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CENTRAL BANK OF THE REPUBLIC OF TURKEY PRESENTATION BEFORE THE COUNCIL OF MINISTERS, AND THE PLANNING AND BUDGET COMMISSION OF THE GREAT NATIONAL ASSEMBLY OF TURKEY Durmuş YILMAZ Governor May 2008 1 Presentation Plan I. International Developments II. Effects of International Developments on the Turkish Economy III. Financial Stability in Turkey IV. Inflation Developments, Forecasts and Risks V. Monetary Policy Stance VI. Markets VII. Economic Outlook 2 I. International Developments 3 International Developments The financial turbulence in global money and capital markets, which started in August 2007, has not abated yet. The magnitude of the turbulence is larger than that experienced in 2006. The full scale of damage that it might cause in economic activities is still uncertain. Volatility Index* 35 (1 January 2004 – 23 May 2008) 30 Volatility Index Average 25 20 15 10 5 * VIX measures the implicit volatility of the options prices of the S&P 500 stock index. Source: Bloomberg 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 10-04 07-04 04-04 0 01-04 4 Reasons for the Turbulence How did we end up here? 1st APPROACH: GLOBAL LIQUIDITY CONDITIONS Abundant credit facilities supported by accommodative monetary policies Surge in leveraged transactions Excessive risk appetite and search for high yields 5 Reasons for the Turbulence In response to deceleration in economic activities, the Federal Reserve Bank, European Central Bank and Bank of Japan loosened their monetary policies considerably and cut benchmark interest rates. Inflation and Federal Funds Rates in the USA Inflation and Policy Rates in the Eurozone (January 2000 – April 2008, percent) (January 2000 – April 2008, percent) 7 7 6 Federal Funds Rate 6 5 5 4 4 3 3 2 2 1 Policy Rate Inflation 1 Inflation 01-08 07-07 01-07 07-06 01-06 07-05 01-05 07-04 01-04 07-03 01-03 07-02 01-02 07-01 01-01 07-00 01-08 07-07 01-07 07-06 01-06 07-05 01-05 07-04 01-04 07-03 01-03 07-02 01-02 07-01 01-01 07-00 01-00 Source: Federal Reserve 01-00 0 0 Source: European Central Bank, Eurostat 6 Reasons for the Turbulence The accommodative monetary policies led to a rise in asset prices. They also encouraged banks to borrow at low interest rates for short maturities and extend loans with longer maturities. With the aim of increasing the demand for loans, banks started to offer diversified loan alternatives and flexible loan conditions, which in return led to a rapid rise in credit utilization of especially subprime borrowers. Total Housing Loans Total Housing Loans in the USA (2001 and 2007, as % of GDP) (1997-2007, as % of GDP) 80 73.6 74.7 69.4 70 65.7 100 85.0 61.3 60 57.0 74.7 80 2001 60.3 60 52.1 47.0 52.1 50 46.6 44.3 45.3 48.4 40 2007 32.5 40 20 0.2 30 3.8 0 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 Source: Federal Reserve England USA Source: Federal Reserve, IMF, ECB, CBT EU-25 Turkey 7 Reasons for the Turbulence After a three-year period, the Federal Reserve resumed hikes in the federal funds rate as of the second quarter of 2004 to alleviate inflationary pressures. Problems arose in the repayments of loans, especially of flexible rate subprime mortgage loans,. In mid-2005 demand for houses slowed down and house prices started to decline. The reversal of the upward trend in house prices restricted customers’ chances of selling their properties to pay off their debt. 8 Reasons for the Turbulence How did we end up here? 2nd APPROACH : NON-TRANSPARENT OPERATIONS Complex instruments due to increased financial engineering practices Business model based on originateand-distribute Arbitrage opportunities arising from the lack of regulations and supervision 9 Reasons for the Turbulence Market Sizes The low levels of long-term interest rates as a result of expanding global liquidity supply led (2001 – 2007, trillion USD) 50 to excessive risk appetite in search of high Credit Default Swap Market yields. 40 One of such risk-bearing assets was subprime mortgage loans. These assets were converted to securities and re-marketed. In this 30 US Bond Market way, they started to be transacted widely in the global financial system. 20 Volume of derivatives transaction increased US Stock Market rapidly and reached astronomical levels. 10 US Mortgage Based Securities Market markets, as well as problems in supervision of Source: ISDA, WFE, SIFMA 2007 2006 2004 2003 0 2002 risks. 2001 such securities hindered the accurate pricing of 2005 However, lack of liquidity in secondary 10 Reasons for the Turbulence Supervision, regulation and information facilities in the finance sector and risk management of the private sector lagged behind the rapid transformation in the business world, which paved the way for problems such as excessive risk appetite, maturity mismatches and inflation in asset prices. Problems observed since 2006 in the repayment of housing loans have led to difficulties in pricing securities that are linked to credit repayments. Investor demand for asset-based securities and commercial papers declined due to loss of credibility, whereas the demand for risk-free government papers increased. Financial institutions started to face difficulties in using their asset-based securities as collateral in order to meet their short-term liquidity requirements. The financial turbulence that appeared as a liquidity squeeze in the markets at first, later turned into solvency problems as financial institutions reported high losses on their balance sheets, which brought them to the edge of bankruptcy. 11 Reasons for the Turbulence Both of these views on the underlying causes of the financial turbulence should not be perceived as alternatives of each other. They are in fact complementary and explain different aspects of the financial turbulence. 1st VIEW: 2nd VIEW: GLOBAL LIQUIDITY CONDITIONS NON-TRANSPARENT OPERATIONS Turbulences in Financial Markets 12 Recent Developments Measures Taken In the face of a credit crunch, the Federal Reserve Bank started to cut the federal funds rate from September 2007 onwards. The federal funds rate was reduced from 5.25% to 2% by April 2008. At the beginning of the crisis, a strong demand emerged for central bank liquidity, which was met by central banks of developed countries. However, due to the growing need for liquidity, the Federal Reserve, the European Central Bank and the Bank of England intervened in a coordinated manner. The scope of collateral defined for liquidity operations was widened, maturities were extended and new liquidity tools were formed in addition to the discount window. With the aim of underpinning economic growth in the United States, an economic package including extensive fiscal policies was put into force. For the first time since 1970, a bank that had liquidity problems and faced bankruptcy was bailed out in the United Kingdom through expropriation. 13 Recent Developments Current Situation and Outlook The Difference Between Interbank Interest Rates and 3 Month Treasury Bills in US Dollars and Euro (1 January 2007 – 22 May 2008, basis points) 250 200 US Dollars 150 There is a credit crunch in the United 100 States and the European Union. 50 05-08 04-08 03-08 02-08 01-08 12-07 11-07 10-07 09-07 08-07 07-07 06-07 05-07 04-07 Source: Bloomberg these markets in the second half of 2007. 03-07 interest rates increased remarkably in 0 02-07 money markets of developed countries, Euro 01-07 Due to the setbacks observed in the Collateralized Debt Obligations Issuance (2004 Q1 – 2007 Q4, US Dollars billion) 200 150 The issuance of complex securities declined significantlly, while the risk 100 50 Source: SIFMA 2007 Q4 2007 Q3 2007 Q2 2007 Q1 2006 Q4 2006 Q3 2006 Q2 2006 Q1 2005 Q4 2005 Q3 2005 Q2 2005 Q1 2004 Q4 2004 Q3 0 2004 Q2 market increased to high levels. 2004 Q1 premium in the private sector bond 14 Recent Developments Global Risk Appetite Index The Global Risk Appetite Index indicates that the deterioration trend in risk perceptions that became apparent (1 January 1999 – 22 May 2008) 8 6 Excessive Optimism mid-October intensified in early 2008 and reached “panic” level as investors 4 continued to prefer low-risk 2 instruments. 0 The improvement seen in the index -2 in late January did not last long and -4 Panic the index once more approached to the “panic” level. -6 The negative outlook in the risk perceptions still continues. 01-99 05-99 09-99 01-00 05-00 09-00 01-01 05-01 09-01 01-02 05-02 09-02 01-03 05-03 09-03 01-04 05-04 09-04 01-05 05-05 09-05 01-06 05-06 09-06 01-07 05-07 09-07 01-08 05-08 -8 Source: Credit Suisse 15 Recent Developments The problems in the sub-prime mortgage markets gradually have spreaded to other parts of the housing loan market and other financial markets. The April 2008 Global Financial Stability Report of the International Monetary Fund (IMF) estimated that the total loss to be incurred would be about USD 945 billion. The October 2007 Report by the same institution had forecasted the total loss to be USD 240 billion. 16 Recent Developments While the developments in the last nine months showed the fragility of the global financial system, they have also led to the questioning of the effectiveness of the measures taken. Currently, central banks have succeeded in solving the liquidity problem. Yet, central banks can only provide liquidity, they cannot solve the entire credit problems. Moreover, it should be kept in mind that the measures taken might lead to the moral hazard problem in the financial markets in the future. Policy makers should carefully analyze the factors causing the developments experienced since mid-2007 and encourage the private sector to use effective risk management techniques and to increase transparency. To minimize possible similar fragilities in the upcoming period, regulation and supervision functions should be reviewed. Considering the moral hazard problem, it is crucial that the measures taken should be selective, clearly defined, and temporary. 