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DISINFLATION AND BALANCE OF PAYMENTS IN THE TURKISH ECONOMY Erdem Başçı Deputy Governor Central Bank of Turkey March 4, 2008 1 Presentation Outline 1) 1) Inflation Inflation and and Monetary Monetary Policy Policy •• Recent Recent Developments Developments •• Monetary Monetary Policy Policy Stance Stance •• Demand Demand Conditions Conditions •• Inflation Inflation Outlook Outlook 2) 2) Balance Balance of of Payments Payments •• Sources Sources of of Current Current Account Account Deficit Deficit •• Foreign Foreign Trade Trade Developments Developments •• Capital Capital Flows Flows 2 Inflation – Recent Developments Annual CPI Inflation and Target Path Central Central Bank Bank of of Turkey Turkey (CBT) (CBT) isis implementing implementing aa formal formal inflation-targeting inflation-targeting regime regime since since the the beginning beginning of of (December 2005 – December 2007 , yoy, percent) 2006. 2006. 12 11 10 9 8 7 6 5 4 3 2 1 0 Central Central Bank Bank has has been been decisively decisively fighting fighting against against inflation inflation for for the the last last seven seven years. years. -- percentage percentage points points between between the the years years 2001 2001 and and 2005. 2005. Annual CPI Inflation Target Path -12.07 10.07 08.07 06.07 04.07 02.07 12.06 10.06 08.06 06.06 04.06 02.06 Outer Band 12.05 Inflation Inflation targets targets were were achieved achieved and and inflation inflation was was lowered lowered by by more more than than 60 60 Inflation Inflation exceeded exceeded the the targets targets in in 2006 2006 and and 2007. 2007. Disinflation Disinflation isis aa dynamic dynamic and and ongoing ongoing process. process. Source: TURKSTAT, CBT 3 Inflation – Main Causes Contribution to End-year CPI Inflation Food Food prices prices were were the the main main factor factor impeding impeding disinflation disinflation in in 2007, 2007, with with aa (percentage share) 2004-2006 Average Others 49.4 % marked marked contribution contribution of of about about 3.4 3.4 percent percent on on headline headline inflation. inflation. 2007 Food* 23.9 % Others 30.1 % Food* 40.8 % Others The The contribution contribution of of food food prices prices to to the the headline headline inflation inflation in in 2007 2007 was was significantly significantly higher higher than than itit had had been been during during the the past past three three years years 49.5 % Energy 17.0 % Tobacco** Tobacco** 10.4 % 9.7 % Energy 18.7 % * Food: Food and non-alcoholic beverages ** Tobacco: Tobacco products and alcoholic beverages Source: TURKSTAT,CBT 4 Inflation – Subcomponents Subcomponents of CPI Annual Annual inflation inflation in in certain certain subgroups subgroups of of the the (Annual Percentage Change) CPI CPI reveals reveals the the main main factors factors behind behind the the rise rise in in 20 2006 18 2007 inflation inflation in in 2007 2007 Better-than-expected Better-than-expected inflation inflation figures figures in in the the services services sector sector in in the the second second and and 16 14 third third quarters quarters of of the the year year gave gave aa positive positive signal signal 12 for for inflation inflation outlook. outlook. 10 The The fast fast pace pace of of disinflation disinflation in in services services and and 8 core core goods goods (goods (goods excluding excluding food, food, energy energy and and 6 4 tobacco) tobacco) in in 2007,confirms 2007,confirms that that supply supply side side 2 shocks shocks were were mainly mainly responsible responsible for for the the breach breach of of 0 Energy Food* Tobacco** Goods exc. Food, Energy and Tobacco Services the the uncertainty uncertainty band. band. * Food: Food and non-alcoholic beverages ** Tobacco: Tobacco products and alcoholic beverages Source: TURKSTAT, CBT 5 Inflation – Services