In its ‘Monetary Policy Assessment Note’, TEPAV emphasized that the policy rate should be raised by 500 basis points and urged the CBRT to state that additional tightening may be made depending on the data. The report emphasized two main problems for economic policies.
Economic Policy Research Foundation of Turkey (TEPAV) published its Monetary Policy Assessment Note. “Weekly repo rate should be raised by 500 basis points from the current 45%and it should be stated that additional tightening may be made depending on the data”.
TEPAV stressed that there have been some developments deepening Turkey’s fundamental economic problems, while the monthly inflation in February was higher than expected and inflation expectations continued to deteriorate.
The report, which also evaluated the rise in the exchange rate in recent weeks and the downward trend in the CBRT’s net foreign exchange reserves, drew attention to two main problems that need to be solved.
“Turkey’s monthly inflation of 4.53 percent in February 2024 is higher than the annual inflation of 14 members of the G20 in the same month. Argentina and Turkey differ markedly from other G20 countries in terms of both inflation and risk premium.
In our previous assessments, we underlined that in order to achieve the government’s short-term objectives of putting growth on a sustainable path and reducing inflation, interest rates and the risk premium; there were two main problems that it needs to solve.
The first is the financing need arising from the current account deficit and how it was not being met through normal channels. While net financing was provided in excess of the current account deficit in the June-December 2023 period, this picture deteriorated significantly in January and there were net capital outflows.
The second main problem was the possibility that both pre-election spending and earthquake expenditures would cause the budget deficit to remain elevated. February realizations show that spending pressures continued. Our studies at TEPAV suggest that the deterioration in the budget deficit and debt stock may continue unless additional measures are taken.
HOW WILL DISINFLATION BE ACHIEVED?
In our previous notes, we emphasized that the main problem for monetary policy is how to reduce inflation, which is expected to peak at around 75 percent in May 2024. The government target is much lower at 36 percent by the end of 2024 and how to maintain this downward trend in the following period is puzzling. Today, there are some developments that deepen this fundamental problem.
First, monthly inflation in February was higher than expected and inflation expectations continued to deteriorate. Seasonally adjusted monthly inflation was 4 percent, exceeding the Central Bank’s forecast of 3 percent. Expected inflation for end-2024 has been increasing since the beginning of the year. The most recent March data suggest that expected year-end inflation is still as high as 44.2 percent.
The second is the recent rise in the exchange rate and the downward trend in the CBRT’s net foreign exchange reserves. This trend stems from the increased demand for foreign exchange in recent weeks in anticipation of a correction in exchange rates after the local elections. The Central Bank’s delayed resort to precautionary policies also reinforced this trend.
The third is the possible inflationary impact of fiscal measures to reduce the budget deficit, which is expected to be above 6 percent of GDP in 2024. As stated in the Central Bank’s inflation reports, the SCT and VAT-dominated tax adjustments made in 2023 are among the factors pushing inflation upwards.
“THE INCREASE IN THE POLICY RATE WAS NOT REFLECTED IN DEPOSIT RATES”
Fourth, the policy rate – the repo rate – was raised to 45 percent at the January MPC meeting. However, the increase in the policy rate was not reflected on Turkish lira deposit rates to the extent that it would both significantly reduce residents’ demand for foreign exchange and lower the rate of increase in consumption expenditures. Nevertheless, the policy rate was kept unchanged at the February MPC meeting and some tightening measures other than interest rate hikes were taken in March in response to the negative developments summarized above. One negative consequence of such decisions is that they raise the suspicion that there is an upper limit beyond which the policy rate can be raised, thus adversely affecting the program’s chances of success. Another negative consequence was that the imbalance in monetary tightening made access to credit more difficult than necessary.
Unless the process of rationalization in the economy that started after the May 2023 elections is transformed into a comprehensive program and this program is supported by social segments, it is not possible to eliminate the above-mentioned negativities.
However, external conditions for achieving the end-2024 inflation target remain favorable in light of available information. Forecasts for the average level of the Brent crude oil price in 2024 have been revised upwards in recent weeks, but they are still not significantly different from the 2023 average. Major central banks such as the Fed and the ECB are also expected to begin the process of lowering policy rates. These two factors will help to keep the current account deficit on the one hand and the financing of the deficit and exchange rate increases on the other at reasonable levels.”
WHAT TO DO?
The increase in the discrepancy between inflation expectations and the CBRT’s inflation forecast and the upward pressure on the exchange rate must be prevented. In this framework, a series of steps should be taken to strengthen economic fundamentals and economic agents should be convinced that the recent movements are temporary deviations from the strengthened fundamentals.
To this end, measures to reduce the budget deficit and the tightening in monetary policy should be maintained in the upcoming period. In addition, government decisions on administered and administered prices should be supportive of the inflation target.
The new-term action plan of the Coordination Board for the Improvement of the Investment Environment is highly suitable for initiating a comprehensive structural reform process. However, in addition to policies to ensure macroeconomic stability, it is important that this plan is supported by structural reforms that will make institutions – such as the CBRT, TurkStat and the BRSA – independent, increase productivity, accelerate the green transformation process, improve the quality of education, and create a fair and fast legal system.
“REPO RATE SHOULD BE INCREASED BY 500 BASIS POINTS”
In light of these assessments, steps should be taken as soon as possible to strengthen the rationalization process in the economy, the main headings of which are given above, into a comprehensive program.
The repo rate should be raised by 500 basis points and it should be indicated that further tightening may be implemented depending on the data.
In order to eliminate the imbalances in monetary policy, arrangements should be made to ensure that the increase in the policy rate is adequately reflected on deposit rates in particular and that the credit market functions more soundly; the functioning of the transmission mechanism should be facilitated.”