17 Global Economic Growth It is inevitable that the current financial turbulence will have affects on growth and employment performance. In fact the data for the United States and European economies in the last quarter of 2007 and early-2008 have signaled that the turmoil in financial markets have started to spread to the real sector. The financial turbulence is expected to significantly drop growth rates throughout the world, and mainly in the USA. Growth Expectations Worldwide (percent) Regions 2007 World USA EU Russia-Central Asia Central and Eastern Europe Middle East 4.9 2.2 2.6 8.5 5.8 5.8 Source: IMF World Economic Outlook 2008 (7/07 forecasts) 4.8 2.8 2.5 7.1 5.4 5.5 2008 (10/07 forecasts) 4.4 1.9 2.1 7.0 4.9 6.0 2008 (1/08 forecasts) 4.1 1.5 1.6 7.0 4.6 5.9 2008 (4/08 forecasts) 3.7 0.5 1.4 7.0 4.4 6.1 18 Global Economic Growth Real Sector Confidence Index in the US and the EU The real sector confidence index in the USA, which had been falling since mid-2007, dropped to its lowest level since 2001. (January 2005 – April 2008) 106 105 European Union 104 103 102 101 100 USA 99 98 03-08 01-08 11-07 09-07 07-07 05-07 03-07 01-07 11-06 09-06 07-06 05-06 03-06 01-06 11-05 09-05 07-05 05-05 03-05 97 01-05 Although the real sector confidence in the EU index has been declining, it is still higher than that of the USA. Source: OECD (January 2005 – January 2008) 109 European Union 108 107 106 USA 105 104 103 Source: OECD 11-07 09-07 07-07 05-07 03-07 01-07 11-06 09-06 07-06 05-06 03-06 01-06 11-05 09-05 07-05 05-05 102 03-05 The International Monetary Fund is expecting a recession in the USA economy in 2008. Leading Indicators in the US and the EU Economies 110 01-05 The leading indicators show that the slowdown in the USA economy is more severe than that in the EU. 19 Expectations and Risks World Growth Figures and Expectations Recent forecasts suggest that the impact of the current financial turmoil on developing countries will be less severe (2006-2009, percent) 8 compared to earlier periods. 7 The progress made in recent years 6 towards macroeconomic stability in 5 7.9 7.8 Developing countries 6.7 5.0 4.9 developing countries reinforces this view. World 4 Other supporting factors are the reforms adopted in the corporate structure, the adoption of good governance principles 3.3 3 European Union 2 3.7 3.8 1.8 1.7 0.5 0.6 2008 2009 3.1 2.9 USA and the expanded volume of trade between developing countries. 6.6 2.2 1 0 2006 2007 Source: IMF 20 Expectations and Risks The prevailing turmoil is not simply a liquidity squeeze. It is expected to have more widespread, deeper and more complicated impacts on the world economy. Four major risks for the upcoming period are: 1. Recession in the US economy and a severer-than-expected slowdown in the global economy, 2. Wide fluctuations in commodity and housing prices, 3. Fragilities arising from weakened capital structures of financial institutions, 4. Problems in accessibility to the credit. The International Monetary Fund anticipates that with 25% probability, global growth will be below 3%, which would imply a global recession. 21 II. Effects of International Developments on the Turkish Economy 22 Effects on the Turkish Economy Risk Indicators 380 Big losses incurred by international 340 financial institutions coupled with concerns 300 260 220 Source: JP Morgan Risk indicators for the Turkish economy 80 2007 and February 2008, parallel to the 60 increase in other developing countries. 40 05-08 03-08 01-08 11-07 09-07 07-07 05-07 03-07 Risk Indicators (1 January 2006 – 23 May 2008, basis point) 100 increased in the period between August 01-07 100 11-06 of developing countries. EMBI + 09-06 140 07-06 perceptions and increased the risk premium 05-06 180 01-06 led to significant deterioration in risk 03-06 over recession in the USA economy have (1 January 2006 – 23 May 2008, basis point) EMBI + Turkey (Turkey) – (EMBI +) 20 Source: JP Morgan 05-08 03-08 01-08 11-07 09-07 07-07 05-07 03-07 01-07 11-06 09-06 07-06 -40 05-06 March. -20 03-06 risk premium of Turkey since the start of 0 01-06 There has been a deterioration in relative 23 Effects on the Turkish Economy Slowdown in the global economy Likely to strain growth in external demand Exports (January 2007 – April 2008, year-on-year change, 3-month moving average, percent) The economic data for 2008 Q1 suggest that the financial fluctuations have not yet had a significant 40 Leading indicator 50 (right scale) Euro (left scale) 30 decelerating effect on external demand. 40 USD (right scale) 30 20 20 Data for Q1 and leading indicators 10 Source: TURKSTAT, UFT, TEA (TIM) 04-08 03-08 02-08 01-08 12-07 11-07 10-07 09-07 08-07 07-07 06-07 05-07 04-07 0 03-07 0 02-07 of exports continues. 10 01-07 for April suggest that the rapid growth 24 Effects on the Turkish Economy Likely to limit domestic demand by increasing the cost of credits extended by domestic banks Problems in external credit markets FX Position of the Banking Sector The recent deterioration in risk (9 July 2007 – 16 May 2008, billion USD) perceptions is likely to decrease in 14 the Turkish banks’ tendency to 10 8 borrow from abroad and lend 14 12 12 Off-Balance Sheet Position 10 8 6 6 4 4 2 2 0 -2 0 -2 -4 -4 -6 -6 strain credit expansion and domestic -8 -10 -8 -10 demand in the upcoming period. -12 -12 04-08 03-08 02-08 02-08 01-08 12-07 -14 11-07 10-07 -14 On-Balance Sheet Position 09-07 credit conditions will continue to 08-07 It is estimated that tightened 07-07 domestically in YTL. Source: BRSA 25 A Shock-Resistant Economy Effects of fluctuations in financial markets are felt in all economies of the world. However, the extent and the duration of these effects will vary in each country and will depend on the economic policies followed in this period. Global economic outlook for 2008 and 2009 underlines the significance of adhering to good governance principles and the decisive implementation of reforms to support growth, for Turkey as well as for other countries. As long as the economic program is implemented decisively and no concessions are made from policies of sustainable growth, the Turkish economy will be more resistant and less vulnerable to shocks. 26 A Shock-Resistant Economy Tight fiscal policy along with budget management compatible with the principles of transparency, unity, generality and accountability has made significant contribution to the progress made since 2002 in reaching sustainable growth as well as in reducing inflation (Public Fiscal Management and Control Law No: 5018). It should be kept in mind that in the recent period when external risks became more pronounced, should notions indicating a possible diversion from fiscal discipline occur, there might be a deterioration in the risk perceptions regarding the Turkish economy. In order to enhance the resistance of the Turkish economy against exogenous shocks, maintaining and improving the gains in public finance, as well as the reforms made in institutional infrastructure are essential. 27 A Shock-Resistant Economy Accordingly: Instead of policies that will increase the rate of growth artificially in the short run, a reform agenda should be created with a long-term perspective; reforms that would be implemented as a part of this agenda should be listed in a transparent manner and shared with the public. These steps will provide an anchor and affect expectations on the Turkish economy favorably. Preparing a road map for the implementation of the reform agenda that includes time and performance criteria for the implementation schedule is essential. If the targets cannot be achieved in due time, causes and measures to be taken should be shared with the public, as stipulated by the principle of accountability. Mechanisms to be created for this end will enhance the credibility of the economic program. 28 A Shock-Resistant Economy Turkey has made significant progress towards macroeconomic stability in recent years, compared to previous periods. Yet, it is crucial that the efforts to reach price stability and to sustain high growth rates continue. In this framework, the European Union accession process and the implementation of structural reforms envisaged in the economic program remain crucial. 29 III. Financial Stability in Turkey Banking Sector Corporate Sector Households Public Sector 30 Banking Sector Net FX Position of the Banking Sector (2000 Q1 – 2008 Q2, billion USD)* 2 The sector does not hold a noteworthy 1 FX short position. Net FX positions of the -1 banks are at a low level compared to -3 their equity capital. 0 -2 -4 -5 -6 of 12.1%. 2008 Q1 2007 Q3 2007 Q1 2006 Q3 2006 Q1 2005 Q3 2005 Q1 2004 Q3 2004 Q1 2003 Q3 2003 Q1 2002 Q3 2002 Q1 2001 Q3 2001 Q1 above the legal limit and the EU average 2000 Q3 -7 2000 Q1 The capital adequacy ratio is well * As of 16 May 2008 Capital Adequacy Ratio (December 2005 – March 2008, percent) 28 24 Operational risk included 16 Target rate is 12% 12 an indirect credit risk on the banking 8 sector. 4 Legal limit is 8% Source: CBT - BRSA 02-08 12-07 10-07 08-07 06-07 04-07 02-07 12-06 10-06 08-06 06-06 04-06 0 02-06 FX short position of the real sector poses 20 12-05 Still, it should be kept in mind that the 31 Banking Sector Short-Term FX Liquidity Adequacy Ratio (6 July 2007 – 9 May 2008, percent) Up to 1 month 150 100 05-08 04-08 03-08 02-08 01-08 12-07 0 11-07 ratios remain at high levels, as well. 50 07-07 Total short-term liquidity adequacy Legal limit is 80% 10-07 legal limit of 80%. 200 09-07 adequacy ratios are well above the 0-7 days 250 08-07 Banks’ short-term FX liquidity 300 Total Short-Term Liquidity Adequacy Ratio (6 July 2007 – 9 May 2008, percent) 300 Recent fluctuations in global 250 financial markets once again 200 highlighted the importance of liquidity 150 risk management. In this juncture, it 100 is important for banks to be cautious 50 Up to 1 month Legal limit is 100% Source: CBT – BRSA 05-08 04-08 03-08 02-08 01-08 12-07 11-07 10-07 09-07 08-07 0 07-07 in liquidity management. 