Subcomponents of Services Inflation The The effects effects of of the the monetary monetary tightening tightening were were (Annual % Change) clearly clearly visible visible on on the the prices prices of of durable durable goods goods and and 20 2006 2007 16 services, services, consistent consistent with with the the slowdown slowdown in in the the economic economic activity activity of of related related sectors. sectors. The The weaker weaker 12 8 demand, demand, coupled coupled with with aa strong strong domestic domestic 4 currency, currency, helped helped durables durables inflation inflation to to come come down down Other Services Restaurants&Hotels Rent Transport Services 0 significantly. significantly. Services Services inflation inflation also also eased eased remarkably, remarkably, declining declining by by 3.6 3.6 percentage percentage points points throughout throughout 2007. 2007. Source: TURKSTAT, CBT 6 Inflation Worldwide Inflation in Other Regions* Lately, Lately, inflation inflation has has been been rising rising almost almost all all over over the the world world In In 2007, 2007, food food group group has has added added 3.4 3.4 6 percentage percentage points points to to annual annual inflation. inflation. USA Elevated Elevated prices prices of of crude crude oil, oil, agricultural agricultural products products Euro Area 5 and and other other commodities commodities have have continued continued to to exert exert Inf. Tar. inflationary inflationary pressures. pressures. 4 Although Although second second round round effects effects have have been been so so far far limited–thanks limited–thanks to to well-established well-established credibility credibility of of 3 monetary monetary authorities authorities all all over over the the world, world, sustained sustained increases increases in in commodity commodity prices prices have have started started to to take take 2 their their toll toll on on headline headline inflation, inflation, ifif not not on on core core inflation. inflation. 12.07 10.07 08.07 06.07 04.07 02.07 12.06 10.06 08.06 06.06 04.06 02.06 12.05 1 *Sample of emerging economies under inflation targeting covers Brazil, Czech Republic, Colombia, Philippines, South Africa, Israel, Hungary, Mexico, Peru, Poland, Romania, Chile, Slovakia and Thailand. Source: Web sites of central banks 7 Inflation – Relative Success Difference Between Turkey and Other Emerg. IT’ers Inflation Rates 9 Monetary Tightening 8 In In 2007 2007 inflation inflation in in Turkey Turkey followed followed aa more more Start of the Easing Cycle favorable favorable trend trend compared compared to to other other emerging emerging economies economies with with inflation inflation targeting, targeting, despite despite the the administrative administrative price price hikes hikes in in November, November, which which 7 added added by by about about 1-percentage 1-percentage points points to to the the Turkish Turkish CPI CPI inflation. inflation. 6 5 4 3 12.07 10.07 08.07 06.07 04.07 02.07 12.06 10.06 08.06 06.06 04.06 02.06 12.05 2 *Sample of emerging economies under inflation targeting covers Brazil, Czech Republic, Colombia, Philippines, South Africa, Israel, Hungary, Mexico, Peru, Poland, Romania, Chile, Slovakia and Thailand. Source: Web sites of central banks 8 Monetary Policy and Core Indicators Response of Inflation to the Monetary Tightening Annual Annual percentage percentage change change in in CPI CPI excluding excluding food, food, energy energy and and tobacco tobacco items items 19 12,0 indicate indicate an an inflation inflation trend trend of of around around 4.5 4.5 percent. percent. 10,0 Underlying Underlying inflation inflation isis not not far far away away from from the the medium medium term term target. target. Under Under the the 8,0 assumption assumption that that oil oil and and food food inflation inflation will will follow follow aa more more benign benign path path in in 2008 2008 than than in in 18 17 16 15 6,0 14 13 2007, 2007, itit isis fair fair to to expect expect some some contribution contribution to to disinflation disinflation from from the the base base effects. effects. 