgan EM Currency Index 07.13 emerging economies and accordingly, some concerns about Selected Emerging Economies** 250 05.13 I.1.9). Appreciation of the US dollar increases the debt burden of Emerging Economies* 03.13 has moved upwards compared to the pre-crisis period (Chart 08.14 Chart I.1.8 CDS Premiums for Emerging Economies and JP Morgan Exchange Rate Index 01.13 exchange rate. FX borrowing in most of the emerging economies 06.14 Source: EPFR The differences between monetary policies of advanced economies increase the sensitivity of emerging markets to 04.14 -8 -10 05.14 as the capital flows toward emerging economies. 0 -2 02.14 will have a significant impact on the global risk appetite as well Equities 03.14 of emerging and advanced economies and commodity prices 0.0 2 12.13 Expectations for the Federal funds rate, growth performances 40 4 01.14 economies is rising due to capital outflows (Chart I.1.7 and I.1.8). 30 Long term 2016 6 10.13 in the March meeting. The CDS premiums of emerging Bonds 8 11.13 members revised their interest rate expectations downwards 10 09.13 of the emerging economies was partly offset when the FMOC 20 (Weekly, Billion USD) 08.13 in these countries. Nevertheless, the depreciation in currencies 2015 Chart I.1.7 Capital Flows to Emerging Economies 06.13 have depreciated and exchange rate volatility has increased 10 * Fed fund futures rates have been used for market expectations. Median of FOMC Members' interest rate expectations have been used. Source: CME Group, Fed 04.13 monetary policy. Moreover, currencies of emerging economies 0 2014 02.13 been fluctuating due to the uncertainties in the United States' 0.0 12.12 Capital movements in emerging economies have 0.5 0.5 04.15 might lead to fluctuations in the global financial system. 2.5 3.0 Source: Bloomberg * Emerging economies include Brazil, Czech Republic, Indonesia, South Africa, Colombia, Hungary, Mexico, Poland, Romania, Chile and Turkey. **CDS premia of Brazil, Indonesia and South Africa have been used to calculate the average of selected emerging economies. 5 Central Bank of the Republic of Turkey foreign debt maturities and supporting prudent borrowing will Final Domestic Demand Net Exports Change in Inventories GDP growth strengthen financial stability. Chart I.1.9 FX Indebtedness of Households and the Corporate Sector (Percent of GDP) 2014 developments offer both upside risks in inflation in emerging economies that are importing commodities. Moreover, this decline is expected to have a 12.14 09.14 06.14 03.14 12.13 positive impact on the current account deficit and the growth. 25 20 Recovery in the US economy and the signs of recovery in the 15 euro area due to measures taken will make a positive effect on 10 5 Chile Poland Turkey Russia S. Africa Indonesia Brazil India Argentina Colombia the growth outlook of emerging economies. 0 Source: IMF I.2. Domestic Developments Growth was slightly slower in 2014 compared to 2013. Despite the weak external demand, net exports contributed positively to growth (Chart I.2.1). Industrial production slightly Chart I.2.1 Contribution to Growth From The Spending Side accelerated in the first quarter of 2015. This acceleration was (Percentage Point) mainly driven by the robust vehicle production. While consumer Final Domestic Demand Net Exports Change in Inventories GDP growth 10 8 confidence and investment tendency implies moderate private 6 sector domestic demand, the leading indicators suggest that 4 external demand is relatively weak. The weak global economic 2 activity coupled with the geopolitical developments pulls 0 12.14 09.14 06.14 03.14 12.13 in the euro/dollar parity is also adversely affecting exports. Signs 09.13 -4 06.13 down growth by curbing exports growth. The excessive volatility 03.13 -2 12.12 Source: CBRT, TURKSTAT of recovery in the euro area are expected to be one of the factors supporting external demand in the upcoming period. An analysis of the developments in economic activity with respect to labor market reveals that the unemployment rate climbed because the rise in employment in 2014 fell short of the Chart I.2.2 Price Indices growth in the labor supply. Recently, both industrial production (Annual Percentage Change) CPI 11 11 data and survey results point to a moderate recovery in the 10 labor market. H Index I Index 10 6 The cautious monetary and fiscal policies coupled with the 5 5 macroprudential measures are having a positive impact on Source: CBRT, TURKSTAT 6 03.15 6 12.14 more limited than forecasted due to cost-side pressures. 09.14 7 06.14 7 03.14 Despite the decline in demand, the fall in inflation was 12.13 8 09.13 8 06.13 9 03.13 9 12.12 09.13 06.13 economic decline in commodity prices, particularly in oil prices, reduces 40 30 global opportunities and challenges for emerging economies. The 2007 35 The core inflation indicators (Chart I.2.2). Moreover, the low level of commodity prices underpins the improvement in inflation. Financial Stability Report- May 2015 Central Bank of the Republic of Turkey 30 correction in food prices is expected to take place in the 25 near future as the adverse weather conditions seem to have 20 subsided and the Food Committee started to operate. But still, 15 food prices and exchange rate volatility continue to be the 10 fluctuations in the risk premium and the value of the Turkish lira. Uncertainties over the normalization process of the Fed's 2014 25 15 10 5 0 5 -10 Dec Oct Nov Sep Jul Aug Apr Jun -5 (1) Calculated by weekly net portfolio flows. Includes data on repo, GDDS and securities portfolio as well as banks' off-balance sheet FX position. Source: BRSA, CBRT Chart I.2.4 Exchange Rates and Turkey's 5-Year CDS Prices monetary policy lead to fluctuations in financial markets. The Turkish lira has depreciated against the US dollar and has 30 20 0 While portfolio flows to Turkey remain weak, there are 2013 2012 May primary risk factor on inflation outlook. 