0-7 days 32 Banking Sector The ratio of non-performing loans to total loans dropped by 8 points to 3.5% in the 2003-2007 period. The current level of the ratio is below the average of other developing countries. Ratio of Non-Performing Loans to Total Loans (2003 and 2007, percent) 14 12 11.5 Developing Countries* 10 Turkey 8 6 Developed Countries** 4.9 3.9 4 3.5 3.7 2.8 2 0 2003 2007 * Developing countries: Argentina, Brazil, Bulgaria, Czech Republic, Croatia, Hungary, Latvia, Lithuania, Poland, Romania, Russia, Slovakia, Ukraine ** Developed countries: France, Germany, Italy, United Kingdom, USA Source: IMF 33 Corporate Sector Corporate Sector’s Resistance to Exogenous Shocks FX Position of the Non-Banking Sector (2005 Q4 – 2007 Q2, billion USD) 140 120 The FX short position of the non- FX Liabilities FX Assets 100 banking sector was USD 51 billion 80 as of the second quarter of 2007. 60 87 96 98 105 77 50 53 54 58 67 123 113 69 72 40 20 Exchange rate risk exists in both directions. It is crucial that companies hedge themselves against exchange rate risk. 0 Net FX Position -20 -40 -60 2005 Q4 2006 Q1 2006 Q2 2006 Q3 2006 Q4 2007 Q1 2007 Q2 Source: CBT 34 Corporate Sector In Turkey, the ratio of short-term debt to total debt of the real sector is higher than that of other developing countries. Yet, the borrowing maturity has improved in recent years. The share of real sector’s short-term FX-denominated debt continues to decline. Ratio of Short-Term Debt of the Real Sector to Total Debt * (2000-2007, percent) 90 Ratio of Short-Term FX-Denominated Debt of the Real Sector to Total FX-Denominated Debt * (2000-2007, percent) 90 Manufacturing 80 70 80 Manufacturing 70 Non-Manufacturing 60 60 Eastern Europe Average (2005) 50 50 Non-Manufacturing Latin America Average (2005) 40 * According to days to maturity Source: CBT * According to days to maturity Source: CBT 2007 2006 2005 2004 2003 2002 2001 2000 2007 2006 2005 2004 2003 2002 2001 2000 40 35 Corporate Sector Similarly, although the dollarization of the real sector’s debt (i.e. the ratio of FX-denominated loans to total loans) is relatively high in Turkey, it has followed a downward trend in the recent period. Debt dollarization is higher for export-oriented companies and large-scale companies, whereas it is lower for companies manufacturing for domestic markets and small-scale companies. Debt Dollarization of the Manufacturing Sector Debt Dollarization of the Real Sector (2000-2007, percent) 90 Companies with High Export Share Manufacturing Sector Non-Manufacturing Sector Companies with Low Export Share 80 70 (2000-2007, percent) 90 80 70 Large-Scale Companies 60 60 50 50 Medium-Scale Companies 40 Source: CBT Small-Scale Companies Source: CBT 2007 2006 2005 2004 2003 2002 2001 20 2000 2007 2006 30 2005 2004 2003 2002 2001 20 Latin America Average (2005) 2000 30 40 36 Corporate Sector It may be assumed that the companies with FX-denominated income (exports, tourism, etc.) have a natural hedge against exchange rate risk. In addition to this natural hedge, exchange rate risk can also be contained via forward and derivative transactions. The sectors where FX loan utilization is high also have large shares of sales to foreign markets, whereas FX loan utilization is below the sector average in the sectors that generally have sales to the domestic market. The companies with YTL-denominated income should manage exchange rate risk with caution. Exports and FX-denominated Loans (2006, percent) 80 Main Metal FX Credit / Total Credit 70 Transport and Comm. Other Metal 60 50 Chemicals Construction Food 40 Vehicle Textile Plastic Average Electronic Machinery Commerce Average 30 10 20 30 40 Exports / Net Sales Source: CBT Company Accounts 50 60 37 Corporate Sector The financial structure ratios of the corporate sector show that the ratio of total debt to equity declined in the 1996-2006 period, whereas there was a recovery in the interest coverage ratio. This situation ensures a considerable degree of safety for creditors. Ratio of Companies’ Total Debt to Equity and Interest Coverage Ratio (Operating Profit /Interest Payments) (1996 - 2006, percent) 350 300 Interest Coverage Ratio Total Debt / Equity Capital 250 200 150 100 50 Source: CBT Sectoral Balance Sheets 2006 2005 2004 2003 2002 2001 2000 1999 1998 1997 1996 0 38 Households Exchange Rate and Interest Rate Risk of Households 10 Ratio of FX-indexed Consumer Loans to Total Consumer Loans (2003 – May 2008, percent) 8.6 8 6.4 In Turkey, the practice of variable interest 6 rate for consumer loans is limited. 4 FX denominated loans are not extended 2 to consumers and companies with no FX 0 4.8 2003 income. loans. 2005 3.9 4.1 2006 2007 May 2008 Source: CBT Ratio of Household Liabilities to GDP FX-indexed consumer loans make up only 4.1% of total amount of consumer 2004 3.6 (2004-2006, percent) 70 57 60 63 60 European Union 50 Eastern Europe The ratio of non-performing loans to 40 consumer loans is 1.57%, by May 2008. 30 Household indebtedness is at a low level compared to European Union and Eastern Europe countries. Turkey 20 10 12 5 23 17 9 8 0 2004 Source: ECB, CBT 2005 2006 39 Public Sector Public Sector Net Debt Stock / GDP Public Finance (2000-2007, percent) 70 Net Domestic Debt 60 50 39 40 Thanks to fiscal policies implemented since 2001, public sector has become more resilient to external shocks. Net Foreign Debt 36 38 30 36 29 35 20 28 10 25 17 14 13 2002 2003 2004 4 1 2005 2006 2007 Central Government FX-denominated and FXindexed Debt Stock (2004 Q4-2008 Q2*, Ratio to The ratio of FX-debt within the total central government debt stock is 32% as of April 2008. Ratio of net foreign debt stock to GDP declined to 1% by end-2007. 2001 28 6 0 2000 30 Total Central Government Debt, percent) 70 60 50 40 * As of April 2008 Source: Treasury, CBT 2008 Q2 2007 Q4 2007 Q2 2006 Q4 2006 Q2 2005 Q4 2005 Q2 2004 Q4 2004 Q2 2003 Q4 2003 Q2 2002 Q4 2002 Q2 2001 Q4 20 2001 Q2 reserves with the aim of minimizing any liquidity risk that might arise in cash and debt management. 30 2000 Q4 The Treasury maintains a high level of FX 40 Central Bank Foreign Exchange Reserves Even in floating exchange rate regime, keeping a strong foreign exchange reserve position is very important for the economies of developing countries like Turkey in order to eliminate the unfavorable effects of potential shocks and to boost confidence in the country’s economy. Foreign exchange reserves of the Central Bank amounts to USD 77.5 billion as of May 2008. Ratio of FX Reserves to GDP in 2007 in the Countries Implementing Floating Exchange Rate Regime* Central Bank FX Reserves (2002- May 2008, billion USD) (2007, percent) 18.7 20 18 16 14 12 10 8 6 4 2 0 90 80 11.0 71,3 70 58,3 60 48,3 50 40 30 77,5 33,7 36,0 2003 2004 27,0 20 Average of Countries Implementing Floating Exchange Rate Turkey * Countries used in the calculation: Argentina, Brazil, Chili, Colombia, Croatia, Czech Republic, India, Indonesia, Kazakhstan, Mexico, Paraguay, Peru, the Philippines, Poland, Romania, Russia, South Africa, South Korea, Thailand, Uruguay Source: IMF, CBT 10 0 2002 2005 2006 2007 2008 May Source: CBT 41 Overall Assessment Evidently, in the floating exchange rate regime, the Central Bank can implement a more flexible liquidity policy in comparison to fixed or managed exchange rate regime. It can also respond to liquidity requirements of the banking system in a more flexible and prompt manner, and prevent any excessive volatility in money market interest rates. However, it is imperative that the banking sector and the real sector should not slacken risk management principles by relying on the more flexible and effective Turkish lira liquidity management and the foreign exchange liquidity facility of the Central Bank. Considering the fact that they operate in an environment where the exchange rate risk is in the market, they should establish mechanisms that will ensure the effective management of this risk. 42 Overall Assessment All in all, current indicators show that endurance of the Turkish economy in the face of fluctuations in global markets has relatively increased compared to the previous years. Having said that, the decline in fragilities in comparison to the previous periods should not be interpreted as the absence of risks. 43 IV. Inflation Developments, Outlook and Risks 44 Global Inflation Developments Global Inflation Developments (January 2005 - March 2008, consumer prices, year-on-year change, percent) 14 Since 2007, there is an apparent 12 upward acceleration in consumer 10 Turkey prices inflation all over the world. 8 Developing Countries 6 The rate of increase in developed World 4 countries’ annual inflation is at its 2 highest level of the last 16 years. Developed Countries 03-08 01-08 11-07 09-07 07-07 05-07 03-07 01-07 11-06 09-06 07-06 05-06 03-06 01-06 11-05 09-05 07-05 05-05 03-05 01-05 0 Source: IFS, Central Banks, CBT 45 World Commodity Prices International Price Indices of Selected Products 380 metal, and energy are among the main 330 factors leading to global inflation risk. 280 Metal Energy 230 Wheat 180 130 developing countries, mainly China and 80 India, has createsda demand-driven Source: IMF pressure on commodity prices. Crude Oil Prices and Global Growth Rate Moreover, the utilization of food stuff 80 such as corn, wheat, and sugar beet in 70 %4 40 %3 30 20 %2 10 Source: IMF 2007 2006 2005 2004 2003 2002 2000 1999 1998 1997 1996 1995 %1 1994 0 1993 commodity prices. %5 50 1992 factors leading to an increase in the %6 Oil Prices (USD, left scale) Global Growth Rate (right scale) 60 1991 unfavorable weather conditions are (1990 –2007) 1990 producing biofuels accompanied with Rice 01-04 03-04 05-04 07-04 09-04 11-04 01-05 03-05 05-05 07-05 09-05 11-05 01-06 03-06 05-06 07-06 09-06 11-06 01-07 03-07 05-07 07-07 09-07 11-07 01-08 03-08 Recovery in the general prosperity of 2001 Hikes in the prices of especially food, (January 2004 – March 2008, 2002=100) 46 World Commodity Prices Crude Oil Prices, Europe (Brent) 100 130 (1 January 2007 – 23 May 2008) 120 90 110 In US dollars (right scale) Although economic slowdown is 80 expected in the developed countries, 70 90 60 80 In Euro (left scale) 50 05-08 04-08 03-08 02-08 01-08 12-07 11-07 10-07 09-07 08-07 07-07 06-07 countries. 