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CENTRAL BANK OF THE REPUBLIC OF TURKEY MONETARY POLICY FRAMEWORK September 2002 1 Outline of the Presentation Macroeconomic Prospects Key Indicators of Financial Stability Inflation External Sector Growth Recent Monetary Policy Actions A Brief Overview of the FX Policy Inflation Targeting: The Eventual Monetary Policy Framework 2 Signs of Stability are Emerging Volatility of the exchange rate has diminished compared to its peak in June. The CBT continues to strictly limit its discretionary FX interventions. Pre-announced auctions have been suspended in June. Volatility of Exchange Rate (TL/USD, Coefficient of Variation) FX Auctions 1700000 1600000 1500000 1400000 1300000 2% 1100000 1000000 1% 5/4 5/18 6/1 6/15 6/29 7/13 7/27 8/10 8/24 9/7 9/21 10/5 10/19 11/2 11/16 11/30 12/14 12/28 1/11 1/28 2/8 2/21 3/8 3/22 4/5 4/19 5/3 5/17 5/31 6/14 6/28 7/12 7/26 8/9 8/23 9/6 09/02 08/02 07/02 06/02 05/02 04/02 03/02 02/02 01/02 12/01 TL / USD (Weekly Average,Selling Price) 11/01 03/01 Sales Amount (Weekly , Millions of USD) 0% 10/01 -200 1200000 09/01 0 08/01 200 3% 07/01 400 4% 06/01 600 5% 05/01 800 04/01 1000 * (+) indicates FX sales to the market. The upward trend in spreads between May and July was reversed in August in light of the improved political outlook. 95 1000 Overnight Repo, Simple, Left 09-02 08-02 500 07-02 8/26 8/11 7/27 7/12 6/27 6/12 5/28 5/13 4/28 4/13 3/29 3/14 2/27 2/12 1/28 1/13 12/29 12/14 11/29 11/14 10/30 9/30 10/15 9/15 8/31 8/1 8/16 7/2 45 7/17 50 600 06-02 55 53 700 05-02 65 56 04-02 59 800 03-02 75 02-02 62 900 01-02 85 12-01 65 Turkish Eurobond Spreads (bps) 11-01 68 1100 10-01 Interest Rates 71 105 08-01 74 09-01 Following its upward trend caused mainly by increased political uncertainty in July, interest rates have been declining since August. ISE Bonds and Bills Market, Compound, Right Spread =The difference between Turkish Eurobonds and US Treasury bills. Source: JP Morgan 3 Price Developments between January-August 2002 Inflation displayed a declining pattern during this period owing to: The increase in the credibility of the program which, in turn, had a favorable impact on expectations; The absence of demand pressures; The relative stability of the exchange rate and the marked decline in the pass-through from the exchange rate. The significant slowdown in food and agricultural prices. CPI (y-o-y percent change) 80.0 60.0 40.0 07-02 05-02 03-02 01-02 11-01 09-01 07-01 05-01 03-01 01-01 11-00 09-00 07-00 05-00 03-00 01-00 11-99 09-99 07-99 05-99 03-99 20.0 01-99 Annual change 4 Price Developments between January-August 2002 12 10 8 6 4 2 CP I mo nthly % change, sa Jul-02 May-02 Mar-02 Jan-02 Nov-01 Sep-01 Jul-01 May-01 Mar-01 Jan-01 Nov-00 Sep-00 Jul-00 May-00 Mar-00 Jan-00 0 Due to the increased political uncertainty between May and July, both CPI and CPI excluding food displayed an upward trend. The acceleration in prices, however, was limited in August as a result of the improved market sentiment and political outlook. The current trend of inflation suggests that the end year target should be comfortably met. CP I excluding fo o d, mo nthly % change, sa 14.0 12.0 10.0 8.0 The increase in price of services has been more subdued compared to that of price of goods. 6.0 4.0 2.0 Go o ds, mo nthly % change, sa Services, mo nthly % change, sa Jul-02 May-02 Mar-02 Jan-02 Nov-01 Sep-01 Jul-01 May-01 Mar-01 Jan-01 Nov-00 Sep-00 Jul-00 May-00 Mar-00 Jan-00 0.0 5 Price Developments between January-August 2002 Inflation expectations are rapidly converging to the target. End-year Inflation Expectations (Consumer Prices) 75.0 70.0 65.0 60.0 Impact of the new 55.0 economic program 50.0 45.0 40.0 34,8 35,0 2002 Target 35.0 Sep-1 Aug-1 Jul-1 Jun-1 May-1 Apr-01 Mar-01 Feb-01 Jan-01 Dec-01 Nov-01 Oct-01 Sep-01 30.0 Aug-01 6 Price Developments between January-August 2002 The implementation of the economic program is steering the inflation expectations for 2003 towards the target. Inflation Expectations for the Next 12 Months (Consumer Prices) 52 48 44 40 % 30,5 36 32 Aug-01 Aug-02 Sep-01 Sep-02 Oct-01 Oct-02 Nov-01 Nov-02 Dec-1 Dec-02 Jan-01 Jan-02 Feb-01 Feb-02 