To refresh your memory, as a reaction to the missed targets in the consumer price index (CPI) in 2006, the Turkish Central Bank has been implementing quite tight or contracted monetary policies. Basic policy tools have been relatively higher interest rates and a quite cautious liquidity management in connection with the target inflation rate of 4 percent in 2007.
Needless to say, monetary policies resulted in a dramatic decline in the final consumption figures in the first half of the year. It was expected that the rate of gross domestic product (GDP) growth throughout the year would be around 5 to 5.5 percent. The second element that forced policymakers to slow down economic activities was the persistent and ever-rising current account deficit, which first began to climb in 2003 and reached almost 8 percent of GDP by the end of 2006.
What are the early results then? Monthly data on inflation for November has shown that there will be a dramatic failure in inflation targets by the end of year. Let's summarize the latest data on CPI as explained by the Turkish Statistics Institute (TurkStat). The rise in CPI is 1.95 percent --and in producer price index (PPI), 0.89 percent. With this monthly data, annual inflation rates reached 8.4 percent as of November 2007.
Major factors in the monthly rise in CPI are the increase in excise taxes on cigarettes and gasoline, a hike in water bills and rising transportation costs. On the other hand, the same higher monthly CPI figures can be expected for December. With this expectation, annual consumer inflation would be over 8.5 percent. Obviously this is not only dramatically higher than the target rate, but also still above the level reached in 2005. When we evaluate the recent performance in inflation, we can conclude that besides the current monetary policy discipline, the emphasis must be shifted to fiscal policies and other reform measures so as to improve production circumstances and enhance the competitive strength of domestic firms.
The urgent question now is related to the possible impact of the recent inflationary divergence on interest rates, capital inflows and exchange rates. In my view there will not be any major break from the existing trends in money markets provided that further deterioration in the US mortgage industry is avoided. Let me elaborate on this point. As you may recall, when it became clear that consumer inflation targets would not be realized by the first half of 2006, there were significant reactions in the money markets. At that time there was a significant but temporary rise in exchange rates and a drastic upward surge in Treasury borrowing rates. In other terms, the magnitude of the reaction was quite large because Turkey's political as well as economic risk factors such as current account deficit and inflation rate were higher.
Although again we will not be able to hit the inflation target this year, both the domestic and the external environment are now quite different. Although the conditions in the external environment are much worse than last year, this time the situation in emerging market economies, including Turkey, is relatively much more stable. So the major concerns are not over the emerging markets but on the US and western European countries. Second, most of the political risks are now a thing of the past, and there are new expectations for further reforms.
Last, but not least, fortunately the central bank has been quite aware about what is happening and what could happen in both domestic as well as external markets, and thus has continuously resisted popular demand for drastic interest rate cuts.
To conclude, in terms of fighting inflation, it seems that 2007 will be the second consecutive year that we have lost. In terms of political ends, however, it could be one of the turning points in the long history of Turks, because the way for further reforms both in politics as well as the economy was opened after the general elections so as to continue Turkey's recent economic achievements with no major interruptions.