05-07 40 04-07 30 03-07 expectations in the developing 60 40 02-07 continued in 2008 due to high growth 70 50 01-07 the upsurge in commodity prices has 100 Source: Bloomberg In May 2008, crude oil prices surpassed their highest level Spot Gold Prices* 800 1100 (1 January 2007 – 23 May 2008) 1000 In US dollars (right scale) 700 experienced in 1979 in real terms. 900 600 800 In the first quarter of 2008, 600 * Price of one ounce of gold quoted on the London gold market Source: World Gold Council 05-08 04-08 03-08 02-08 01-08 12-07 11-07 10-07 09-07 08-07 07-07 06-07 05-07 04-07 500 03-07 400 02-07 gold prices. In Euro (left scale) 01-07 consecutive peeks were observed in 700 500 47 Inflation Differentiation Among Country Groups Share of the Food Items in the CPI Basket (2006, percent) Income Per Capita (Purchasing Power Inflation rates of both developed and Parity, 2006, USD) developing countries has accelerated 70 differentiation in underlying inflation dynamics between these two groups. The most important reason for the differentiation is significant differences between the consumer prices baskets used in inflation calculation. • Food products have a substantial weight in the inflation basket of developing economies. • Technological products, prices of which have downward tendency, have significant weight in the inflation basket of the developed countries. Share of the Food Items in the CPI Basket (percent) recently, but there also appears to be a White Russia Haiti My anmar Sri Lanka Bangladesh Armenia Ky rgy zstan Egy pt 60 Jamaica Algeria Bulgaria Senegal Morocco Russia Zimbabwe Y emen UkraineTunisia India RomaniaLithuania 50 Uganda Portugal Ghana Keny a Colombia Guatemala Malta HondurasMacedonia Costa Rica Latv ia Israel Uruguay Croatia Thailand Ecuador Argentina 40 Malay sia Kuwait Panama Poland Estonia Chile Saudi Arabia Korea ChinaTurkey Hong Kong Singapore Israel Japan Slov akia Hungary Slov enia 30 Ireland Brazil Germany South Af rica New Zealand 20 Austria France Switzerland the Netherlands Australia Iceland the USA Belgium Canada Norway Finland Sweden the United Kingdom Denmark 10 Developed Countries 0 0 10000 20000 30000 40000 Income Per Capita Source: ILO 48 Differentiation in Monetary Policies Food prices have caused upward inflationist pressures in all country groups. This pressure is more evident in the developing countries. Due to problems in financial markets, the central banks of the developed countries have given more priority to financial stability and growth, whereas the central banks of the developing countries focus on price stability. Consequently, a tighter monetary policy stance is observed in the developing countries. Policy Rates in Developing Countries* Policy Rates in Developed Countries* * USA, Eurozone, UK, Japan, Canada Source: Central banks 04-08 03-08 02-08 01-08 12-07 11-07 6.1 10-07 2.6 09-07 6.3 08-07 2.8 07-07 6.5 06-07 3.0 05-07 6.7 03-07 3.2 02-07 6.9 01-07 3.4 03-08 7.1 01-08 3.6 11-07 7.3 09-07 3.8 07-07 7.5 05-07 4.0 03-07 7.7 01-07 4.2 04-07 (January 2007 – April 2008, percent) (January 2007 – April 2008, percent) * Brazil, Czech Republic, China, South Africa, S. Korea, Hungary, Malaysia, Mexico, Poland, Romania, Russia, Chile, Thailand, Taiwan, Ukraine Source: Central banks 49 Effects on the Turkish Economy Effects of global inflation 60 developments on the Turkish economy Inflation and Import Unit Prices in Turkey* (January 2007 – March 2008, year-on-year change, percent) 50 Agricultural Products Import Unit Price 40 High increases especially in the prices of agricultural products have caused a Mining Products Import Unit Price 30 significant burden for developing countries like Turkey where the share of Import Unit Price 20 food expenditures within total consumer expenditures is high. As Turkey is a net commodity importing CPI 10 0 country, hikes in the prices of energy and balance. * In US dollars Source: TURKSTAT, CBT 03-08 02-08 01-08 12-07 11-07 10-07 09-07 08-07 07-07 06-07 05-07 04-07 03-07 02-07 both inflation and the foreign trade -10 01-07 metals have also unfavorable impacts on 50 Comparative Inflation Developments Inflation Developments in Turkey and the World (Difference Between the Inflation Rates of 2006 and 2007, -2 0 2 4 6 percent) Despite unfavorable exogenous shocks, Turkey is among the few countries that lowered inflation in 2007. In this period, the inflation rate increased by approximately 2 percentage points on average among 60 countries, while the said rate decreased by 1.3 percentage points in Turkey. LATVIA BOLIVIA BULGARIA VENEZUELA BELARUS CHILE UKRAINE ESTONIA CZECH R. LITHUANIA CROATIA CHINA SINGAPORE SAUDI ARABIA ISRAEL S.AFRICA SLOVENIA RUSSIA PERU MALTA POLAND AUSTRIA URUGUAY SWEDEN ECUADOR ROMANIA SPAIN USA KOREA HONG KONG BELGIUM GERMANY SWITZERLAND BRAZIL COLOMBIA USA LUXEMBOURG FRANCE HUNGARY GREECE HOLLAND ITALY CANADA NORWAY N.ZEALAND DENMARK JAPAN FINLAND PORTUGAL INDONESIA IRELAND THAILAND AUSTRIA MEXICO ENGLAND PHILIPPINES MALAYSIA SLOVAKIA INDIA ICELAND TURKEY 8 Average Increase Turkey -2 0 Source: IMF, TURKSTAT, CBT 2 4 6 8 51 Comparative Inflation Developments Turkey’s ranking in inflation has Turkey in the Global Inflation Ranking (1997 – 2008, January) 70 improved in recent years. 59 60 53 Between 1997 and 2003 Turkey was among the 10 countries that had 50 the highest inflation. 40 Despite the exogenous shocks in 30 2007, Turkey moved down to the 59th place as of January 2008. 34 25 26 20 10 4 7 7 10 8 9 4 0 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 20072008* * Most recent data announced in January 2008 The total number of countries is 155. Tha ranking is in descending order. Source: IMF, TURKSTAT, CBT 52 Comparative Inflation Developments Inflation Differential Between the Countries Implementing Inflation Targeting* and Turkey (December 2005 – April 2008, year-on-year change, percent) In the third quarter of 2006, the 9 Monetary Tightening inflation in Turkey was 8 percentage points higher compared to the inflation figures in other developing 8 Prudent Rate Cuts 7 countries that implement inflation targeting. 6 5 The said difference began to narrow due to the monetary tightening exercised from mid-2006 4 3 onwards and decreased to 3 04-08 02-08 12-07 10-07 08-07 06-07 04-07 02-07 12-06 10-06 08-06 06-06 04-06 02-06 2 12-05 percentage points by early-2008. * Countries Implementing Inflation Targeting Regime: Brazil, Czech Rep., Colombia, Philippines, South Africa, Israel, Hungary, Mexico, Peru, Poland, Romania, Chile, Slovakia, Thailand Source: Central Banks, TURKSTAT, CBT 53 Comparative Inflation Developments Inflation Targets, Uncertainty Band and Inflation in Countries Implementing Inflation Targeting Regime (April 2008) 12 Ratio of Inflation to Inflation Target in Economies Countries Inflation Targeting Regime (April 2008) 3 Inflation 10 Inflation Target Uncertainty Band 2 8 6 1 4 Brazil Thailand* Colombia Mexico Poland Philippines Slovak Republic Hungary Czech Republic Romania Israel Turkey Peru Thailand* Slovak Republic Israel Peru Poland Mexico Hungary Czech Republic Chile Romania Turkey Philippines Colombia Brazil South Africa * In Thailand inflation targets are determined according to core inflation. Therefore, calculations were made utilizing the core inflation rate instead of consumer prices. Source: Central Banks, TURKSTAT, CBT Chile 0 0 South Africa 2 * In Thailand inflation targets are determined according to core inflation. Therefore, calculations were made utilizing the core inflation rate instead of consumer prices. Source: Central Banks, TURKSTAT, CBT 54 Inflation Developments in Turkey Consumer, Services and Goods Inflation In the first three quarters of 2007, inflation, as projected, fell gradually and was 7.1% in 18 (January 2004 – April 2008, year-on-year change, percent) Services Inflation September 2007. 16 In the last quarter of the year, supply-side shocks such as drought and hikes in energy 14 prices as well as adjustments in administered prices interrupted the downward tendency of 12 Consumer Inflation inflation. 10 As of April 2008, year-on-year inflation Despite the downward trend apparent in services inflation, goods inflation has followed a more upward course due to external and supply-side factors. 8 6 Goods Inflation 4 01-04 03-04 05-04 07-04 09-04 11-04 01-05 03-05 05-05 07-05 09-05 11-05 01-06 03-06 05-06 07-06 09-06 11-06 01-07 03-07 05-07 07-07 09-07 11-07 01-08 03-08 stood at 9.66%. Source: TURKSTAT, CBT 55 Inflation Developments in Turkey Prices of the items outside the control of monetary policy such as food, energy and administered prices contributed to the annual inflation by 51% in 2004-2006 period, whereas this contribution increased to 71% in April 2008. Annual Inflation Components (share, percent) April 2008 Average of 2004 – 2006 Tobacco** Tobacco** Energy Others 9.7 28.4 25.5 17.0 Others 6.0 Energy 49.4 23.9 Food* 40.0 Food* * Food: Food and non-alcoholic beverages ** Tobacco: Tobacco products and alcoholic beverages Source: TURKSTAT, CBT 56 Inflation Developments in Turkey Food prices stand as one of the main factors that have impeded the disinflation process in 2007. - As of April 2008, food group has added 3.9 percentage points to annual inflation. Food and Non-Food CPI* 16 14 (January 2004 – April 2008, year-on-year change, percent) Food and NonAlcoholic Beverages 12 - Non-food inflation, which was 9.1% in December 2006, declined to 4.98% in October 2007. - Adjustments to administered prices in November and January halted the deceleration in non-food inflation. As of April 2008, the year-on-year increase in non-food inflation was 8.1%. 