Another addendum to this week’s Hurriyet column
It turns out some recent developments forced me to do another addendum to this week’s Hurriyet column, which appeared at my blog as well.
Two big themes of the column, although I did not explicitly mention either, is 1. The CBT is not doing a great job with communication, to say the very least. 2. The policies that are being implemented are misguided. I have a few things to say on each:
On CBT Communication
The last example of the CBT’s communications mishaps happened when the Bank announced its most recent meeting with bank economists and investors at the last minute. As a result, many of my economist friends could not make it. The presentation is on the CBT’s web site, but TEB, who could make it, noted that the Bank sounded confident that there is no overheating in the economy as evidenced by the subdued service inflation and the current level of capacity utilization rate. I have quite a few objections to this story:
I. Until very recently, unemployment was part of this story as well, but now, with unemployment having come down significantly, we don’t see the Bank mentioning it at all:)
II. A similar U-turn came from the current account side: Before, the Bank was saying we would start seeing signs of the current account deficit slowing down at the end of the first quarter. Now, they are saying the slowdown will appear during the last quarter. This makes sense: As you can see below, the deficit really exploded starting the last quarter of 2010, so base affects will ensure a slowdown during 4Q11:
In other words, I have to say no shit, Sherlock to this one..
III. Another inconsistency is with the Bank’s reasoning for decreasing the daily amount in the FX purchase auctions: Concerns related to the sustainability of the increasing government debt of some European countries adversely affect the risk appetite which in turn cause a relative slow down in capital flows towards emerging countries, including Turkey. Taking into consideration the slowdown in the capital flows, the daily amount to be purchased in auctions was decreased from USD 50 million to USD 40 million. EPFR data, as well Turkish banks’ off-balance sheet positions, a good proxy for swaps activity, point to a slowdown:
But the slowdown does not seem material enough to warrant the decrease in purchases. Besides, there is still quite a bit of demand for the auctions, as evidenced from the bid-t0-cover ratio:
Make no mistake: I am quite happy that the CBT is decreasing the liquidity it is providing through this channel, but if that is the main reason, they should say so.
IV. I find the Bank’s methodology in measuring credit growth extremely confusing. A couple of economist friends, who were also confused, had asked me on how to get the CBT figures early last month. And it seems that sufficient people were puzzled that the Bank felt the need to put out a short note explaining its methodology. Something so basic should not be so confusing…
Believe me, I am not the only one with these doubts: To my Tweet sharing an FT Lex article on which measure of inflation is best, a friend, who is a professional economist, answered: The CBT doesn’t target inflation anymore. That’s how they can get away with above-target inflation. They target credit growth. Or CUR. Or whatever else works for them that week. Another friend, who also happens to be an economist, had the following to say: I can`t understand how they say no service inflation no overheating, what about all those imports then…
Conceptual Problems
I am really sick of discussing whether the economy is overheating/overheated or not. As I discussed in the first addendum, if it is not, the CBT has not provided us with enough evidence. But on a more basic level, it really does not matter. The CBT agrees that the growth is unbalanced, and to balance it, you have to cut demand and shift the balance of growth to exports, whether the economy has overheated or not! For the former, you’d need tight fiscal policy, whereas loose monetary policy would do the trick for the latter, through a weaker lira, in the short-run.
Besides, Murat Ucer at Turkey Data Monitor / GlobalSource Partners makes the interesting argument that the current account deficit could have jumped permanently to a new plateau. Whereas he does not offer a compelling argument why this would be the case, he does suggest that losses in productivity, mainly the result in strong gains in employment, may account for it. I will be looking forward more solid proof of this argument in his and others’ work.
BTW, all charts are courtesy of my friends at Turkey Data Monitor; contact them at the email/number at the hyperlink if you want to learn more about their software.
4 Responses to “Another addendum to this week’s Hurriyet column”
RogoCop • June 5th, 2011 at 6:23 pm
Great post. Two points:
1) "Concerns related to the sustainability of the increasing government debt of some European countries adversely affect the risk appetite which in turn cause a relative slow down in capital flows towards emerging countries, including Turkey. Taking into consideration the slowdown in the capital flows, the daily amount to be purchased in auctions was decreased from USD 50 million to USD 40 million."
Wasn't the surge in capital (esp. speculative) the reason for the CBT's policy in December? So, all else equal, shouldn't the slowdown in capital flows support more orthodox monetary policy (raising the policy rate)?
2) The CBT agrees that the growth is unbalanced, and to balance it, you have to cut demand and shift the balance of growth to exports, whether the economy has overheated or not! For the former, you’d need tight fiscal policy, whereas loose monetary policy would do the trick for the latter, through a weaker lira, in the short-run.
Wouldn't monetary tightening also reduce domestic demand? Higher interest rates reduce consumer borrowing, raise the cost of capital for firms (reduce fixed investment), and therefore reduce domestic demand.
Judging by the CBT's past tightening cycles, they seem to wait and wait, until it's too late. Then they raise rates quite aggressively (2006 and 2008).
edeliveli • June 5th, 2011 at 9:34 pm
Thanks Rogocop,
1) Good point. You should have been a reporter: You would have really cornered Erdem Basci in an interview:)…
2) Yes, but that would bring more capital flows and strengthen the currency. So you'd have to resort to capital controls or macroprudential measures by the Banking Regulator for that. I am arguing that if you want to curb domestic demand as well as shift growth to exports, very thigh fiscal policy, combined with loose monetary policy would do the trick. Right now, we have expansionary fiscal policy, even though the government claims otherwise, and near-neutral monetary policy disguised as tight:)…
RogoCop • June 5th, 2011 at 11:33 pm
Hi Emre,
I generally agree with your views, but on your last point, I respectfully disagree (don't worry I won't become your second perennial spammer). I think Turkey needs to raise interest rates to slow credit growth and keep real interest rates in positive territory (otherwise you discourage savings and you risk creating asset bubbles).
While higher rates may attract more foreign capital, dampening demand for credit will reduce the current account deficit and external financing needs, and you can accumulate more reserves. While a case could be made for capital controls or macroprudential measures, I believe these eventually will create distortions or economic actors will find loopholes and ways to avoid them.
Reducing domestic absorption (through tighter fiscal policy AND tighter monetary policy) will reduce external financing needs (because the C/A deficit will be smaller) and make Turkey less vulnerable to a sudden stop or even just a slowdown in capital inflows. The best way to reduce nominal interest rates (which I think is your point in loose monetary policy) is to enhance central bank credibility, meet inflation targets, and lower inflation (if the CBT could meet its 5% inflation target for 2012, then a nominal interest rate of 6.25 or even 7% could be a stable equilibrium. Right now, 6.25% is just too low.
edeliveli • June 6th, 2011 at 6:27 am
Hi Rogocop,
I agree with you: If I were the PM or Econ tzar, I would have enacted tighter fiscal AND monetary policy. I am just saying that if you need to shift growth into exports, you would need loose monetary policy. But to do that, you would need very tight fiscal policy, so that the demand-expanding measures of loose monetary policy are accounted for.
In essence, measures effecting the exchange are temporary fixes. Turkey would need to address structural issues such as general competitiveness for a permanent fix to the unbalanced nature of growth…
