Tag: Inflation

How Banks Benefited From Easy Money Policy

One immutable rule in developing nations is the existence of politicians who palpably need fast economic activity to keep its voter base strong. In Turkey, this is absolutely proven to be right by the President Erdogan whose repeated pro-growth economic views are well known ─which include very dissenting opinions to generally accepted theories such as high interest rates cause high inflation. It is also not a secret that Turkish President has been piling pressure on the central bank and other financial institutions and pushing for lower interest rates.

Well, the chart above tells us an interesting story (might be even more interesting for the Presidential economy team). The colorful lines show the evolution of commercial lending and deposit rates implied by Turkish banks, and lines in grey show the policy rates (or average cost of funding) of Turkish central bank and the inflation rate where the lighter one shows the ‘real cost’ of money and the dark one is the inflation. Important point to gleam from the chart is that Turkish central bank had clearly maintained tight monetary policy as it has turned more and more accommodative following the global financial crisis.

Now here is thing: As Turkish central bank loosens its monetary policy, banks become more dependent on collecting deposits and deposit rates fall to extremely lows that they even provide negative returns in real terms as they remain below inflation rate. On the other hand, commercial lending rates, that could be considered as a critical source for the economy, do not track other the so-called policy rate as much as deposits do, and create a huge spread (between lending-borrowing) for banks to benefit (also need to note the QE impact here). Eventually, ‘interest rate lobby’ seems to have enjoyed the low rate environment much more than some think it would have.

Turkey Inflation: A Year with A Bad Ending

‘Hate to Say I Told You So’ was one of the most iconic songs in early 2000s, performed by the band called The Hives. Now the phrase also reflects my views on the evolution of Turkey’s price stability indicators this year. In line with my (ahead of the curve) expectations, which I shared in a blog post in May (Why Inflation May Not Fell to Single-Digit Figures This Year), the year finished with a double-digit inflation figure in Turkey as the new year also brought no good news.

The prospect of market consensus is now for an inflation rate remaining above 10% until the last quarter as Turkey will hopefully reach a single-digit inflation rate as of Q4 2018. In our view, in case Turkish lira does not face a severe depreciation against major currencies, the improvement in inflation should be faster than market expected, though we remain pessimistic on the outlook of price stability in Turkey mostly due to the central bank’s reluctance of (needed) monetary tightening. From a statistical point of view, all price indicators currently stand at unprecedently high levels based on their historical averages, which should be supportive for an optimistic case. On the other hand, Turkish lira’s long-standing vulnerability to external shocks prevents us from attaching credence to this scenario amid the fears around a pick-up in global inflation.

On a separate note, our long-term caution for rising inflationary pressure in Turkey stems from the relevant dollarization process in the economy as evidenced by individuals’ strengthening demand for deposit account in foreign exchange.  The chart above shows the relationship of the dollarization, which we try to quantify as individuals’ FX deposits as percentage point of M2 monetary base, and the core inflation, which just posted an all-time high in December (for the current series). Note that our VAR analysis suggests dollarization is the leading variable here.

One other thing that should be highlighted would be the deposit rates offered by the banks have been on rising trend recently touching post-financial-crisis era highs as of the year end. This demonstrates the declining level in the efficiency of the monetary policy as the gap between market rates and the average cost of funding rate widens. This somehow could limit the dollarization to some extent, but Turkish central bank will eventually to need to keep real rates high to stabilize the local currency as well as the prices, and to regain its credibility. Sadly, this primarily requires to be given the green light by some authorities other than the policymakers at the central bank.

Why Inflation May Not Fell to Single-Digit Figures This Year

The following is an update about April inflation print in Turkey (source: Hurriyet Daily News):

Turkey’s annual inflation rate increased in April, reaching its highest level in around nine years, as a result of a weak Turkish Lira in several sectors, according to official data released on May 3.

Consumer prices in Turkey rose 11.87 percent year-on-year in April from 11.29 percent in March, data from the Turkish Statistics Institute (TÜİK) showed. Annual consumer price inflation was also at the highest level since October 2008.

The volatility in food prices again had its impact on the headline inflation registering an April reading of 16.09% y/y while the 12-month moving average stood at 7.2%. As being one of the biggest importers of Turkish agriculture products, Russia’s ban/unban policy has had influenced the pricing behaviors in the local unprocessed food markets. That being said, Turkey has not managed to reduce the dependence on intermediaries in logistics operations that has enabled oil prices and some other factors to heavily impact the food prices in Turkey. We believe that negative low-base effect will be here to stay until early 2018 that would potential lead Turkey’s annual inflation figures to stay higher than targeted range for longer than expected.

Turkey’s producer prices also hit a nine-year high in April at 16.37% on the back of the depreciating lira. This, not surprisingly, is being and will be reflected at price tags for the products, which builds a supportive case a double-digit inflation figure for the rest of the year. We also see the strong short-term momentum as we newly started to detect signals of the beginning of a malign cycle in PPI, as evidenced by the chart below.

Finally, Turkey’s inflation history also tells us a lot about the possible trajectory of the macroeconomic indicator. For this, we calculate median and adjusted average (average when maximum and minimum values excluded) of the monthly changes in monthly CPI growth over the past twelve years, and imply it to the figures reported as of April 2017. Admittedly, it is hard to forecast inflation via some simulation process, but we aim to make a modest contribution.

Our analysis shows that inflation may peak on November this year and finish the year at double-digit figures. We also see core indicators being close to the threshold of 10% this year. With pointing that this research is solely based on the historical pricing behaviors of economic agents, we fear that Turkey may perform even worse this time given the imminent further deterioration in expectations with inflation becoming hardened at the current levels.

A close look at the other factors affecting CPI such as negative low-base effect, the strong increase in lending growth, also suggests that April reading is a cause for alarm and may whip up a tsunami of opinion that an abnormal cycle is about to emerge.