4,0 Policy Rate 12 H (right axis) 2,0 H (excl. processed food, right axis) 11 12-07 09-07 06-07 03-07 12-06 09-06 06-06 03-06 12-05 10 Source: CBT 9 Monetary Policy Stance Monetary Policy Committee (MPC) Decisons in 2007 and 2008 Dates for MPC Meeting The The turbulence turbulence in in mature mature financial financial markets markets in in August August increased increased the the likelihood likelihood of of aa sooner-thansooner-than- Decision on Interest Rate Interest Rate 16 January 2007 No Change 17.50 and and thus thus paved paved the the way way for for initiating initiating the the policy policy 15 February 2007 No Change 17.50 rate rate cuts cuts that that was was hinted hinted earlier earlier in in the the year. year. 15 March 2007 No Change 17.50 18 April 2007 No Change 17.50 14 May 2007 No Change 17.50 14 June 2007 No Change 17.50 Policy Policy rates rates were were lowered lowered by by 225 225 basis basis points points 12 July 2007 No Change 17.50 since since then. then. 14 August 2007 No Change 17.50 13 September 2007 -.25 17.25 16 October 2007 -.50 16.75 14 November 2007 -.50 16.25 13 December 2007 -.50 15.75 17 January 2008 -.25 15.50 14 February 2008 -.25 15.25 Source: CBT envisaged envisaged slowdown slowdown in in global global economic economic activity, activity, Accordingly, Accordingly, the the MPC MPC decided decided to to start start aa measured measured rate rate cut cut cycle cycle in in September September 2007. 2007. 10 Monetary Conditions Real Interest Rate and Real Exchange Rate* Although Although medium medium term term interest interest rates rates followed followed aa downward downward trend trend in in the the past past quarter, quarter, 2-year 2-year real real 200 14 190 13 180 12 percent, percent, implying implying aa non-accommodative non-accommodative 170 11 monetary monetary stance. stance. 160 10 The The currency currency remains remains strong, strong, curbing curbing 9 inflationary inflationary pressures pressures and and easing easing the the impact impact of of 8 rising rising commodity commodity prices prices on on domestic domestic production production 150 Real Exchange Rate (Left Axis) 140 2 -year Real Interest Rates 130 7 costs costs 11.07 09.07 07.07 05.07 03.07 01.07 11.06 09.06 07.06 05.06 03.06 6 01.06 120 rates rates at at this this point point fluctuate fluctuate around around 99 to to 10 10 *Real interest rates are computed by using the Expectations Survey and 2-year nominal rate estimated with Extended Nelson-Siegel method. Real exchange rate is CPI based (an increase means an appreciation). Source: CBT 11 Demand under Control Real Private Consumption (Quarterly, seasonally adjusted) Strong Strong monetary monetary tightening tightening was was effective effective in in Monetary Tightening 26000 moderating moderating the the private private consumption consumption demand demand 25000 Although Although government government spending spending accelerated accelerated 24000 2007-III 2007-II 2007-I 2005-II 2005-I 20000 2006-IV successful successful in in curbing curbing the the aggregate aggregate demand, demand, 2006-III 21000 2006-II following following quarters, quarters, monetary monetary tightening tightening was was 2006-I 22000 2005-IV and and external external demand demand remained remained strong strong in in the the 2005-III 23000 especially especially through through the the slowdown slowdown in in durable durable goods, goods, housing housing and and other other services. services. Source: TURKSTAT, CBT 12 Moderate Credit Growth Selected Subitems of Consumer Loans Credit Credit data data also also suggest suggest that that monetary monetary (Annual Percentage Change) 450 60 Housing conditions conditions are are non-accommodative. non-accommodative. 