Turkey’s Central Bank has pledged to maintain tight monetary policy to meet inflation targets, warning that, despite predicted continuation of recent disinflation, the risk of inflation is far more serious. Despite monetary control, the banking sector remains dynamic. External demand and the growth of housing and consumer spending loans have partly offset a cooling of domestic demand, and several banks have recently cut rates, giving incentive to borrow further. The implementation of a new mortgage law is expected further to boost demand for credit, albeit in the medium- to long-term.
At the end of May, the monetary policy committee of Turkey’s Central Bank announced that short-term interest rates would not be cut, despite the trend of disinflation. The committee said that high levels of consumer spending and investment, high oil prices, an uncertain political environment and service price inflation all combined to make a cut in rates unwise. The bank operates on a policy of inflation-targeting.
“The committee assessed that meeting the medium-term inflation targets requires the maintenance of the tight policy stance,” the committee reported. The report, issued on May 14, noted that sound fiscal policies and structural reform were important tools for restraining inflation, and that monetary policy alone was not enough to rein in prices.
“The recently elevated prices of crude oil and commodities add to the inflationary pressures via imported input costs and thus curb the disinflation process,” the report added.
Managing inflation
Consumer price inflation of 1.21% in April brought annual inflation down to 10.72%, within the annual uncertainty band set by TCMB. A rise in clothing prices offset some of the decrease in consumer durable and service inflation, local press reported. The first-quarter year-on-year inflation rate was 10.86%, partly attributable to an increase in food and tobacco prices.
The central bank stated that disinflation would be a continuing trend, but counselled caution, due to the existence of inflationary risk. “Against this background, disinflation is expected to become more significant in the upcoming period. However, there are some remaining risks to the inflation outlook,” the report said, announcing that the central bank was prepared to act swiftly should economic shocks change the economic outlook.
Despite inflationary pressures, both current and potential, year-end inflation will be likely to fall between 4.5 and 7.1%, with a midpoint of 5.8%, according to the central bank’s second 2007 inflation report. The outlook was for inflation to continue to fall to 1.3% to 5.0% in 2008, with a midpoint of 3.2%. Bank Governor Durmufl Yilmaz said that this was due to bank policy since June last year, following the market correction in May. Yilmaz announced that “the tight stance for monetary policy and the ongoing perceptions of uncertainty continue to restrain the demand for credit.” He noted that demand for durable goods and machinery had weakened. Yilmaz said that there would be little scope for monetary relaxation if the medium-term goal of 4% was to be met.
However, the impact of tight monetary policy on inflation has been smaller than predicted. While there has been a cooling in domestic demand recently, exports have flourished, boosting industrial production and offsetting the internal slowdown to an extent. Recent increases in public spending also look set to lessen the effectiveness of the interest rate freeze, hence perhaps the Central Bank’s warning that fiscal caution and economic reform were also needed to bring inflation down to target levels. However, in the midst of a tough election campaign, it is unlikely that the government will back off from spending until the third quarter.
Another issue has been inflation expectations, which have stalled over the past three months after dropping for some time, affecting price and wage setting behavior. Yilmaz said that he expected inflation expectations to start dropping again as headline inflation falls.
The central bank noted that the trend of late has been for banks to ease interest rates due to an increase in lira bond issues and the proceeds of privatization. In May, HSBC dropped its monthly TRY consumer loan and TRY consumer loan at interest. Home financing interest rates have gradually been fallen to 1.49% per month. Vehicle loans have backed down at 12 month terms to 1.67%, at 36 month terms from 1.69% to 1.65% and at 48 to 60 month terms from 1.69% to 1.59. Even though home financing loan has been set on interest rate of 1.67%, the rate has backed down by 0.89%.
Garanti Bank also moved to decrease its lending rates. The monthly mortgage rate which, was initially set up at 1.53% has now been cut to 1.44%. According to Garanti Bank General Manager, Ali Fuat Erbil, the bank is not expecting further decrease in interest rates, stating that any forecasts should be put aside until the end of the general elections.
While automobile loan growth has slowed, housing and consumer spending loan growth continues.
New mortgage law
One factor set to increase the rate of housing loans is the new mortgage law, which was implemented in February. For several decades, due to inflation, high interest rates, poor securitization and cultural traditions, Turkey has had a relatively small mortgage market. This was already beginning to change due to interest falling below the psychologically important benchmark of 20% in 2005. By mid-2006, interest on housing loans accounted for 10.7% of banking assets, up from 1.3%.
The new provisions create a secondary market in securitized mortgages, which should increase the number of mortgages with maturities of 10 years or more. It reinstates a 2% early payback or break charge and gives the green light to floating-rate mortgages, as well as cutting lender liability to one year for defaults and giving lenders more powers to repossess property, for example in the case of three consecutive non-payments.
The law also makes possible the formation of non-bank financing organizations working with floating mortgage-backed securities and, at implementation, converted all housing loans into mortgages unless specific requests are made by the debtor.
Deeper problems
However, despite widespread praise for the reforms, it may take some time for the new law to boost mortgage take-up significantly. One issue is that many banks do not have the administrative infrastructure for large-scale mortgage transactions. They will need property assessment divisions that can evaluate mortgage applications. Insurance companies will also have to be equipped to investigate the properties and provide guarantees for the lenders.
Perhaps a bigger problem is the fact that, at conservative estimate, half the housing in Turkey is illegal and therefore not eligible for mortgages. Earthquake standards will also eliminate many of the legal buildings.
While it will doubtless take time for the new systems to be fully operational, the emergence of the legal provision for a proper mortgage market is a positive step.
Overall, careful monetary policy seems set to support confidence in a maturing banking sector and the economy as a whole in a time of underlying inflation risk. It does not seem to have deterred banks from cutting lending rates further, and the reforms of the mortgage sector not offer a real prospect for loan growth in a relatively under-banked market. However, with the election coming up in July, the policy of the Central Bank may come under review depending on the victor.