10 8 6 CPI Excluding Food 4 2 0 01-04 03-04 05-04 07-04 09-04 11-04 01-05 03-05 05-05 07-05 09-05 11-05 01-06 03-06 05-06 07-06 09-06 11-06 01-07 03-07 05-07 07-07 09-07 11-07 01-08 03-08 Non-food inflation demonstrated a significant slowdown in 2007 compared to 2006. *CPI excluding food and non-alcoholic beverages Source: TURKSTAT, CBT 57 Inflation Developments in Turkey Food Inflation: Year-on-year increase in unprocessed food inflation declined significantly by 6.7 percent in comparison to April 2007. Year-on-year increase in processed food prices maintained their upward trend and reached 20.2 percent on. Year-to-date inflation in processed food prices stood at 9.2 percent. Bread and cereals prices continue to climb in response to soaring domestic and global wheat prices. The year-to-date increase of the prices in this group is 12.8 percent. Unprocessed Food and Processed Food Inflation Food Prices (January 2006 –April 2008, year-on-year change, percent) (2006 –2008, year-to-date change, percent) 24 24 2008 21.2 20 Unprocessed Food 16 Processed Food 20 2007 16 12 13.5 12 9.2 8 9.9 12.8 2006 11.0 9.2 10.5 8 4 Non-food CPI 4 03-08 01-08 11-07 09-07 07-07 05-07 03-07 01-07 11-06 09-06 07-06 05-06 03-06 01-06 0 4.0 5.0 2.2 2.6 0 Processed Food Unprocessed Food Fresh Fruit and Vegetable Bread and Cereals 58 Inflation Developments in Turkey Goods Inflation: Goods Group Inflation and Selected Sub-items (January 2006 – April 2008, year-on-year change, percent) Year-on-year goods inflation, which started to decelerate in March 2007, Automobile 15 Furniture Goods Group declined to 5.7% in July, but rebounded to 9.8% in April 2008 due to increased food 10 and energy prices along with adjustments to administered prices. 5 Prices of durable goods posted a yearon-year decrease, albeit limited, while the 0 rise in gold prices continued to affect Durables (excluding Gold) -5 energy and unprocessed food. Source: TURKSTAT, CBT 03-08 01-08 11-07 09-07 07-07 05-07 03-07 01-07 11-06 07-06 05-06 01-06 -10 09-06 Electrical and NonElectrical Appliances 03-06 adversely the prices of goods excluding 59 Inflation Developments in Turkey Services Inflation and Selected Sub-items (January 2006 – April 2008, year-on-year change, percent) Services inflation stood at 9.2% as 21 of April 2008. 19 Restaurants and Hotels Transport Services 15 energy prices curbed the downtrend in services inflation. 13 - The deceleration in rent inflation is 11 9 which was 20% at end-2006, 03-08 01-08 05-07 03-07 01-07 11-06 09-06 05-06 03-06 5 01-06 decreased to 14.4% in April 2008. Services Group 7 07-06 noteworthy. Year-on-year increase, 11-07 services due to soaring food and 17 09-07 - Price hikes in catering and transport Rent 07-07 Services Inflation: Source: TURKSTAT, CBT 60 Inflation Developments in Turkey In the last three years as of April; Services inflation has slowed down significantly compared to previous years. Year-on-year inflation in energy prices displays a higher trend compared to that of 2005 and 2006 owing to supply shocks. Year-on-year inflation excluding energy and unprocessed food increased by 8.6% in April 2008. This development was mainly driven by significant price hikes in processed food, tobacco and gold. Inflation by Groups Inflation by Groups (2006-2008, year-on-year change, as of April, percent) (2006 –2008, year-to-date change, as of April, percent) 22 20 18 16 2006 2007 2008 17.5 16 12 14 10 12 10 11.8 11.3 2007 2006 9.9 2008 8.0 8.7 9.1 8 6.7 6 8.6 5.6 4 Energy Source: TURKSTAT, CBT Unperocessed Food Goods exc. Energy and Unprocessed Food 9.2 7.8 8 9.2 Services 13.5 14 16.6 16.3 6 4 3.3 2.9 3.5 3.4 3.4 2.0 1.6 2 0 Services Energy Source: TURKSTAT, CBT 0.0 Unprocessed Food Goods exc. Energy and Unprocessed Food 61 Inflation – Expectations The recent upward movement in expectations has increased the risks to the price setting behavior. Inflation and Inflation Expectations 14 (January 2005 – May 2008, year-on-year change, percent) Inflation expectations • Year-end: 9.64% CPI 12 12 Months • 12 months ahead: 7.88% • 24 months ahead: 6.67% Increases in food and energy prices 9,66 10 24 Months 7,88 8 6,67 impede the disinflation process as well as the recovery in expectations. Moreover, the deterioration in exchange 6 4 rate movements and risk perception have expectations. 2 01-05 04-05 07-05 10-05 01-06 04-06 07-06 10-06 01-07 04-07 07-07 10-07 01-08 04-08 07-08 10-08 01-09 04-09 07-09 10-09 01-10 04-10 negative implications on inflation 2008-2009-2010 Target: 4 % Source: CBT, TURKSTAT 62 Inflation – Trend The slowdown in the inflation trend observed throughout the four quarters from September 2006, was interrupted in the last quarter of 2007. Potential second round effects of rising food and energy prices will continue to be monitored closely in the upcoming period. Inflation Trend (January 2006 – April 2008, year-on-year change, percent) 11 10 9 8 7 6 5 4 3 03-08 01-08 11-07 09-07 07-07 05-07 03-07 01-07 11-06 09-06 07-06 05-06 03-06 2 01-06 * Annualized monthly change of seasonally adjusted SCA-I index (3-month moving average) . Source:TURKSTAT, CBT 63 Inflation – Forecasts Persistency of supply shocks, ongoing uncertainties in global economy and second round effects have necessitated a significant upward revision in our inflation forecasts. The Sources of Changes in Inflation Forecasts (percentage point) 2008 2009 Food Prices 1.2 1.1 Oil Prices 0.9 0.4 1.5 – 2.0 1.0 Other - 0.5 Total 3.8 3.0 Exchange Rate Source: CBT 64 Inflation – Forecasts Forecasts for Inflation and Output Gap Baseline scenario assumptions: 2008 2009 2010 Oil Prices $ 105 $ 105 $ 105 Food Prices 13% 8% 7% Under the assumption that policy rates are increased gradually and cautiously until mid-2008 and then kept flat for the rest of the year... (2007 Q4 – 2011 Q1, percent) 12 Forecast Range* Output Gap Medium Term Target Uncertainty Band for 2008 10 8 6 4 2 0 -2 2011-I 2010-IV 2010-III 2010-II 2010-I 2009-IV 4.0 % 2009-III mid-2011 2009-II 4.9 % 2009-I 2010 -6 2008-IV 6.7 % 2008-III 2009 2008-II 9.3 % 2008-I 2008 -4 2007-IV Inflation Forecasts: *The shaded region indicates the 70 percent confidence interval for forecast. Source: CBT 65 Inflation – Risks Pessimistic scenario: Inflation Forecast 2008 2009 2010 Oil Prices $ 125 $ 150 $ 150 Food Prices 17% 11% 10% Increasing the policy rates gradually until end-2008. (2007 Q4 – 2011 Q1, percent) 12 Pessimistic Scenario Baseline Scenario 10 Optimistic Scenario Medium Term Target 8 6 2011-I 0 2010-IV Increasing the policy rates cautiously in the upcoming months, then keeping constant, followed by gradual cuts in the last quarter of 2008. 2 2010-III %4 2010-II 5% 2010-I 9% 2009-IV Gıda Fiyatları 2009-III 85 $ 2009-II 85 $ 2009-I 95 $ 2008-IV Petrol Fiyatları 4 2008-III 2010 2008-II 2009 2008-I 2008 2007-IV Optimistic scenario: Source: CBT 66 Inflation – Risks Risks: Energy and Food Prices A protracted period of rising food and energy prices have led to a significant overshooting of the inflation targets since the adoption of the inflation targeting regime and consequently increased stickiness in inflation expectations, as economic agents have become more backward looking. Risks related to energy and food prices exist in both directions: • In case the prices turn out to be worse than expected, the monetary policy stance might get tighter. • In case the prices turn out to be better than expected, inflation is expected to reach the level of 4 percent in a shorter period of time. 67 Inflation – Risks Risks: Expectations and Pricing Behaviors Under normal conditions, supply shocks are expected to affect relative prices temporarily, not the underlying inflation trend. Nevertheless, the fact that several long-lasting shocks appeared concurrently has increased the risks to price setting behavior. In the period ahead, it may be necessary to pursue a tighter monetary policy for a longer duration in comparison to the aforementioned baseline scenario, should the price setting behavior continues to deteriorate and inflation continues to be more rigid than expected. It is assumed that government expenditures will evolve in line with the budget and that there will be no further increases in indirect taxes or administered price adjustments, except those required by the automatic pricing mechanism. Any deviation from this may have an effect on the outlook for inflation and monetary policy. 68 Inflation – Risks Risks: International Developments Another major risk to the inflation outlook is a sharper than expected slowdown in the global economic activity, which, in turn, could lead to further volatility in financial markets. Movements in exchange rates resulting from global uncertainties carry the risk of impeding the disinflation process. On the other hand, given the weak demand conditions, second round effects of the exchange rate pass-through should be relatively limited at this point. The Central Bank of Turkey will not react to temporary fluctuations in financial markets via policy rates. Yet, we will not hesitate to tighten monetary policy in case of a significant worsening in the general pricing behavior. 69 VI. Monetary Policy Stance 70 Monetary Policy Decisions Monetary Policy Decisions Interest Rate Decisions of the Monetary Policy Committee (January 2007 – May 2008, percent) At its meeting of 13 September 2007, Monetary Policy Committee initiated a cautious rate cut cycle, which continued until 19 March 2008 and involved a total of 225 basis point cut. The recent rise in food and energy prices, along with the ongoing uncertainties in global economy, has increased the risks regarding the price setting behavior and the degree of inflation persistence. The MPC decided to raise policy rates by 50 basis points in May 15 meeting to prevent the the potential second-round effects of the Meeting Date Policy Rates Change 16 January 2007 15 February 2007 15 March 2007 18 April 2007 17.50 17.50 17.50 17.50 0 0 0 0 14 May 2007 17.50 0 14 June 2007 17.50 0 12 July 2007 17.50 0 14 August 2007 13 September 2007 16 October 2007 14 November 2007 13 December 2007 17 January 2008 14 February 2008 19 March 2008 17 April 2008 15 May 2008 17.50 17.25 16.75 16.25 15.75 15.50 15.25 15.25 15.25 15.75 0 - 0.25 - 0.50 - 0.50 - 0.50 - 0.25 - 0.25 0 0 + 0.50 Source:CBT adverse developments in food and energy prices. 