In the five years since taking up office, Sureyya Serdengecti, governor of the central bank of Turkey, has overseen the most important development in the country's economic recovery: the move from hyperinflation to single-digit inflation.
"This has been the single most significant achievement while I have been at the central bank," says Serdengecti in an interview with Emerging Markets. "We have overcome more than three decades of hyperinflation, and the impact of this on Turkey's economy as a whole should not be underestimated." Inflation has fallen from a staggering level of 125.5% in 1994 to 9.35% in December last year. Serdengecti says the central bank is forecasting 8% inflation for 2005 and 5% for 2006.
"We are confident of hitting 2005's target, and we are working hard to achieve our goal for 2006," he says. He adds that, although it is too early to issue a firm deadline, he expects this figure to fall further, to between 2% and 4%, over the next few years.
"The ultimate goal for this country is to fulfil the Maastricht criteria as we aim to join the European Union and then European Monetary Union," says Serdengecti.
The independence of the central bank, granted in 2001, and the end of lending to public-sector entities has been vital to curbing inflation.
By communicating policy in a transparent and accountable way, Serdengecti has both stabilized policy and bolstered public confidence in monetary and exchange rate policy. This has had a positive knock-on effect on many different areas of the country's economy, including boosting growth and cutting unemployment. "Disinflation has contributed to economic growth beyond anyone's expectations. Since the end of 2001 we have seen 25% growth in the Turkish economy," says Serdengecti.
Inflation targeting
Inflation has long been the bogeyman of Turkey, and despite this stunning progress Serdengecti is far from resting on his laurels. "We will continue to work towards price stability and maintaining single-digit inflation. Key to this is the implementation of a formal inflation targeting framework in January next year. In the chronic inflationary environment of the past we knew that monetary targeting would not work and exchange rate targeting had failed, for reasons totally outside the exchange rate system. The only option left to us was inflation targeting."
Ahead of this, Serdengecti says that the central bank has worked hard to enhance its communication strategy. As part of this, the bank introduced regular monetary policy board meetings in 2005 aimed at bolstering public confidence in monetary and exchange rate policy. Furthering accountability, Serdengecti says that next year a voting policy will be introduced into the monetary council over interest rate decisions. "We will continue to work on our communication policy and on enlarging our information base," he says.
Currency reform
Cementing this success in controlling inflation is currency reform. The redenomination of the Turkish lira initiated in January led to no less than six zeros being lopped off the currency. "This has had a very important psychological effect," says Serdengecti. "It has been extremely difficult for our people to live with a currency with so many zeros and it acted as a reminder of the years of high inflation. People have been hesitant to believe in the progress we have made over the past five years, given the country's bad track record. What I think the currency reform shows in their minds is that there is no going back."
Serdengecti says that the decision to reform the currency was taken back in the summer of 2003. It was then a question of waiting for the right moment to press ahead with the process. To this end, Serdengecti says that over the past 10 years the central bank has exhaustively researched the examples of 49 other countries that have gone through a similar process. "We were confident that we would be able to hit our inflation targets last year so we went ahead with the currency redenomination. It has been a relatively straightforward process," he says.
The redenomination of the currency also led to growth in the Turkish lira bond market, although there have been concerns that initial investor enthusiasm has died down. Serdengecti is unfazed by such fears. "We saw many potential investors in the Turkish lira market waiting for currency reform to take place before investing their money. As a result there was pent-up demand in the market. This has not gone away. As we make further progress in our stabilization programme we will see more and more issuance of lira bonds."
Market interventions
Price stability remains a key issue. In what signals a more aggressive approach in managing the exchange rate, the central bank has staged four interventions so far this year in the money markets. This includes a massive intervention in March that saw the central bank purchasing $2.5 billion to ensure the stability of the new Turkish lira ahead of a rate move by the US Federal Reserve. "We assessed the situation and anticipated some volatility and took steps to avert this," says Serdengecti.
It requires a subtle touch. While a strong lira has helped the country to obtain longer-term loans at lower interest rates than in the past and helped in rolling over some of the country's huge domestic and foreign debts, it has also impinged on Turkish exports and led to a widening in the current account deficit.
In 2004, Turkey had a balance-of-payments deficit of $15.6 billion, or 5.2% of GNP. The debt burden is also significant. At the end of February, Turkey's foreign debt stood at $154 billion, of which $89.1 billion was government debt. Its domestic debt stood at TL231,300,000 billion ($179.5 billion).
"This concerns the whole balance of payments, both the current account and the capital account," says Serdengecti. "I believe the level of the exchange rate is now determined by economic fundamentals and expectations, especially of the balance of payments, and the progress of the stabilization programme. The lira operates under a floating exchange rate regime and so reacts to these factors."
Inflation control and fiscal stability were seen as vital to May's successful conclusion of a draft agreement with the IMF to provide a new three-year $10 billion loan. Indeed, the Fund described the controlling of inflation as one of Turkey's big policy successes of the past three years, paying tribute to the independence and effectiveness of the central bank.
The passing of the banking law through parliament is also regarded by the IMF, and others, as a significant step forward in the reform process. "Structural reforms are always painful to accomplish, and this was the case in the passing of the banking law," says Serdengecti. "It does represent a breakthrough in the banking reform process. We will see the role of banking supervisors better defined and strengthened. It also paves the way for the eventual privatization of public-sector banks. The adoption of Basel II within the Turkish banking sector is also high on the agenda."
As reform gathers pace, there is no shortage of foreign interest in the Turkish market. One illustration of this is the sale in May of Yapi ve Kredi Bankasi to Koc Financial Services, a 50-50 joint venture between Koc Holding of Turkey and UniCredito of Italy. The deal for a 57.4% stake in Turkey's fifth largest bank was worth €1.160 billion.