In a letter sent to the government by the Central Bank of the Republic of Turkey (CBRT), it was noted that in the second half of 2023, external financing conditions significantly improved, reserves showed a stable increase, demand conditions began to lose strength in reflecting on the current account deficit, domestic and foreign demand for Turkish lira assets increased, and all these developments contributed to the effectiveness of monetary policy.
The Central Bank sent an “Open Letter” to Minister of Treasury and Finance Mehmet Şimşek on behalf of the government.
The letter reminded that according to Article 42 of Law No. 1211 on the Central Bank, if the inflation target cannot be achieved, the CBRT is required to inform the government in writing about the reasons for the deviation from the target and the measures to be taken, and to announce it to the public.
It was stated in the letter that the uncertainty range around the inflation target for the year 2023 was significantly exceeded, and the following statements were included:
“This text explains the reasons for the deviation of inflation from the target and the measures taken and to be taken to achieve the target. Along with this document, the 2024 First Inflation Report, which includes analysis and evaluations regarding the factors influencing inflation in 2023 and explains in more detail the monetary policy to be implemented to achieve the inflation target in the short and medium term, is attached for your information. Annual consumer inflation, which was 64.3 percent at the end of 2022, decreased in the first half of 2023 due to base effects in addition to the horizontal trend of the exchange rate, falling prices of foreign currency imports, and the impact of energy subsidies. Thus, annual inflation in June realized as 38.2 percent.
On the other hand, the high rate of increase observed in credit growth due to monetary conditions, wage adjustments, and transfers to households made demand-oriented factors significantly effective on inflation in the first half of the year. These developments led to an increase in the current account deficit through the channels of gold and consumer goods imports for inflation protection purposes and increased uncertainty in financial markets. In addition, the earthquakes centered in Kahramanmaraş in February increased the pressure on inflation by causing imbalances in supply and demand in the housing market, especially in the markets of goods, services, and labor, and short- and medium-term effects on public finances due to reconstruction activities. These developments negatively affected pricing behaviors and laid the groundwork for the increase in inflation in the second half of the year after the decline in the first half.”
“Simplification measures were taken to enhance market mechanisms and strengthen macro financial stability” It was reminded in the letter that in June 2023, the Monetary Policy Committee (MPC) decided to initiate a strong monetary tightening process to establish disinflation as soon as possible, anchor inflation expectations, and control distortions in pricing behaviors.
In this context, it was stated in the letter that the policy rate was increased by a total of 34 basis points to 42.5 percent from 8.5 percent in the June-December period, and the following was recorded:
“Concurrently with monetary tightening, within the framework of macroprudential, measures were taken to enhance market mechanisms and strengthen macro financial stability. Monetary tightening was also supported by selective credit and quantitative tightening measures. In the third quarter of 2023, the cumulative effects of the continued strong trend in domestic demand, tax adjustments, exchange rate developments, wage increases, stiffness in service inflation, and sudden rises in crude oil prices were effective on inflation dynamics. In addition, the simultaneous occurrence of all these developments within a short period of time caused additional distortion in pricing behaviors, resulting in an increase in inflation. In this context, inflation reached 61.5 percent between June and September, increasing by 23.3 points. 4.7 points of this increase, excluding the exchange rate effect including taxes, came from developments in fuel prices, 3.8 points from the rise in the exchange rate, and 2.8 points from tax increases other than fuel. In this period, the simultaneous occurrence of shocks increased inflation by 10.0 points due to the additional distortion in pricing behavior, while the effect of factors other than these remained limited to a total of 2.0 points.”
It was stated in the letter that the initial effects of monetary tightening were observed on financial conditions and partially reflected in demand conditions, and the following statement was made: “In the second half of the year, external financing conditions significantly improved, reserves showed a stable increase, demand conditions began to lose strength in reflecting on the current account deficit, Turkish lira deposit share increased, and domestic and foreign demand for Turkish lira assets strengthened. All these developments contributed to the effectiveness of monetary policy.”
The letter stated that when looking at the last quarter of the year, the effects of the monetary tightening process on financial conditions and domestic demand, and the consumer annual inflation rate increased by a limited rate of 3.2 points, and the important part of this effect was due to the upward mechanical effect of households exceeding the free usage limit due to an increase in natural gas consumption.
It was reported in the letter that the main trend of inflation also decreased during this period, and the following assessments were made:
“Pricing behaviors, especially in durable goods, showed relatively stronger improvement, primarily in basic goods. Although service inflation showed stiffness, the trend in transportation and food services inflation, which are more sensitive to demand and cost conditions, also slowed down in the last quarter. The ongoing excessive increases in housing prices gave way to a monthly increase below inflation, and leading indicators indicated a slowdown in new rental listing price increases. Core, statistical, and model-based indicators monitored indicated that inflation’s main trend slowed down during the last quarter. Thus, the end-of-year inflation rate of 64.8 percent came close to the midpoint of the forecast range shared in the last Inflation Report of the year.”