71 Monetary Policy Decisions 2008 January Inflation Report: “Main message of the forecast is that continuation of the gradual easing cycle that started in 2007 September will remain conditional on favorable data and developments.” MPC Decision dated 14 February 2008: ”Ongoing uncertainties in the global economy and the risks to the price setting behavior compel the CBT to be cautious with regard to the monetary policy” MPC Decision dated 19 March 2008: “The Committee assesses that rising global uncertainty and the adverse developments in food and energy prices may lead to some delay in reaching the inflation target.” 2008 April Inflation Report: “Supply shocks have turned out to be more persistent than expected, increasing the risks to the second round effects and necessitating a significant upward revision in our inflation forecasts. Accordingly, monetary policy has already assumed a more cautious stance.” MPC Decision dated 15 May 2008: “Central Bank will continue to take necessary measures to prevent the potential second round effects of the adverse developments in food and energy prices. Accordingly, the Committee will consider the possibility of a further measured rate hike in the next meeting.” 72 Monetary Policy Decisions Ensuring a steady decline in inflation will likely require tight monetary policy to be maintained for an extended period. Policy Rates (simple interest) and Core Inflation Indicators (January 2006 – May 2008, year-on-year change, percent) 13 20 Policy Rate (right scale) 12 19 11 18 10 17 9 16 SCA-H (left scale) 8 15 7 14 6 13 5 12 SCA-I (left scale) 05-08 03-08 01-08 11-07 09-07 07-07 05-07 03-07 01-07 11-06 09-06 10 07-06 3 05-06 11 03-06 4 01-06 Source: TURKSTAT, CBT 73 Monetary Policy Stance The rise of risks related to food and energy prices indicate that reaching the 4 percent inflation target will take longer than estimated. Monetary policy focuses on price stability in the medium term. However, under current circumstances, the CBT will not stick to a tight stance about the duration of reaching the target. In fact, a strong response to the hike in inflation caused by supply shocks may lead to undesired fluctuations in the economic activity and relative prices. Therefore, we envisage a framework, in which inflation will realize above the target at the end of 2009. In this period where uncertainties and risks grow, the CBT will continue to implement the policies focusing on keeping inflation under control, ensuring convergence to the target in the medium term and maintaining the achievements on the way to price stability. 74 Monetary Policy Stance The Central Bank will not let the recent deterioration in inflation expectations worsen the overall pricing behavior. In this respect, the CBT will be more responsive against bad news than good news and will consider a measured tightening when needed. In this conjuncture, where economic uncertainties increase throughout the world, the CBT will put effort to keep the monetary policy relatively foreseeable, but resilient to shocks at the same time. 75 Monetary Policy Stance Importance of the Coordination Between Monetary and Fiscal Policies: Prudent monetary policy is a necessary but not a sufficient condition in itself for attaining price stability. The support from fiscal policy and structural reforms are also critical in this respect. Sound fiscal policy has been one of the main factors in driving inflation down to single digits. The role of fiscal policy will continue to be critical on the road to price stability. Preserving the resilience of the economy, especially under current conditions, requires the continuation of fiscal discipline and structural reforms. 76 Inflation Target The views on the persistency of the rise in energy and food prices have started to gain more support recently. In case the food and energy-driven inflationary pressures persists, the 4 percenttarget may not be attained in the short run. In April, the Committee meeting agenda covered the issue of target revision. Committee members indicated that changing the target for end-2008 would not be appropriate, since doing so would be a clear violation of the accountability principle in practice. Regarding targets for 2009 and afterwards, the Committee assessed that, given the uncertainty surrounding the food and energy prices as well as the global economy, it would be wiser to reconsider the issue towards the end of this year in tandem with the budget preparations. We envisage a framework in which the inflation forecasts announced in 30 April 2008 serve as intermediate anchors while the medium term is anchored by the 4 percent target. 77 Monetary Policy Stance Current liquidity conditions provide the CBT with a flexible tool to engineer a rapid monetary tightening when needed. The excess liquidity in the money market has been shrinking during the past few months, due to factors such as reduced daily minimum amount in reserve purchase auctions, the Treasury’s preference of borrowing in YTL, and rising money demand. This trend is expected to prevail in the forthcoming period, possibly leading to a tightening in monetary conditions. This framework provides the CBT with a flexible and efficient tool, which makes it possible to implement a monetary tightening without conducting a formal MPC meeting. 78 Monetary Policy Stance Monetary policy stance is determined in view of inflation targets, available data, future expectations and medium-term inflation expectations. Any new data related to the medium-term inflation outlook will lead to revision of future stance of monetary policy. Examples of data dependency in the event of: • Sharper than expected slowdown in European economies: External demand would slow down, inflation expectations would drop below the target, the monetary policy would be loosened. • Loosening of fiscal policies: Inflation forecast would surpass the inflation target, a new monetary policy (monetary tightening) would be implemented to render the inflation expectations consistent with the target. 79 Monetary Policy for Price Stability Significant progress has been achieved on the way towards price stability, but we have not reached price stability yet. In this conjuncture, a monetary policy that is consistent with inflation targets and that take domestic demand under control will be pursued in order to reduce inflation and to ensure its convergence to the inflation target. Many developed countries that have achieved price stability were obliged to adopt strong monetary tightening in the past in order to bring inflation under control. 80 Monetary Policy for Price Stability Example : USA, 1976 – 1982 (1976 – 1986, year-on-year change, percent) 20 The strong monetary tightening that was put into practice in 1980 was instrumental in taking the inflation - under control and restoring price stability. 16 The main reasons for severe monetary tightening in this period were that a monetary policy, which would bring inflation under control, was not adopted in the 1976-1980 period and that the rises in policy rates lagged inflation developments. 10 Eventually, the cost of reestablishing price stability became much more higher for the US economy. Strong monetary tightening 18 14 Lagged response Policy Rate 12 8 6 4 2 Inflation 0 01-76 07-76 01-77 07-77 01-78 07-78 01-79 07-79 01-80 07-80 01-81 07-81 01-82 07-82 01-83 07-83 01-84 07-84 01-85 07-85 01-86 07-86 In the early 1980s, the rate of inflation rose to 14% due to the failure of the monetary authority to give a strong response to the inflation that had gained pace in late 1970s. Policy Rates (simple interest) and Inflation in the USA Source: FED 81 Monetary Policy for Price Stability Policy Rates (simple interest) and Inflation in Brazil Example 2: Brazil, 2002 – 2003 (2000 – 2007, year-on-year change, percent) In the 2001-2003 period, inflation in Brazil overshot the targets due to the sudden stop 30 Strong monetary tightening Policy rate 25 in capital inflows as well as the depreciation of the Brazilian currency against the US dollar. As a result of strong monetary tightening 20 15 10 Inflation and disciplined fiscal policy, inflation was taken under control in the following periods 5 and driven back to the target path. 07-07 01-07 07-06 01-06 07-05 01-05 07-04 01-04 07-03 01-03 07-02 01-02 07-01 01-01 07-00 01-00 0 Source: Banco Central do Brasil (BCB) 82 -2 Source: Central Banks 07-96 01-96 -2 07-95 10-94 2 01-94 10 04-93 Inflation 07-92 10-91 01-91 Inflation 04-90 0 07-89 6 10-88 6 01-88 10 07-86 04-87 12 10-85 Policy rate 01-85 12 04-84 Sweden 07-83 6 10-82 8 01-82 Policy Rate 07-80 04-81 12 10-79 16 01-78 05-78 09-78 01-79 05-79 09-79 01-80 05-80 09-80 01-81 05-81 09-81 01-82 05-82 09-82 01-83 05-83 09-83 01-84 05-84 09-84 01-85 05-85 09-85 England 01-79 8 07-95 10 01-95 07-91 01-92 07-92 01-93 07-93 01-94 07-94 01-95 07-95 01-96 07-96 10 07-94 01-94 07-93 01-93 07-92 01-92 14 07-91 18 01-91 07-90 01-90 0 07-89 07-85 01-86 07-86 01-87 07-87 01-88 07-88 01-89 07-89 01-90 07-90 01-91 01-85 2 01-89 07-88 01-88 2 07-87 01-87 Monetary Policy for Price Stability Examples of Monetary Tightening Against High Inflation Holland 14 Policy rate 8 6 4 4 0 Inflation Japan 8 Policy rate 4 4 2 0 Inflation 83 VII. Markets 84 Interest Rates Recent rise in interest rates in market can mostly be attributed to the reflections of global risks on the domestic environment. In line with deterioration in risk perceptions, interest rates started rising particularly as of endFebruary and stayed above policy rates. Most recently, the difference between policy rates and the benchmark interest rates has reached to 280 basis points. CBT Policy Rates and Benchmark Government Securities Interest Rate (1 January 2006 – 22 May 2008, compound, percent) 24 Real Interest Rate of 2-Year Government Bonds and 3-Year CDS Rate (1 October 2008 – 23 May 2008, compound, percent) 13 250 23 22 Source: CBT. 100 2-Year Real Interest Rate (left scale) 50 Source: Bloomberg, CBT. 05-08 9 04-08 04-08 01-08 10-07 07-07 04-07 01-07 10-06 07-06 04-06 01-06 12 10 03-08 Benchmark Govt. Sec. Interest Rate 14 13 150 02-08 15 11 01-08 17 16 200 3-Year CDS (right scale) 12-07 18 12 11-07 Policy Rate 20 19 10-07 21 85 Interest Rate Developments Real Borrowing Interest Rate Thanks to the achievements in macroeconomic stability, nominal (January 2002 – April 2008, compound, percent) 14 35 13 interest rates and real interest rates have substantially declined from 2002 onwards. 