Mar-01 Mar-02 Apr-1 Apr-02 May-01 May-02 Jun-1 Jun-2 Jul-1 Jul-2 Aug-1 Aug-2 Sep-1 28 Corporate sector % 29,2 Financial sector 7 Outlook for Inflation Medium-term inflation Price stability: targets: Price stability–-the primary objective of monetary policy–-is a prerequisite for rapid, balanced and sustainable growth. Risks: 2002 % 35 2003 % 20 2004 % 12 2005-... Single digits Backward-looking indexation and price-setting behavior in the economy Price-setting behavior of the public sector: public service prices (natural gas, electricity, water), wages, backward re-evaluation coefficient, monopoly, tobacco, wheat etc. Price-setting behavior of the health sector Price-setting policy of the education sector Oil price shocks Resumption of the political uncertainty and the spillover effect on financial markets 8 External Sector: Turnaround in BoP Current Account (Billions of USD) 3.4 6.0 1.0 -4.0 -1.5 The economic slowdown and the depreciation of the Turkish lira have led to a noticeable turnaround in the current account balance in 2001, giving a surplus of US$ 3.4 billion from a deficit of US$ 9.8 billion in 2000. -9.0 -14.0 -9.8 2000 2001 2002 Forecast A current account deficit of US$ 1.5 billion is projected for 2002. Capital Account* (Billions of USD) 13.0 6.4 12.0 4.0 -4.0 February 2001 crisis and resulting confidence loss in TL left the capital account with a deficit of US$ 4 billion in 2001 from a surplus of US$ 13 billion in 2000. -4.0 -12.0 -20.0 2000 * Including Fund credits 2001 2002 Forecast Capital inflows are projected to be US$ 6.4 billion in 2002. 9 External Sector: Evolution of the RER Turkish lira started to depreciate in real terms after May and... Real Effective Exchange Rate ($1 + € 0.77, producer price index for foreign goods & private manufacturing index for domestic goods) 115 110 105 100 95 90 85 80 75 07/02 01/02 07/01 01/01 07/00 01/00 07/99 01/99 07/98 01/98 07/97 01/97 07/96 01/96 07/95 01/95 70 ...the cost-based real exchange rate indices point to an increase in competitiveness. 140 Unit Labor Costs 120 100 80 94Q1 94Q2 94Q3 94Q4 95Q1 95Q2 95Q3 95Q4 96Q1 96Q2 96Q3 96Q4 97Q1 97Q2 97Q3 97Q4 98Q1 98Q2 98Q3 98Q4 99Q1 99Q2 99Q3 99Q4 00Q1 00Q2 00Q3 00Q4 01Q1 01Q2 01Q3 01Q4 02Q1 60 unit labor costs ($) tradables / non-tradables 10 Growth: Signs of recovery are becoming more apparent A stronger-than-expected recovery to date suggests that the 3 percent GNP growth projection for 2002 should be comfortably met: GNP grew by 8.5 percent in the first half of the year. Production A sharp recovery in business confidence since October 2001 as a result of stability in financial markets and the implementation of the new economic program supported by the international financial institutions. Better than envisaged performance in industrial production: Industrial production rose by 7.4 % (y-o-y) in the first six months of 2002. Increase in agricultural production: Agricultural production rose by 1.9 % in the first half of the year and the growth rate of agricultural value added is expected to be around 5 % in 2002. Strong increase in inventory building and replacement investments in industrial sector: The contribution of inventory changes to GDP growth was 8.5 % in the first six months of 2002. 11 Growth: Signs of recovery are becoming more apparent Demand Net Exports: The contribution of net exports to GDP growth was 2.9 % in the first quarter and –5 % in the second quarter. Improved expectations: Decline in uncertainties had a positive impact on investment and consumption decisions Improved exchange rate stability and the downward trend in short-term rates: This development promoted consumption and created a more conducive environment for investment decisions. As a result, the contribution of private expenditures turned positive in the second quarter of 2002. Contributions of Aggregate Demand Components to Growth 2001 Private Expenditure Government Expenditure Net Exports Inventory Accumulation GDP Q1 -5.0 -0.3 9.8 -5.3 -0.8 2002 Q2 -14.9 -3.1 16.9 -8.6 -9.6 Q1 -6.4 -0.5 2.9 5.9 1.9 Q2 1.9 0.4 -5.0 10.9 8.2 12 Growth: Signs of recovery are becoming more apparent Both the production and demand side indicators, except the