As Manchester United’s Cristiano Ronaldo discovered in Moscow in May the twisting path from being a hero to potential super villain and back to hero can be very short. The man who is arguably the world’s best footballer scored a goal, missed a penalty but ended on the winning side at the Champions League final against Chelsea. Durmufl Yilmaz, governor of the Turkish Central Bank (TCMB) and arguably the best macro-manager of the economy the country has, might care to take lessons on how to achieve the same rapid transformation.
The bank and its boss have gained many plaudits for shepherding the monetary measures that slashed inflation rates of three figures to single digit levels. The TCMB at one time even forecast the level would fall to 4% this year, an event as likely as sacked Chelsea manager Avram Grant getting his job back.
Measured by the consumer price index (CPI), inflation hit 9.66% year-on-year in April, in which monthly inflation was 1.68%, according to the Turkish Board of Statistics (TUIK). Electricity price increases in June will not help. Domestic usage is to go up by 14% while the rise for industry is even higher, at 19%.
Inflation, long Turkey’s largest macroeconomic bugbear, has been on the rise again after a significant drop from the 1990s, when it regularly registered 100% or more. In 2005, the rate was brought down to 8.2%, from around 25% the year before, before climbing again to 9.5% in 2006 and 9.8% in 2007.
Inflation was so rampant that the Turkish lira was at times the least valuable currency in the world until six zeros were lopped off the currency in 2005. In 2004, $1 was equal to 1.35 Million lira. Thus controlling inflation has been seen as one of the greatest successes of Turkish macroeconomic policy in recent years, earning praise not only for the central bank but also for the Justice and Development Party (AKP) government.
Whose trophy?
Skeptics of the latter’s rule attribute more credit to the former, as well as to previous governments and the International Monetary Fund (IMF), which imposed a fiscal straightjacket on Ankara in exchange for more than $45 billion of funding since Turkey’s 2001 financial crisis.
Arguably, the AKP has risen conveniently on the world boom in emerging markets, facilitated by policies actually implemented by its predecessors. Nonetheless, given its parliamentary majority — a rare occurrence in Turkey’s notoriously unstable political history — the stability afforded by the AKP’s rule has helped secure investors’ confidence.
Economy Minister Mehmet Simsek has argued that the spike in inflation has largely been caused by external factors on the supply side, particularly rising global food and fuel prices. He asserts that the long-term trend is unequivocally toward deflation. “The risk of a persisting inflation shock in Turkey is very low. Currently, we are faced with the pressure of supply side and cost-based inflation,” he has told the press.
“What we have in Turkey is relative success. If you compare our inflation increase with that of other countries which are targeting lower rates of inflation like us, the difference has become smaller. Inflation in Turkey has gone up relatively less.”
The numbers game can, however, be a little deceptive. Turkey’s inflation rate has been on a gentle upward path even since the first year it came down to single digit level. Even so, fiimflek has a point — the ailing economies of the United States and Western Europe are experiencing a jump in inflation due to the rising cost of oil, food and commodities.
Oil prices recently hit $130 a barrel and counting. The effects of geopolitical instability — near-civil war in Iraq, Iran’s increasing belligerence towards the West, tension over the Palestine issue, unpredictability in Nigeria, declining confidence in the intentions of the CIS and Venezuela’s brand of eccentricity — have contrived with increasing demand-pull from burgeoning economies such as China and India to drive up the price of crude.
Food prices have been driven up by a number of factors. Many emerging markets experienced bad harvests last year. Turkey itself suffered drought, as did Morocco and Syria, among others, while floods slashed Bulgaria’s agricultural output.
More importantly as a long-term trend, increasing consumption of meat in emerging markets has put upward pressure on prices. Land that previously supplied cereal crops has been turned over to livestock, which is a less efficient and more expensive way of generating calories for consumption. Furthermore, the enthusiasm that North America, Europe and parts of Southeast Asia have found for biofuels has led to a shift away from food crops. Few countries have been immune from rising food costs, which have contributed to escalating wage demands and therefore fed through to the wider economy.
Building boom inflation
A third factor is the rising cost of other commodities, particularly building materials. Due partly to a worldwide construction boom, particularly in China, prices of steel and cement have been rising at double-digit annual rates. New buildings to satisfy increased demand for higher-grade property (of all types) are getting more expensive to construct. The commensurate rise in property prices and rents has fed through to increased consumer prices and, again, rising wage demands. So if fiimflek is saying in a long-winded way that it could have been worse, he is right.
One of the three domestic factors helping to push up prices in Turkey is the influx of capital. After a sluggish performance in the 1980s and 1990s, Turkey has of late experienced a flood of foreign direct investment (FDI): $19 billion in 2007, up from $17.6 billion in 2006 and $622 million in 2002, according to the central bank. The rise in oil prices has not only had a demand pull but also a supply shock effect as Gulf investors have pumped their petrodollars into the Turkish economy, particularly in the banking and real estate sectors.
Secondly, the AKP has been accused of upping public spending too much, further fuelling inflation. The government has a mandate to reduce poverty and has a large following among the less well-off, encouraging it to increase wages and public spending. Facing rising resistance from the secular and largely middle-class opposition, the AKP is loosening the purse strings to secure its support with the bulk of the population.
On May 15, in what some have seen as a symptom of increasing fiscal laxity, parliament voted to forego most of the interest payments due on $18.8 billion of late social security payments. The government also cut its primary public sector surplus target from 4.2% of GDP to 3.5%, compared to the 6.5% goal imposed under the tutelage of the IMF, whose mandate to recommend policy in Turkey (the condition of a $10 billion loan) expired May 10.
Finally, the weakening of the lira this year (by around 10%) has added to import costs, although it should be noted that inflation was climbing before the currency took a hit, and some consider it still overvalued.
The central bank appears more concerned with inflation than the government. On that busy May 15, the TCMB increased its overnight borrowing rate 50 basis points to 15.75%, indicating it saw inflation as a greater immediate risk than slowing the economy. The lending rate increased from 19.25% to 19.75%.
Yilmaz expects inflation to remain high the next few months and further increases may be required.
But the rate rise has drawn the ire of some business leaders, who argue that promoting growth should be the bank’s priority. GDP growth dropped to around 4.5% last year after topping 6% in 2006, and the IMF foresees a figure of less than 4% this year.
Ömer Cihad Vardan, Independent Industrialists and Businessmen’s Association (MÜSAD) President and Ankara Chamber of Commerce (ATO) head Sinan Aygün said the rate hike would impair business expansion and employment, while benefiting only currency speculators.
Rumor has it government has been leaning on the TCMB to freeze rates — claims strenuously denied by the AKP. But certainly the relationship appears anything but cordial. Zaman Today Columnist Asim Erdilek said the bank would “probably have to increase its benchmark policy rates by another 100 basis points by the end of the year.” He also recounted the tale of Yilmaz and his senior aides being left to “cool their heels for five hours in the Prime Ministry, in a room without cell phone reception, prior to Yilmaz’ more than hour-long, 107-slide PowerPoint presentation” justifying the rate rise. Some ministers are said to have criticized what they saw as an attempt to blind them with science in a talk that was highly technical. Yilmaz retorted that bankers have their own language. As Erdilek explained, “Perhaps what bothered some of the ministers was Yilmaz telling them the government had to practice fiscal discipline and move forward with structural reforms.”
Clearly there is some disagreement within Turkey about whether slower growth is a price worth paying for keeping the old inflationary beast caged. Given the tense political situation as well, the argument seems unlikely to be settled conclusively at the moment and the government has enough problems without facing a penalty shootout against a supposedly independent central bank.