12 30 11 10 9 25 8 in the 20-30% interval in early 2002, 03-08 01-08 11-07 09-07 07-07 05-07 03-07 01-07 11-06 07-06 09-06 05-06 20 03-06 Real interest rates, which fluctuated 01-06 7 15 dropped to 9.8% at the end of 2007. 10 In early 2008, real interest rates rose to 10.8% due to financial turbulences. ** 01-02 04-02 07-02 10-02 01-03 04-03 07-03 10-03 01-04 04-04 07-04 10-04 01-05 04-05 07-05 10-05 01-06 04-06 07-06 10-06 01-07 04-07 07-07 10-07 01-08 04-08 5 * Based on the interest rates accepted in the Treasury’s domestic borrowing auctions and the 12-month inflation forecasts of the Expectations Survey. Source: Undersecretariat of Treasury and CBT. 86 Interest Rate Developments Nominal interest rate is determined by three variables: Nominal Interest Rate= Real Interest Rate + Inf. Expectations+ Inf. Risk Premium Real interest rate is determined by real variables such as the marginal efficiency of capital and the savings rate. The level of inflation compensation, which is the sum of inflation expectations and the inflation risk premium, will be lower in an environment where price stability is achieved. A fall in both inflation expectations and the risk premium leads to a decline in nominal interest rates. It is not possible to bring interest rates down by artificial cuts in policy rates and below the level required to sustain the disinflation process. On the contrary, such a move would lead to higher medium and long-term interest rates since it would deteriorate inflation expectations and risk perceptions. 87 Policy Rate - Market Rate Relationship Policy rate cuts are not sufficient to reduce the financial costs of commercial enterprises and consumers, which are set in free market environment. For instance, despite the monetary loosening being implemented by the Federal Reserve since September 2007, cost of financing for housing and commercial sector follow an upward trend, contrary to the decline in policy rates, chiefly owing to the deterioration in risk perceptions. Difference Between the Overall Level of Interest Rates and Policy Rates in the US Economy Interest Rates in the US Economy (January 2006 – April 2008, percent) Fed’s rate cut process 8 7 (April 2006 – April 2008, percent) 6 5 6 4 5 2 Fed Funds Target Rate Yields on Corporate Bonds (AAA Rating) Yields on Corporate Bonds (BBB Rating) Fixed Rate Conventional Mortgage Rates Fixed Rate Conventional Mortgage Rates 2 1 0 01-06 02-06 03-06 04-06 05-06 06-06 07-06 08-06 09-06 10-06 11-06 12-06 01-07 02-07 03-07 04-07 05-07 06-07 07-07 08-07 09-07 10-07 11-07 12-07 01-08 02-08 03-08 04-08 1 Source: FED 01-06 02-06 03-06 04-06 05-06 06-06 07-06 08-06 09-06 10-06 11-06 12-06 01-07 02-07 03-07 04-07 05-07 06-07 07-07 08-07 09-07 10-07 11-07 12-07 01-08 02-08 03-08 04-08 3 Yields on Corporate Bonds (AAA Rating) Yields on Corporate Bonds (BBB Rating) 3 4 Fed’s rate cut process Source: FED 88 Exchange Rate – Interest Rate Relationship Floating Exchange Rate Regime Real Borrowing Interest Rate (percent) and Real Exchange Rate (CPI-based, January 2003 – April 2008) 34 200 The exchange rates is determined under market conditions and reflects all economic and political policy CPI-based Real Exchange Rate (right scale) 29 implementations, macroeconomic variables, as well as expectations. The Central Bank does not follow a 180 24 160 19 140 14 120 policy of “high interest rate - low exchange Real Interest Rate (left scale) 9 interest rates and the value of the Turkish rate policy needed for low inflation”. * Based on the interest rates accepted in the Treasury’s domestic borrowing auctions and the 12-month inflation forecasts of the Expectations Survey. Source: CBT, Undersecretariat of Treasury. 01-08 07-07 01-07 07-06 01-06 07-05 80 01-05 The Central Bank’s follows “the interest 100 4 01-03 currency have moved in opposite direction. 07-04 The post-2001 period shows that real 01-04 not an objective, but a consequence. 07-03 rate”. The value of the Turkish currency is 89 Exchange Rate – Interest Rate Relationship The relationship between Central Bank policy rates and the exchange rates is complex and multidimensional. Policy rate cuts would set off two mechanisms that work in opposite directions: 1. Primary effect: The yield of the YTL-denominated assets would decline, demand for foreign exchange would increase, Turkish currency would come under pressure for depreciation. 2. Expectation Channel: A positive signal would be given about the economic outlook, confidence would increase, reverse currency substitution would strengthen, appreciation pressure would mount on Turkish currency. In addition, exchange rate may move independently from economic fundamentals and policy rates due to liquidity conditions, investor sentiment and changes in expectations. The immediate market conditions would determine which of these channels will prevail to what extent. 90 VIII. Economic Outlook 91 Economic Growth The contribution of domestic demand to economic growth increased in the second half of 2007 due to the pick-up in private consumption demand, while that of the net external demand stayed negative. Effects of the supply-side shock originating from the agricultural sector and the unfavourable developments in the global credit markets were the leading factors to decelerate economic growth in the second half of 2007. Growth Components Growth Components (2006 Q1 – 2007 Q4, year-on-year contribution, percent) 12 10 GDP 9.7 8 6 Final Domestic Consumption (2006 Q1 – 2007 Q4, year-on-year contribution, percent) 10 Construction 8 Services 7.6 6.3 5.9 Industry 6 5.7 4.0 4 3,4 3,4 2 4 2 0 Net Exports -2 0 Agriculture -4 06 Q1 06 Q2 06 Q3 Source: TURKSTAT 06 Q4 07 Q1 07 Q2 07 Q3 07 Q4 -2 06 Q1 06 Q2 06 Q3 Source: TURKSTAT 06 Q4 07 Q1 07 Q2 07 Q3 07 Q4 92 Production Data pertaining to the first months of 2008 indicate the moderate growth in economy continues, albeit with slight slowdown. Accumulation of problems in the international credit markets has increased the downside risks in economic activities in the upcoming period. 165 displayed a flat course in 160 the first quarter of 2008. 155 Capacity utilization rate 145 82 150 81 140 Industrial Production 135 despite recently decreasing 130 figures. 125 80 (3-month moving averages, left scale) 79 Industrial Production Index (Left scale) 120 * Seasonally adjusted Source: TURKSTAT,,CBT 04-08 01-08 10-07 07-07 04-07 01-07 10-06 07-06 04-06 01-06 10-05 07-05 78 04-05 115 01-05 maintains its high level Capacity Utlization Rate (3-month moving averages, right scale) 10-04 83 07-04 industrial production index 170 04-04 Seasonally adjusted 01-04 Industrial Production Index* and Capacity Utilization Rate* (January 2006 – April 2008, percent) 93 Investment Demand Indicators of investment demand, such as production and import of investment goods, sales of commercial vehicles do not point to an increase in investments in the first quarter of 2008. Investment Demand Indicators* (2006 Q1 – 2008 Q1 year-on-year change, percent) 15 10 5 0 -5 Production of Capital Goods** -10 Import of Capital Goods (real) -15 Domestic Sales of Commercial Vehicles -20 -25 2006 Q1 2006 Q2 2006 Q3 2006 Q4 2007 Q1 2007 Q2 2007 Q3 2007 Q4 2008 Q1 * Seasonally adjusted ** Average of the production indices of Machinery-Equipment and Electrical Machinery and Appliances Source: TURKSTAT, AMA, CBT 94 Commercial Activities Ratio of Bad Checks to the Total Amount of Checks Submitted to the Clearing House (2003-2008*, percent) Parallel to the economic activities that 7 6.8 gained pace between 2002 and 2007, the number of bad checks increased in line with 6.0 6 5.6 the number of bank checks used. The ratio of the amount of bad checks to 5.5 5.2 5.1 5 the total checks submitted to the clearing house, which was 6.8% in 2003, declined to 4 2003 5.5% in 2007. This ratio stood at 5.1% in 2004 2005 2006 2007 2008* * January-April average Source:CBT, ICHC the first 4 months of 2008. 12 Ratio of the amount of Protested Bills to (12month rolling, real), percent Total Commercial Loans (January 1999 – April 2008, real, percent) 10 Likewise, the ratio of protested bills to commercial loans (an indicator of commercial activities) declined to 3.3% in April 2008 after reaching 11% in 2002. 8 6 4 2 0 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 Source:CBT 95 Private Consumption There are signs of moderate recovery in consumption expenditures since the last quarter of 2006. The CBT Private Consumption Index points to a moderate pick-up in private final consumption expenditures in the first quarter of 2008. Private Consumption Index(2004 Q1 –2008 Q1) and Resident Household Consumption Expenditures (2004 Q1– 2007 Q4 constant prices, seasonally adjusted) 19000 101.4 Private Consumption Index (right scale) 18000 101.2 101.0 17000 100.8 100.6 16000 100.4 Resident Household Consumption Expenditures (left scale) 15000 100.2 2008 Q1 2007 Q4 2007 Q3 2007 Q2 2007 Q1 2006 Q4 2006 Q3 2006 Q2 2006 Q1 2005 Q4 2005 Q3 2005 Q2 2005 Q1 2004 Q4 2004 Q3 2004 Q2 100.0 2004 Q1 14000 Series making up Private Consumption Index: Seasonally adjusted imports of consumption goods, seasonally adjusted real domestic taxes on goods and services, seasonally adjusted total domestic sales of white goods, seasonally adjusted domestic sales of automobiles. Source: TURKSTAT, CBT 96 Bank Credits Although both commercial and consumer loans have continued to rise, a slowdown is expected in the lending tendeny of the banks in the upcoming period due to the deterioration in the international liquidity conditions and global risk appetite. Commercial Loans and Household Loans 90 (1 January 2006 – 9 May 2008, year-on-year change, percent) 80 Household Loans 70 60 50 40 Commercial Loans 30 20 10 Source: CBT 05-08 04-08 02-08 03-08 01-08 12-07 11-07 10-07 09-07 08-07 07-07 06-07 05-07 04-07 02-07 03-07 01-07 12-06 11-06 10-06 09-06 08-06 07-06 06-06 05-06 04-06 02-06 03-06 0 01-06 97 Domestic Demand Sales of white goods and automobiles, indicators of the economic activities in the domestic market, maintained their current levels. Domestic White Goods Sales Domestic Auto Sales (2005 Q1 – 2008 Q2*, seasonally adjusted, monthly averages, in thousands) (2005 Q1 – 2008 Q2*, seasonally adjusted, monthly averages, in thousands) 45 470 40 450 Trend 35 Trend 430 30 410 25 * April 2008 Source: AMA,CBT * April 2008 Source: AMA,CBT 08 Q2* 08 Q1 07 Q4 07 Q3 07 Q2 07 Q1 06 Q4 06 Q3 06 Q2 06 Q1 05 Q4 05 Q3 05 Q2 20 05 Q1 08 Q2* 08 Q1 07 Q4 07 Q3 07 Q2 07 Q1 06 Q4 06 Q3 06 Q2 06 Q1 05 Q4 05 Q3 05 Q2 05 Q1 390 98 Domestic Demand Sub-components of Imports The Rate of Increase in Imports (January 2005 – March 2008, 12-month rolling, year-onyear change, percent) 60 50 Squeeze in credits accompanied with recent developments in exchange rates increases the possibility of slowdown in imports. Imports of consumption goods has been following an upward trend since July 2007. 