50 Annual Annual growth growth rates rates in in the the automobile automobile and and 40 housing housing loans loans are are much much lower lower compared compared to to 300 30 the the periods periods of of vigorous vigorous domestic domestic demand demand 250 20 200 10 150 0 100 -10 50 -20 0 -30 400 01.08 10.07 07.07 04.07 10.06 07.06 04.06 01.06 10.05 07.05 01.07 Automobile (right axis) 350 Source: CBT 13 No Demand Pressures Output Gap Another Another factor factor likely likely to to contribute contribute to to disinflation disinflation isis aa continuing continuing output output gap. gap. 6 Economic Economic activity activity responded responded significantly significantly 4 to to the the strong strong monetary monetary tightening tightening in in midmid2006. 2006. 2 The The sharp sharp slowdown slowdown in in the the second second half half of of 0 2006 2006 created created an an ample ample slack slack in in the the -2 economy. economy. There There are are some some signs signs of of recovery recovery -4 in in the the second second half half of of 2007. 2007. -6 -8 07-III 07-I 06-III 06-I 05-III 05-I 04-III 04-I 03-III 03-I 02-III 02-I 01-III 01-I 00-III 00-I -10 Source: CBT 14 Expectations Improving Slowly Medium Term Inflation Expectations Both Both the the 12-month 12-month and and the the 24-month 24-month ahead ahead inflation inflation expectations expectations exhibited exhibited aa declining declining 14 pattern pattern throughout throughout 2007. 2007. 12 12-Months forward 24-Months forward 10 8 However, However, the the improvement improvement in in expectations, expectations, especially especially in in the the last last quarter, quarter, was was rather rather limited, limited, owing owing to to aa backward backward looking looking behavior, behavior, and and possibly, possibly, due due to to pre-announced pre-announced hikes hikes in in administered administered energy energy prices. prices. 5,99 5,2 6 Nevertheless, Nevertheless, itit isis worthwhile worthwhile to to mention mention that that the the administrative administrative price price hikes hikes in in November November had had little little effect effect on on medium medium term term expectations. expectations. 4 2 01-10 10-09 07-09 04-09 01-09 10-08 07-08 04-08 01-08 10-07 07-07 04-07 01-07 10-06 07-06 04-06 01-06 10-05 07-05 04-05 01-05 0 Source: CBT 15 Inflation Outlook Inflation Projections* We We forecast forecast inflation, inflation, with with 70 70 percent percent probability, probability, between between 4.1 4.1 percent percent and and 6.9 6.9 Forecast range* Uncertainty band for 2008 Medium term target 12 11 percent percent (midpoint (midpoint 5.5) 5.5) at at the the end end of of 2008, 2008, 10 and and between between 1.8 1.8 percent percent and and 5.5 5.5 percent percent 9 (midpoint (midpoint 3.7) 3.7) at at the the end end of of 2009. 2009. 8 7 The The forecasts forecasts are are based based on on aa scenario scenario in in 6 5 which which policy policy rates rates display display aa limited limited decline decline 4 in in 2008. 2008. Main Main message message of of the the forecast forecast isis 3 that that continuation continuation of of the the gradual gradual easing easing cycle cycle 2 2009-IV 2009-III 2009-II 2009-I 2008-IV 2008-III 2008-II conditional conditional on on favorable favorable data data and and 2008-I 0 2007-IV that that started started in in September September 2007 2007 will will remain remain 2007-III 1 developments. developments. *The shaded region indicates the 70 percent confidence interval for the forecast. Source: CBT 16 Balance of Payments Why Why Current Current Account Account Deficit? Deficit? Domestic Domestic savings savings below below investments investments ‘Sustainability’ ‘Sustainability’ and and ‘adjustment ‘adjustment ability’ ability’ are are two two main main issues issues 17 Savings and Investment Current Account Deficit 5 (percentage of GDP) Why Why Current Current Account Account Deficit? Deficit? 