Turkey’s central bank chief remains confident that inflation will fall from the second half of 2007, amid growing political turmoil in the run-up to both parliamentary and presidential elections this year.
In an interview with Emerging Markets Durmus Yilmaz, governor of the Central Bank of the Republic of Turkey (CBRT), said that despite a sharp rise in inflation expectations, both “inflation and expectations will slow from the second quarter.” April’s year-on-year inflation figure of 10.7% (down only 0.1% on March) had led to unease in local markets.
In particular, Yilmaz anticipates accelerated disinflation once the impact of the lira’s sharp depreciation that began in May 2006 drops out of the index. Central bank optimism during an uptick in inflation in early 2006 proved unfounded, with the result that Turkey suffered more heavily than most other emerging markets during the bout of volatility in the second quarter.
This time around, analysts have sided with CBRT’s view. Nehad Chowdhury, emerging markets economist and strategist for BlueBay Asset Management in London told Emerging Markets: “We are in a new paradigm of much lower and sustainable inflation.”
Although the 6% inflation target for 2007 looks unattainable, Chowdhury said that the rate will descend toward 8% from mid-year, assuming there are no external shocks. “This is respectable enough as long as we have not got too much volatility around that number. The expectations the markets had of Turkey were a little unrealistic because, given the structure of the country’s economy and the nature of its institutions, it was unlikely that the CBRT could have established a permanent anchor for inflation so quickly and at such low levels.”
Still, given that the central bank needs to continue this task of entrenching its inflation-targeting credentials, Chowdhury is not anticipating room for interest rate cuts until the final quarter of 2007 at the earliest, even if the outcome of the July 2007 parliamentary election is reassuring for the markets.
In the meantime, BlueBay, which has seen its EM long-only local currency assets surge from seed capital of $20 million in December 2005 to over $1 billion at present, views pre-election volatility as a potential buying opportunity, given their constructive view on Turkey’s medium-term inflation prospects.
However, at financial consultancy Ercel Global Advisory in Istanbul, founder Gazi Ercel, himself a former governor of the CBRT, focuses on the central bank’s limited scope for combating inflation through interest rates.
“It is hard to curb credit growth and domestic demand in an economy where dollarization is about 40%-50%. Risk-takers are assuming that high real interest rates will keep the lira strong, so they are ready to take out foreign currency loans that are much cheaper than those in lira,” Ercel tells Emerging Markets.
This magnifies the importance of fiscal policy sharing the burden for controlling inflation, but Ercel is concerned that not enough is being done on that front.
“Although the overall budget targets are tight, some public sector wages have risen around 10% at the most recent round, and the government responded to the drought conditions in northern Turkey by raising administered agricultural prices up to 12%. This sends the wrong signal to the private sector for setting wages and prices.”
As Chowdhury points out, a looser budget in an election year should not come as any surprise, but it underlines the need for the next government to prioritize playing its role in strengthening Turkey’s inflation-targeting system.