Developments in the last quarter The letter revealed that the developments in the last quarter showed a gradual withdrawal in the factors effective on inflation due to the monetary tightening, and in this period, external financing conditions, strengthening of reserves, improvement in the current account balance, and an increase in demand for Turkish lira assets contributed to the exchange rate stability and effectiveness of monetary policy.
It was stated in the letter that as of the end of 2023, the share of Turkish lira deposits increased from below 32 percent during the year to above 42 percent, and the annual growth rate of consumer loans decreased from its peak of 60 percent to below 40 percent, and the annual growth rate of accumulated gold and consumer goods imports decreased from its peak of 125 percent to 53 percent.
“The CBRT will maintain its tight monetary policy stance” It was reminded in the letter that as the year 2024 began, the MPC raised the policy rate to 45 percent in the January meeting and kept it steady in February considering the delayed effects of monetary tightening and other policy measures supporting monetary transmission, and it was stated that by March, monthly inflation trends were higher than expected and the indicators for the recent period indicated that the resilient trend in domestic demand continued.
In this context, it was reported in the letter that the MPC raised the policy rate to 50 percent at the March meeting considering the deterioration in inflation outlook, and in addition, it was decided to change the operational framework by determining the Central Bank overnight borrowing and lending rates with a margin of +/- 300 basis points compared to the one-week repo auction interest rate, and the following was recorded:
“The change in the operational framework is a technical correction made considering the high level reached by interest rates, and the one-week repo auction interest rate will continue to be used as the main policy rate. The CBRT will continue to maintain its tight monetary policy stance until a significant and permanent decrease in the main trend of inflation is achieved and inflation expectations approach the targeted range. In case of a significant and permanent deterioration in the inflation outlook, the monetary policy stance will be tightened. It is predicted that the steadfastness in monetary policy will decrease the main trend of monthly inflation through balancing domestic demand, real appreciation of the Turkish lira, and improvement in inflation expectations, and establish disinflation in the second half of 2024. It is expected that inflation will reach 36 percent at the end of 2024, decrease to 14 percent at the end of 2025, and then stabilize at 9 percent by the end of 2026, followed by stability at 5 percent. The stiffness in service inflation, inflation expectations, geopolitical risks, and food prices keep the risks on inflation alive.”
It was emphasized in the letter that coordination between monetary and fiscal policies is of great importance in the process of disinflation, and the assumptions about public policies concretized by the Medium-Term Program (MTP) (2024-2026) increasing predictability are reflected in the CBRT’s inflation forecasts.
In this context, it was stated in the letter that it is crucial for fiscal policies to support the monetary stance of tightness until the disinflation path is established, and the following statements were included:
“Adherence to medium-term targets declared in the MTP in line with the disinflation path will play a critical role in establishing price stability. On the other hand, continuing structural reforms to reduce the rigidity and volatility in inflation and supporting technological and digital transformation to improve supply capacity will contribute positively to price stability and therefore social welfare in the medium and long term. In this context, the CBRT will continue its efforts to analyze structural factors, develop relevant policy recommendations, and create awareness among relevant stakeholders and the public about the importance of combating inflation. Within the framework of the indicators expected to guide economic units regarding the future trend of inflation, short-term inflation forecasts and the inflation target in the medium term are key. In this regard, monetary policy will continue to be determined to provide monetary and financial conditions that will reduce inflation and achieve the target of 5 percent in the medium term. Maintaining adherence to medium-term targets in line with the disinflation path, as declared in the MTP, is expected to play a critical role in establishing price stability. On the other hand, continuing structural reforms to reduce the rigidity and volatility in inflation and supporting technological and digital transformation to improve supply capacity will contribute positively to price stability and therefore social welfare in the medium and long term. In this context, the CBRT will continue its efforts to analyze structural factors, develop relevant policy recommendations, and create awareness among relevant stakeholders and the public about the importance of combating inflation.”
The letter concluded by stating that it is crucial for fiscal policies to support the monetary stance of tightness until the disinflation path is established, and the following statements were included:
“Adherence to medium-term targets declared in the MTP in line with the disinflation path will play a critical role in establishing price stability. On the other hand, continuing structural reforms to reduce the rigidity and volatility in inflation and supporting technological and digital transformation to improve supply capacity will contribute positively to price stability and therefore social welfare in the medium and long term. In this context, the CBRT will continue its efforts to analyze structural factors, develop relevant policy recommendations, and create awareness among relevant stakeholders and the public about the importance of combating inflation.
source: aa.com.tr/ prepared by Melisa Beğiç