Inflation and Growth Rates in Turkey

Bloomberg has an article about recent developments in Turkey and the direction of the country. It is mostly accurate but a tad pessimistic about the effects of inflation on the growth rate. Namely it says "Higher inflation will likely lead to the shuttering of more businesses such as those along Hosdere Street, dragging the economy down even further. "

They talked about a bakery on Hosdere Street in Ankara and its problems. That bakery's problem is the high food prices which was partly the result of enourmous increases in oil prices. I don't think the inflation rate will stay above 10% level for too long in Turkey. I predict that oil prices will decline below $100 next year and this will bring down global inflation.

They are claiming that high inflation rates in Turkey will drag the economy down. Not true. What is important is not high inflation but high interest rates. Normally high inflation entails high interest rates and slower growth. However interest rates in Turkey is currently below 19% compared to 18% last year this time. This means that people are also expecting interest rates to go down to about 8% next year. So, current inflation is not a problem.

Considering that government will increase spending significantly for the rest of the year, this will also translate into better growth rates than pessimistic forecasts of the Bloomberg writers.

On the other hand they were quite accurate when they talk about the Central Bank:

"Yilmaz, the 61-year-old central bank governor, has stumbled in trying to check inflation. The bank won its independence from government control in 2001 as a prelude to the IMF accord. Yilmaz, a City University, London- trained economist, worked at the bank for 26 years before he was promoted to the top spot in April 2006.

He wasn't the government's first choice: one AKP candidate, who was rejected by then President Ahmet Necdet Sezer, was the head of an Islamic bank that follows instructions from the Koran to avoid interest payments.

Within a month of becoming governor, Yilmaz reversed three years of steady cuts that had taken the benchmark overnight borrowing rate to a low of 13.25 percent from 80 percent in 2001. The governor, in moving to boost the slumping lira, added 4.25 percentage points to the rate in the space of two months. The currency rebounded 6 percent in July 2006 after the rate hike to 17.5 percent.

Yilmaz Under Pressure

The following year, government ministers and industrialists, concerned about an economic slowdown, began publicly attacking the higher rates. Although Yilmaz ratcheted down the rate to 16.75 percent in August, arguing that inflation was slowing toward his 4 percent target for 2008, that wasn't low enough for exporters and labor unions, which placed full-page ads in national newspapers.

``Don't let employment and production die,'' the Turkish Exporters Assembly and the country's largest unions said in their Oct. 16 ads. ``Don't just act like you're cutting interest rates, really cut them.''

Yilmaz's series of four more cuts to 15.25 percent by February 2008 prompted economists and investors to question the bank's independence from political pressure. ``The central bank is still maturing into its autonomy,'' Isbank's Ozince says. ``Even central banks can make mistakes, but it's hard to steer the right path, because unknown factors can dominate, especially in shallow waters like Turkey's.''

Missing Targets

Only three months later, in May, as it became clear that the governor would miss his inflation target for the third straight year, Yilmaz began hiking rates again, to 16.75 percent. He also set a higher inflation target of 7.5 percent for 2009.

``They've been missing inflation targets for too long,'' says Jean-Dominique Butikofer, who helps manage about $725 million as head of emerging-market debt at Union Bancaire Privee in Zurich.

``They should have reacted much earlier on rates. The jury is still out to decide if inflation is being tackled or not.'' "

I have one thing to say about Central Bank. Some of the blame rests on the shoulders of the government, because they have been forcing and intimidating the CB for too long to reduce interest rates significantly. They got what they wanted and market interest rates jumped above 22%. After CB started tightening, market rates went down again.