30 20 10 01-08 10-07 07-07 04-07 01-07 10-06 07-06 04-06 10-05 07-05 01-06 Capital Goods 0 04-05 Total growth of imports has outpaced that of the imports of capital goods since May 2006. 40 01-05 The pace of imports, which slowed down since mid-2006 due to the weakening domestic demand, has been rising since July 2007. Intermediate Goods Consumption goods Source: TURKSTAT Sub-components of Consumption Imports (January 2005 – March 2008, 12-month rolling, year-onyear change, percent) 100 80 Durable Goods 60 40 20 0 -20 Source: TURKSTAT 01-08 10-07 07-07 04-07 01-07 10-06 07-06 04-06 01-06 10-05 04-05 07-05 Passenger Car Imports -40 01-05 Year-on-year increases in imports of durable goods and passenger cars are particularly strong 99 Public Finance Central Government Primary Balance In the first quarter of 2008, budget realizations were more favourable compared to the previous year. (Program defined, quarterly total, 2006 Q1 - 2008 Q1, YTL billion) 16 2007 14 12 2008 2006 10 8 6 4 2 0 Q1 government budget accounts, primary surplus stood at YTL 8.3 billion in the first 30 Quarterly rate of increase in tax 25 revenues has outpaced that of the 15 Primary Expenditures Tax Revenues 20 10 5 Source: Ministry of Fİnance 04-2008 03-2008 02-2008 01-2008 12-2007 11-2007 10-2007 09-2007 08-2007 07-2007 06-2007 05-2007 0 04-2007 quarter of 2007. Q4 month moving average, percent) 40 35 primary expenditures since the last Q3 General Budget Primary Expenditures and Tax Revenues (March 2007 – April 2008, year-on-year change, -3- quarter of 2008, increasing by 34% compared to the same period of 2007. Q2 Source: Undersecreteriat of Treasury 03-2007 According to program-defined central 100 Productivity and Wages Productivity and Wages Productivity, Real Wages and Real Unit Wages Index in the Manufacturing Industry (1998 Q4 – 2007 Q4, per hour worked, 4-quarter moving average) In the manufacturing industry; 170 maintains its high level despite its deceleration in the second quarter of 2007. - Real wages have displayed a moderate increase since mid-2003 following the 150 130 - Due to the increase in productivity 110 100 wages index calculated by dividing real decreasing. 95 85 rapid decline in the post-2001 crisis era. wages by the productivity index keeps 105 140 120 above the rises in real wages, real unit Productivity Index (left scale) 160 Real Wages Index (right scale) 75 65 Real Unit Wages Index (right scale) 90 55 45 1998 Q4 1999 Q2 1999 Q4 2000 Q2 2000 Q4 2001 Q2 2001 Q4 2002 Q2 2002 Q4 2003 Q2 2003 Q4 2004 Q2 2004 Q4 2005 Q2 2005 Q4 2006 Q2 2006 Q4 2007 Q2 2007 Q4 - The rate of increase in productivity 115 Source: TURKSTAT, CBT 101 Employment Unemployment and Non-Agricultural Unemployment Rates Labor Market (2000 Q4 – 2008 Q1, 4-quarter moving average, percent) 15 14 Non-Agricultural Unemployment 13 12 Total Unemployment 11 of in February 2008, 2 points higher than compared to the same month of last year. Non-agricultural unemployment rate was unchanged at 14.2%. 10 9 8 7 6 2000 Ç4 2001 Ç1 2001 Ç2 2001 Ç3 2001 Ç4 2002 Ç1 2002 Ç2 2002 Ç3 2002 Ç4 2003 Ç1 2003 Ç2 2003 Ç3 2003 Ç4 2004 Ç1 2004 Ç2 2004 Ç3 2004 Ç4 2005 Ç1 2005 Ç2 2005 Ç3 2005 Ç4 2006 Ç1 2006 Ç2 2006 Ç3 2006 Ç4 2007 Ç1 2007 Ç2 2007 Ç3 2007 Ç4 2008 Ç1 Unemployment rate stood at 11.6% as Ratio of the Non-Agricultural Employment to the Population Aged 15 and Above The employment in non-agricultural economic activities comprising industrial, construction and services decelerated in the second half of 2007. 32.0 (2000 Q4 – 2008 Q1, 4-quarter moving average, percent) 31.5 31.0 30.5 30.0 29.5 in the non-agricultural sectors in the last 12 months as of February 2008. 29.0 28.5 28.0 2000 Ç4 2001 Ç1 2001 Ç2 2001 Ç3 2001 Ç4 2002 Ç1 2002 Ç2 2002 Ç3 2002 Ç4 2003 Ç1 2003 Ç2 2003 Ç3 2003 Ç4 2004 Ç1 2004 Ç2 2004 Ç3 2004 Ç4 2005 Ç1 2005 Ç2 2005 Ç3 2005 Ç4 2006 Ç1 2006 Ç2 2006 Ç3 2006 Ç4 2007 Ç1 2007 Ç2 2007 Ç3 2007 Ç4 2008 Ç1 355 thousand new jobs were created Source: TURKSTAT, CBT 102 Foreign Trade Developments The openness of the Turkish economy has increased since 2001 and foreign trade has posted high growth rates. 180 Real Imports and Real Exports (1982 – 2007, 2003 = 100) 160 140 120 100 Imports 80 60 exports and real imports have grown Exports 20 0 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 Contrary to the 1995-2000 period, real 40 parallel to one another. Imports and Exports (January 2006 – March 2008, 12-month rolling, percentage change) 30 30.0% increase over the last 12 months, 26 while that of imports stood at 26.6%. 22 The expected slowdown in developed 18 economies poses a downside risk in 14 export performance in the upcoming 10 period. Exports Imports 01-06 02-06 03-06 04-06 05-06 06-06 07-06 08-06 09-06 10-06 11-06 12-06 01-07 02-07 03-07 04-07 05-07 06-07 07-07 08-07 09-07 10-07 11-07 12-07 01-08 02-08 03-08 As of March 2008 exports posted a Source:TURKSTAT 103 Balance of Payments – Current Account Current account deficit in 2007 rose by Current Account Balance and The Effect of Energy Prices on the Current Account Deficit* (2002 – 2007, ratio to GDP, percent) 18.0% compared to 2006 and reached USD 38 billion. 2002 2003 In 2007, the ratio of current account deficit to GDP declined by 0.4 points -2 compared to 2006 and stood at 5.7%. -3 -0.7 -2.5 -2.4 -2.9 2007 -3.7 -5 continues. -6 High energy prices contributed around -7 -2.7 -2.5 The adverse effect of high energy current account deficit to GDP in 2007. 2006 Current Account Deficit Excluding the Effect of Energy Prices/ GDP -1.8 -4 3 percentage points to the of ratio 2005 0 -1 prices on current account deficit 2004 -4.6 Current Account Deficit / GDP -5.7 -6.1 •The effect of energy price increases on the current account in the 2003-2007 period was calculated by keeping the prices of 2002 contant. 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. Source: TURKSTAT, CBT 104 Balance of Payments – Current Account There is a direct and strong relationship between current account deficit and economic growth rates. Domestic Savings and Investments (2001-2007, ratio to GNP, percent) 30 Investments The high increase in investments is the primary reason of the current account deficit . 23.8 20.0 20 19.2 investment demand. The structural characteristics intermediate goods in order to meet the increase supply and demand-side macro and micro policies with a medium and long-term perspective. 19.3 20.2 18.2 17.5 15 17.3 16.0 15.1 Savings in production. Current account deficit should be controlled via 24.4 22.6 lead to an increase in consumption and of the economy necessitate the imports of 24.9 25 Current account deficit is a structural problem. Macroeconomic stability and falling interest rates 25.4 10 2001 2002 2003 2004 2005 2006 2007 *1987 based series Source: : SPO Program for 2008, CBT 105 Capital Flows Capital Flows Ratio of the Financing Items of the Current Account Deficit to Current Account Deficit (2000 – 2007, percent) 100 Long-term credits, along with foreign 80 Short Term Capital 1 direct investments, are crucial for the financing quality of current account Long Term Capital 2 Direct Investment 3 60 deficit as well as for reducing fragility of the economy to external shocks. Short-term capital and portfolio 40 Portfolio Investments 4 20 inflows have substantially declined in 2007. In this period, current account deficit has been financed via long-term credits and foreign direct investments. 0 2000 2003 2004 2005 2006 2007 -20 1 Short Term Capital: Net short term loans borrowed by overseas banks, the real sector and the public sector besides the deposits possessed by the residents abroad in the banks 2 Long Term Capital : Net long term loans borrowed by overseas banks, the real sector and the public sector besides the deposits possessed by the residents abroad in the banks 3 Direct Investment: Direct Domestic Investment Inflow 4 Portfolio Investment: Equities and Securities purchases of residents abroad Source: CBT 106 Capital Flows Capital Flows Ratio of the Financing Items of the Current Account Deficit to Current Account Deficit (2000 –2007, percent) 80 The ratio of foreign direct Non-Banking Sector Credits 2 60 Direct Investment 3 investment and long-term capital to GDP, which was 7.5% in 2006, fell to Portfolio Investments 4 40 3.4% in 2007. The ratio of portfolio investments 20 and short-term capital to GDP Bank Credits 1 declined from 3.3% to 1.3%. 0 2000 2003 2004 2005 2006 2007 1 Bank Credits: Short and Long Term Credit Utilization of the Banking Sector abroad Non-Banking Sector Credits : Short and Long Term Credit Utilization of the NonBanking Sector abroad 3 Direct Investment: Direct Domestic Investment Inflow 4 Portfolio Investment: Equities and Securities purchases of residents abroad 2 Source: CBT 107 CENTRAL BANK OF THE REPUBLIC OF TURKEY PRESENTATION BEFORE THE COUNCIL OF MINISTERS, AND THE PLANNING AND BUDGET COMMISSION OF THE GREAT NATIONAL ASSEMBLY OF TURKEY Durmuş YILMAZ Governor May 2008 108