CBRT, inflation, foreign exchange and global environment

The CBRT’s latest rate cut. The Monetary Policy Committee (MPC) decided to cut the policy rate (one-week repo auction rate) from 14% to 13%.

The CBRT says that this reduction of 100 basis points will reflect on loan rates and contribute positively to economic activity. This justification for the rate cut is much more striking than the interest rate decision itself: In a country where consumer inflation is 80% and producer inflation is 144%, announced by the Turkish Statistical Institute, the policy rate is reduced from 14% to 13%, resulting in “the growth in industrial production and the increasing trend in employment”: “To defend that it will continue.”

Rate cuts and the monetary transmission mechanism impact on loan rates. When rates fall, borrowing becomes cheaper, making large loan purchases more affordable, such as home mortgages, auto loans, and credit card spending.

Bond yields and loan rates

Turkey Yield Curve – 19 September 2022. Source: World Government Bonds

Turkish Government Bonds. Source: World Government Bonds

Normally, long-term interest rates are higher than short-term interest rates. Therefore, the yield curve normally slopes upward as time increases. The difference (i.e. the yield difference) between a longer and shorter bond should be positive. If not, the yield curve may be flat or inverted. 

Loan Rates. Source: CBRT

Economic growth. Turkey’s commercial real estate market is expected to grow at a CAGR of 9.74% in the forecast period 2022-2027.

The Turkish economy grew by 11.4% annually in 2021, making it the strongest rate among major countries. The growth was mainly driven by household consumption and exports.

The latest 2Q22 2022 GDP data showed growth recorded at 2.1% QoQ, resulting in a 7.6% YoY expansion, down from 9.1% in the fourth quarter of 2021. The biggest contribution is private consumption, supported by the increase in domestic credits, followed by net exports. Fixed investments also made a small positive contribution to 2Q22 GDP figures. The 2023-25 ​​Medium Term Program (MTP) of the Ministry of Treasury and Finance predicts that the growth rate will be 5% for the end of 2022. IMF and Oxford Economics projections point to 4% and 3.7% growth rates, respectively.

Manufacturing PMI data from Istanbul Chamber of Industry and S&P Global recorded 47.4 as of August 2022 and remained below the neutral 50 mark for six consecutive months. Meanwhile, the seasonally adjusted consumer confidence index was recorded as 72.2 as of August 2022, up 6.1% compared to the previous month.

FDI inflows to Turkey, which increased by 77% in 2021 compared to the same period of the previous year, continued to increase. In the first half of 2022, foreign direct investment volume of approximately USD 5.5 billion increased by 20.7% compared to the same period of the previous year.

 CBRT views on inflation. The strong pace in 2021 and this year was overshadowed by the rising inflation, which was at the highest level in 24 years.

The annual consumer price index (CPI) rose at a slower-than-expected pace in August, but still reached around 80%, the highest level since September 1998.

The smaller increase compared to previous months indicates that the price pressure may slow down.

Economists suggest that inflation may be nearing its peak as energy inflation falls sharply and food inflation appears near its peak.

Saying that he expects inflation to fall to “appropriate” levels in February-March next year, President Mr. Recep Tayyip Erdoğan asked the public to be patient.

Finance Minister Mr. Nebati said that due to the positive base effects, the inflation rate will start to decline sharply from December and the decline will continue throughout 2023.

The Central Bank of the Republic of Turkey (CBRT) raised its year-end inflation forecast to 60.4% and included a path in the form of a peak close to 90% in autumn.

Among other indicators, unemployment data for July were released on September 12. The latest data showed that the unemployment rate fell 0.3 points month on month to 10.1% in June.

Impact on TRY, FX-indexed deposits, import costs, FX inflows. Inflation is more likely to have a significant negative impact than a significant positive impact on a currency’s value and exchange rate. A very low inflation rate does not guarantee a favorable exchange rate for a country, but an excessively high inflation rate is very likely to adversely affect the country’s exchange rates with other countries.

Total gross foreign exchange (FX) and gold reserves of the Central Bank of the Republic of Turkey (CBRT) is 113.7 billion dollars. Excluding foreign currency liabilities, net reserves are $14.1 billion. However, most of its reserves are not officially owned by the CBRT. Instead, $22.9 billion belongs to other central banks, including those in Qatar, UAE, South Korea and China. In addition, $38.9 billion of the reserve belongs to commercial banks in Turkey. When both of these are deducted with the current swap deals, net reserves are -52.5 billion dollars. As this clearly shows, the CBRT has little or no opportunity to control the depreciation of the Turkish lira by selling foreign exchange reserves.