credit volume, confirm that a solid recovery is underway. Indicators Supporting the Production Growth 2001 I II III IV 2002 I II IMPORTS* -4.9 -30.1 -29.6 -32.9 -10.7 19.1 VELOCITY OF EFT 3.25 2.36 2.41 2.47 2.53 2.50 NEW DURABLES BUSINESSES* PRODUCTION* 18.1 -6.5 -19.7 -28.3 -11.4 -19.1 -26.2 -3.8 -7.3 24.4 17.1 68.1 CAPACITY UTILIZATION RATE (%) 69.8 69.9 71.6 73.5 74.0 75.9 PROTESTED BILLS* 48.0 100.6 80.7 80.6 -26.5 -42.8 NON-AGRICULTURAL EMPLOYMENT (Thousand ) 12,954 12,905 13,199 13,310 12,843 13,650 Indicators Supporting the Aggregate Demand Growth 2001 I II III IV 2002 I II EXPORTS* 8.9 13.4 13.7 12.6 4.6 2.3 CREDIT CARDS* 55.30 32.80 12.90 17.10 30.70 CONSUMER CREDIT* 0.9 -38.6 -49.0 -45.2 -24.9 PRIMARY NON-AGRICULTURAL VAT AUTOMOBİLE BUDGETARY EMPLOYMENT COLLECTION* SALES EXPENDITURE* (Thousand ) 55.7 -61.9 22.2 12,954 32.8 -71.1 43.8 12,905 62.4 -73.3 45.2 13,199 91.7 -71.2 49.7 13,310 74.9 -62.0 90.4 12,843 81.3 -16.7 65.0 13,650 * Percentage change with respect to the same period of the previous year. 13 Growth: Signs of recovery are becoming more apparent The evolution of the industrial production until July suggests that economic recovery will continue in the third quarter as well. GNP and Total Industrial Output (Annual percentage change) 25 20 Industrial P ro ductio n GNP 15 10 5 0 -5 -10 02Q1 01Q1 00Q1 99Q1 98Q1 97Q1 96Q1 95Q1 94Q1 93Q1 92Q1 91Q1 90Q1 89Q1 88Q1 -15 14 Recent Monetary Policy Actions The CBT’s Quantitative Targets are on Track Net Domestic Assets (TL Trillion) Monetary Base (TL Trillion) 12000 10000 10600 8250 8900 10850 35000 30000 9250 20000 6000 4000 Realization 15000 Ceiling Values (2) 10000 2000 5000 0 0 February (3) April June September December Net International Reserves (USD Million)(1) February (3) April June September -3000 Realization -5000 Floor Values -11000 33139 31139 -6500 -7200 -7800 -8500 -9700 Realization Ceiling Values (2) February April June September December (1) Defined as Net International Reserves of CBT minus (i) Treasury liabilities to the IMF (ii) Treasury FX denominated borrowing with an original maturity of less than one year. (2) Target for end-February calculated as four working day average of February 11-12 and March 11-12, 2002, to take account of the transitory impact of the Bayram (religious holiday) on currency demand. NDA targets for June onward have been lowered by TL 161 trillion compared to January 18, 2002 to reflect the drop in required reserves following the SDIF’s intervention in Pamuk Bank. (3) Calculated by using the four working day average of Feb. 11-12 and March 11-12, to take account of the transitory impact of the Bayram (religious holiday) on currency demand. December -1000 -9000 28739 25000 8000 -7000 26100 27700 15 Recent Monetary Policy Actions Interest Rate Cuts The favorable outlook for inflation led the CBT to lower the short term rates: Maturity Quotations Previous Rate 20 Feb. 2002 14March 2002 8 April 2002 30 April 2002 5 August 2002 Bid 59 57 54 51 48 46 Ask 62 62 61 58 55 53 Bid 62 59 55 52 49 46 O/N 1 Week In view of the interruption of the improvement in market sentiment and economic outlook between May and July, coupled with increased political uncertainty, the CBT refrained from further interest rate cuts. In August, however, improvements in the inflation outlook and favorable political developments led the CBT to lower its policy rate. 16 A Brief Overview of the FX Policy The CBT remains resolute to keep discretionary FX interventions outside the pre-announced auctions limited. If necessary, the CBT, without interfering with exchange rates reaching their market-determined levels over longer horizons, will smooth (temporary) excessive exchange rate fluctuations. Has there been a “fear of floating” in Turkey? Evolution of the Volatility of Exchange rate, Interest rate, and Reserves Floating Regime Gross Reserves O/N (Compound) Dollar Jan95 – Dec99 2.75 % 15.78 % 1.59 % Jan00 – Feb01 2.62 % 95.93 % 1.91 % Mar01 – Oct01 4.65 % 4.18 % 3.51 % Nov01- Aug02 2.35 % 1.18 % 2.12 % Contrary to “fear of floating” argument, it seems that since the adoption of the float, the volatility of the exchange rate increased while the volatility of interest rates and reserves diminished. The role of the exchange rate as an adjustment variable has clearly increased since the adoption of the floating regime, while the role of interest rates and reserve movements as shock absorbers has declined noticeably. 