2,3 0 -0,8 Current Current account account balance balance deteriorated deteriorated by by 10 10 percentage percentage points points between between 2001 2001 and and 2007 2007 -3,3 -5,2 -5 -6,4 -7,4 -8,2 -10 2001 2002 2003 2004 2005 2006 2007* Domestic Savings and Domestic Investment 30 (percentage of GDP) Investments 25,4 25 24,9 23,8 24,8 22,6 20,0 19,2 20 19,3 15 Between Between 2001 2001 and and 2007: 2007: 20,2 18,2 17,5 16,0 15,1 Domestic Domestic savings savings are are below below investments investments 17,0 Savings Savings decreased decreased by by 0.5 0.5 points points and and investment increased by 9.7 points investment increased by 9.7 points Savings 10 2001 2002 2003 2007 figures are from the 2007 economic program Source: TURKSTAT, SPO 2004 2005 2006 2007* 18 Export Performance Turkey Turkey is is the the one one of of the the best best export export Export Growth Rate (2001 - 2007, average annual growth, percent) performers performers in in the the world. world. 24 20.1 20 17.2 16 12 growth growth in in exports exports was was 17.2 17.2 percent. percent. " 8.8 8 8.8 5.9 Between Between 2001 2001 and and 2007, 2007, average average annual annual 5.9 4 0 World Euro area Developing Asia Middle East Western Hemisphere Turkey 2007 figures are from IMF forecasts. Source: TURKSTAT, IMF World Economic Outlook 19 Trade balance Imports and Exports Quantity Indices 160 (1982 – 2007, 2003 = 100, Annual Average) 140 120 The The openness openness of of the the Turkish Turkish economy economy has has accelerated accelerated since since 2001. 2001. Imports 100 80 60 40 20 According According to to the the quantity quantity indices indices adjusted adjusted for for Exports 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 - (January 2006 – December 2007, 12-month cumulative annual percentage change) Exports Exports growth growth rate rate was was 25.3% 25.3% in in 2007, 2007, while while that that of of imports imports stood stood at at 21.8%. 21.8%. 26 Imports 24 imports imports have have expanded expanded almost almost in in parallel parallel in in recent recent years, years, contrary contrary to to the the 1995-2000 1995-2000 period. period. Imports-Exports 28 exchange exchange rate rate and and price price movements, movements, exports exports and and Annual Annual growth growth rate rate of of exports exports has has outpaced outpaced that that 22 20 18 16 of of imports imports since since March March 2007. 2007. Exports 14 12 Source: TURKSTAT 11-07 12-07 09-07 10-07 04-07 05-07 06-07 07-07 08-07 02-07 03-07 10-06 11-06 12-06 01-07 08-06 09-06 01-06 02-06 03-06 04-06 05-06 06-06 07-06 10 20 Effects of Energy Prices Current Account Balance and the Effect of Energy Prices on Current Account Deficit * (2002 – 2007, ratio to GDP, percent) 2002 2003 2004 2005 2006 the the increase increase in in CAD CAD in in recent recent years. years. 2007** 0 -1 -2 Current account Deficit Excluding the Effect of Energy Prices -0.8 -4 -3.7 -3.4 -4.1 -3.3 High High energy energy prices prices added added 4.1 4.1 percentage percentage points points to to the the deficit deficit in in 2006. 2006. The The deficit deficit would would have have been been 4.1 4.1 % % of of GDP GDP in in 2006, 2006, ifif the the energy energy prices prices had had remained remained at at its its 2002 2002 level. level. -2.4 -3 The The surge surge in in energy energy prices prices was was influential influential on on -3.7 High High energy energy prices prices added added 3.8 3.8 percentage percentage points points to to the the deficit deficit as as of of 2007 2007 Q3. Q3. -5 -5.2 -6 -6.3 -7 -8 Current Account Deficit / GDP -7.5 -8.2 -9 * The effect of energy price increases on the current