-Currency protected deposits

A new mechanism for FX-protected deposits was introduced in December 2021. Although it did not receive much attention at first, requests and warnings to the corporate and financial sectors later led to a significant increase in its size, reaching a total of $85.5 billion at the beginning of September. The main purpose of this mechanism is to provide a guarantee to bank depositors who keep their savings in Turkish Lira (TRY) in case the local currency depreciates further, to be paid by the Ministry of Treasury and Finance or the CBRT for the excess between the exchange rate change and the Turkish Lira. Although it weakened the central government’s budget balance significantly, financial stability was maintained in a very low policy rate (13%). The current consumer inflation rate is 80.2%, the producer inflation rate is 143.8%, and the market expectation for the consumer price index (CPI) for the next 12 months is 36.7%. At first glance, this mechanism was only partially successful, despite its significant side effects: It prevented further dollarization, but failed to meet its goal of converting a large number of foreign currency accounts into lira. More than half of the total deposits in Turkey – 56.3% are in foreign currency or gold, and 15.1% are in foreign currency protected deposits. Thus, the total deposit dollarization rate reached a record level of 71.4%. Deposit rates hovering around 20% and lack of confidence are the main reasons for this.

 -FX inflows

 A significant amount of short-term foreign debt is also on the horizon. In the coming year, a total of $182.4 billion in hard currency needs to be repaid or converted. The Turkish economy needs at least 220 billion dollars in the next 12 months. Another factor that negatively affects Turkey’s external balance is the appreciation of the dollar against the euro. While 58.4% of foreign debt and 71.2% of imports are in dollars, Turkey’s revenues from exports and tourism are mainly in euros. As a result, all else being equal, the external deficit is increasing once again.

 -Import cost

Import Prices in Turkey decreased from 152.27 points in June 2022 to 149.33 points in july. Source: TURKSTAT

 The more the local currency depreciates in the foreign exchange market, the higher the price of imports. Effectively, more money is needed to buy goods and services from abroad. The decrease in import prices in July may indicate that an effective trend that will gradually restrain inflation has started.

Environmental policies and the Turkish economy are signs of structural transformation. UNDP Resident Representative Louisa Vinton said, “The debate on climate policy tends to focus on costs, which shows that there is a trade-off between protecting the planet and protecting the economy.” “This study shows that this is a huge misconception. Investing in renewable energy and moving away from hydrocarbons will bring extensive economic gains, including a large net increase in employment. Green energy is therefore a win-win scenario and based on the analysis, we see space for the country’s leaders to make more ambitious policy decisions.”

Turkey can increase its GDP by as much as $8 billion a year, create more than 300,000 new jobs by 2030, and reduce greenhouse gas emissions by 8% compared to 2019 levels – all by investing in renewable energy rather than continuing to rely on renewable energy. These are the findings of the joint analysis published in Ankara by the United Nations Development Program (UNDP) and the International Labor Organization (ILO). Investing in wind and solar power to meet future energy needs will therefore not only provide environmental benefits, but also strong economic benefits in terms of growth, job creation and trade balance.

In addition to the dramatic numerical gains in employment, this shift will yield a number of other positive outcomes:

-Job gains will expand and benefit all but three of the 66 different Turkish economic sectors.

-Renewable energy will create more demand for higher quality jobs that require investment in skills.

-Green energy is cheaper, so renewable sources will set aside financing for areas such as energy efficiency.

-Investing in renewable energy will increase the demand for Turkish products and services.

-Diversification will make the Turkish electricity system more resilient to climate and price shocks.

-The fossil fuel industry is the biggest loser in a process that requires preparations for a “just transition” for industry workers. But overall, the analysis ends with a vote of confidence, which resonates with the “green works” outlook.

Conclusion? The positive economic environment continued into 2021; The Turkish economy grew by 7.5% in the first quarter of 2021, by 22.2% in the second quarter of 2021 and by 7.9% in the third quarter of 2021, exceeding expectations. While base effects pushed up the recorded growth rates on an annual basis, household expenditures were mainly influential in the growth in the Turkish economy.

However, since the rise of the USD against the EUR, there has also been a currency loss in the TL. While 58.4% of foreign debt and 71.2% of imports are in dollars, Turkey’s revenues from exports and tourism are mainly in euros. As a result, all else being equal, the external deficit is therefore getting larger.

Although the economy is performing well, Turkey’s situation is far from straightening out. Turkey may attract more foreign investors each year, but debt rollback and current account financing will become more difficult if the Turkish lira continues to depreciate.

Kaynak: Tera Yatırım-Enver Erkan
Hibya Haber Ajansı