17 The Eventual Monetary Policy Framework: Inflation Targeting Nominal Anchor: Under the floating exchange rate regime, inflation targeting (IT) will serve as the nominal anchor of the economy. A High Degree of Flexibility: Monetary policy will have a high degree of flexibility to respond to shocks, thanks to the absence of other objectives, i.e. an exchange rate target. Communication: Under IT, the CBT will aim to find the clearest way to share with the public the precise direction of monetary policy—what the target is and how the CBT is trying to achieve it—through periodic reports (Monetary Policy Report) and other means of communication with the public and markets. Sustainable Debt: Aligning the public's inflation expectations with the CBT's inflation target and removing the uncertainty risk premium in the interest rate will also improve debt sustainability. Improved Policy Coordination: Inflation targets are joint targets, determined together with the Government. The joint agreement on inflation targets will enhance the coordination between fiscal and monetary policy. Increased Public Consciousness: Evidence with the adoption of IT suggests that it fosters public awareness and acceptance of monetary policy decisions, which can help reduce the cost of disinflation and enhance credibility. 18 Monetary Policy Strategy–Inflation Targeting Significant progress has been made to satisfy the preconditions for the implementation of IT: The Central Bank Law has been amended to ensure instrument independence, accountability and transparency; and the CBT enjoys full control over its credits. The Law on Public Debt Management will bring about discipline and transparency in the public sector, and facilitate the adaptation of fiscal policy to inflation targeting. Progress on establishing the technical infrastructure: Forecasting and policy analysis models The CBT is receiving technical support from international institutions and central banks implementing IT. The CBT has been working intensively to develop: economic databases and reporting packages • Inflation Expectation Survey for corporate and financial sectors • Daily retail prices analysis by using sampling methods a near-term forecasting system incorporating a wide range of available information a core quarterly macroeconomic model a process for putting together a medium-term projection procedures for presenting the results to the Monetary Policy Council 19 Monetary Policy Strategy–Inflation Targeting The CBT endeavors to enhance its credibility through: Achieving the established objectives. Evidence to date suggests that the end year target of 35 will be achieved. Improving communication, which is pursued with a view to communicate not only the CBT’s quantitative objectives, but also the framework of mechanisms that will be used to attain these objectives. To this end, the CBT has been issuing Monetary Policy Reports and frequent press releases in addition to presentations by the senior Central Bank officials. 20 Monetary Policy Strategy – Inflation Targeting It is important to highlight that IT is only one complementary ingredient in a broad strategy of institutional development and its success, among other things, hinges closely on: Fiscal responsibility Financial deepening Eliminating backward-looking indexation mechanisms in the economy, Flexibility in goods and factor markets to allow smooth adjustment to relative price changes 21 Conclusion Overall, prudent fiscal and monetary policies along with deep seated structural reform measures included in Turkey’s Medium-term Economic Program will lay the foundations of an economy that is: well-placed on the high road of sustained low-inflationary growth more resilient to adverse shocks less vulnerable to crises more equitable in income distribution more conducive to foreign and domestic investment as a consequence, better positioned to integrate into European Structures. 22