account in the 2003-2007 period was calculated by keeping the prices of 2002 intact. Energy Sub-Items: Stone coal and lignite, crude oil and natural gas under the mining and quarrying sector, and coke coal, refined petroleum products and nuclear fuels under the manufacturing industry. ** As of the third quarter of 2007 Source: TURKSTAT, CBT 21 Current Account Deficit and Its Financing Foreign Direct Investment (Annual, 30 billion USD) Directdirect Investment 2007, investment In InForeign 2007, foreign foreign direct investment (FDI) (FDI) net net Inflows inflows inflows was was USD USD 21.9 21.9 billion. billion. 25 21,9 20,0 20 According According to to UNCTAD, UNCTAD, Turkey Turkey ranked ranked fifth fifth among among emerging emerging countries countries in in FDI FDI in in 2006. 2006. 15 The The strong strong performance performance in in FDI FDI inflows inflows isis expected expected to to continue. continue. 10,0 10 5 1,0 1,1 1,8 Average of 19902001 2002 2003 2,9 0 2004 2005 2006 2007 Source: CBT FDI in 2006 Ratio to GDP (USD Billion) (%) China 69.5 2.6 Hong Kong 42.9 22.6 Russia 28.7 2.9 Singapore 24.2 18.3 Turkey 20.1 5.0 Mexico 19.0 2.3 Brasil 18.8 1.8 India 16.9 1.9 Romania 11.4 9.4 Chile 7.9 5.4 Source: UNCTAD, IMF WEO 22 Capital Flows Financing of the Current Account Deficit (2000 – 2007, 12-month cumulative, % of deficit) The The ratio ratio of of the the sum sum of of foreign foreign direct direct 80 Portfolio investments 4 Non-bank loans 2 investments investments and and long-term long-term capital capital to to GNP GNP which which was was 12% 12% in in 2006 2006 declined declined to to 11,5% 11,5% in in 2007 2007 while while share share of of portfolio portfolio investments investments and and shortshort- Bank loans 1 60 term term capital capital to to GNP GNP declined declined from from 3,6% 3,6% to to 0,8% 0,8% Foreign direct investments 40 in in the the same same period. period. 3 20 0 2000 2003 2004 2005 2006 2007 1 Bank loans: Net short-term and long-term loans borrowed by the banking sector from abroad. 2 Non-bank sector loans : Net short-term and long-term loans borrowed by the nonbank sector from abroad. 3 Foreign direct investment: Foreign direct investment inflows. 4 Portfolio investments: Government bonds, Treasury bills and stock purchases of non-residents. Source: CBT 23 Foreign Exchange Reserves Ratio of FX Reserves to GDP in 2007 in Countries Implementing Floating Exchange Rate Regimes* Foreign Exchange Reserves (Excluding gold, billion USD) 80 20 71.3 18,7 70 58.3 60 48.3 50 16 40 33.7 30 18 36.0 15,0 27.0 14 20 10 12 Average of Countries Implementing Floating Exchange Rate Regime 0 2002 Source: CBT 2003 2004 2005 2006 2007 Turkey * Countries included in the calculation: Argentina, Brazil, Czech Republic, Indonesia, Philippines, South Africa, South Korea, Croatia, India, Kazakhstan, Colombia, Mexico, Paraguay, Peru, Poland, Romania, Russia, Chile, Thailand, Uruguay 24 Balance of Payments Why Why Current Current Account Account Deficit? Deficit? Domestic Domestic savings savings below below investments investments -- Deficit Deficit is is driven driven and and financed financed by by the the private private sector. sector. -- Social Social security security and and energy energy sector sector reforms reforms will will improve improve savings. savings. ‘Sustainability’ ‘Sustainability’ and and ‘adjustment ‘adjustment capacity’ capacity’ are are two two main main issues issues -- Private Private sector sector is is relatively relatively better better placed placed both both to to sustain sustain and and adjust adjust ifif necessary. necessary. -- Improvements Improvements in in investment investment climate climate and and labor labor market market reforms reforms will will be be helpful. helpful. 25 DISINFLATION AND BALANCE OF PAYMENTS IN THE TURKISH ECONOMY Erdem Başçı Deputy Governor Central Bank of Turkey March 4, 2008 26