2011 2015 Mar curb further improvement in the inflation outlook. A significant (Billion USD) Jan effects of exchange rate developments on domestic prices Chart I.2.3 Cumulative Portfolio Flows1 Feb Nevertheless, the high level of food inflation and the lagged Euro/TL 3.2 displayed a more stable trend against the euro (Chart I.2.3 and 2.9 I.2.4). Meanwhile, the yield from government domestic debt 2.6 securities has increased significantly. 2.3 USD/TL 280 CDS (RHA) 250 220 190 160 2.0 introduced measured rate cuts in the first quarter of 2015 and maintained the yield curve almost flat by sustaining the cautious monetary policy (Chart I.2.5). The cautious stance 04.15 03.15 12.14 09.14 06.14 03.14 12.13 09.13 100 Source: CBRT, Bloomberg Chart I.2.5 CBRT Rates and BIST Interbank O/N Rates (Percent) 5 Year-BIST Interest Differential 18 18 5-Year Market Rate the monetary policy need to be maintained taking into 16 account the adverse impact of the global uncertainties and 12 12 10 10 8 8 6 6 4 4 some additional measures for the FX liquidity in response to the 2 2 0 0 elevated exchange rate volatility. While the export rediscount -2 -2 -4 -4 reserves can be used as a supporting tool in times of excessive volatility. 04.15 02.15 12.14 10.14 08.14 06.14 04.14 02.14 12.13 10.13 08.13 06.13 credits continue to contribute to the CBRT's FX reserves, these 14 BIST Interbank O/N Rates (5 days MA) 04.13 energy and food prices. In addition, the CBRT has introduced 14 02.13 exchange rate volatility on core inflation and the fluctuations in 16 CBRT Average Funding Rate (5 days MA) 12.12 in 06.13 stance by maintaining a tight liquidity policy. The CBRT 03.13 1.7 12.12 The CBRT has sustained its cautious monetary policy 130 Source: CBRT, BIST Chart I.2.6 Current Account Deficit and Financing Items (12-Month Cumulative, Billion USD) 80 decline in commodity prices are having favorable impacts 70 in terms of the current account deficit, inflation and growth 50 60 in Turkey (Chart I.2.6). The credit growth, which was kept at 40 reasonable levels by maintaining the cautious monetary policy 20 current account deficit is mostly made by long-term sources. Financial Stability Report- May 2015 10 0 02.15 12.14 10.14 08.14 06.14 04.14 02.14 12.13 10.13 08.13 06.13 -10 04.13 recovery in the current account balance. The financing of the 30 12.12 stance and the macroprudential measures, contributed to the Portfolio and Short-term FDI and Long-term Current Account Deficit 90 02.13 The current account balance has been improving. The Source: CBRT 7 Central Bank of the Republic of Turkey The fiscal discipline contributes to bringing down both Chart I.2.7 Central Government Budget Balances the risk premium and inflation. Even if the central government (12-Month Cumulative, Percent of GDP) Budget Balance budget deficit slightly increased, it was still below the pre- Primary Balance 2.5 2.0 defined target (Chart I.2.7). The downward tendency in public 1.5 debts continues. The fact that borrowing is mostly in fixed rate, 1.0 0.5 TL denominated and has long maturities contributes to financial 0.0 -0.5 stability (Chart I.2.8). -1.0 -1.5 The course of the economic activity and level of volatility 12.14 09.14 06.14 03.14 12.13 09.13 06.13 03.13 -2.5 12.12 -2.0 in financial markets will be the key factors affecting financial Source: Ministry of Finance stability in the upcoming period. From the economic activity stance, external demand remains weak while domestic demand offers a moderate support to growth. Volatility in Chart I.2.8 Composition of Central Government Debt Stock and Average Days to Maturity¹ (Month) financial markets might curb the contribution of the private sector final demand to growth. Meanwhile the weak global FX Denominated Floating Rate Fixed Rate Average Maturity of Domestic Debt Stock (RHA) Average Maturity of External Debt Stock (RHA) 100% demand conditions are having negative impact on external 150 80% 100 60% 56.1 40% 50 (1) Data of days to maturity pertains to October 2013. Source: Undersecretariat of Treasury 2015March 2014 2013 2012 2011 2010 2009 2008 2007 2006 20% 0% demand. The recent signs of recovery in the euro area might be promising for external demand. The global uncertainties, the risk 120.2 0 appetite and volatility in capital flows still persist. While the CBRT maintains its cautious monetary stance on one hand, on the other, it aims to mitigate the macro-financial risks by introducing measures to support foreign exchange liquidity, core liabilities and long-term borrowing. In the upcoming period, the macrofinancial risks will be closely monitored and additional measures will be introduced if required. 8 Financial Stability Report- May 2015