To recall, the average annual rate in consumer price inflation was above 70 percent between 1990 and 2001. Thanks to the overall architecture of the implemented stabilization program, the appropriate external environment and the strong leadership quality of the single party government that resulted in political and economic stability, Turkey's inflation has been in the single digits since 2004. As of 2005, almost a ten fold decrease in inflation (from 70 to 7.5 percent) was recorded. From 2002 till 2005, realized inflation figures have been significantly below the target rates and this brought about an enormous credibility to the government's program. However, unlike this historical achievement, there has been significant resistance in the inflationary front since 2006. In fact, the rate of inflation climbed to 9.6 in 2006 and then receded back to 8.4 in 2007. As the targeted rate was 5 and 4 percents in 2006 and 2007 respectively, realized inflation figures constituted a dramatic departure from the targets and therefore significant credibility erosion took place toward the central bank policies.
Then what happened, and what will happen hereafter?
We can explain Turkey's disinflation process using three major parameters. These are the demand-driven factors, cost and productivity driven balance and expectations management.
Until mid-2006, when significant signs of deterioration both in domestic and external environment started, there had been a significant rise in aggregate demand factors. However, as the domestic demand-driven factors constituted a remarkable threat to consumer inflation and global liquidity risks rose, the central bank started implementing a tight monetary policy. Among the tools, high policy rates and liquidity management became the focal point. With an expected time lag, concrete results of this policy have been observed in final private consumption figures of almost every category. For this reason, the lowest growth figure of 4.5 percent in GDP was recorded in 2007 since 2002.
The second important element in inflation has been cost and productivity figures. Since 2002, there has been a significant rise in almost every category of input prices including major commodity baskets and agricultural products due to dramatic rise in input demand triggered mainly by Asian high growth economics. Global warming also created an upward pressure on food prices.
Fortunately, as a neutralizing element on cost factors, Turkey recorded a dramatic positive surge in both labor as well as total factor productivity since 2002. In our view, until 2006, as the surge in productivity heavily dominated that of rising cost profile, Turkey recorded a significant decline in inflation while achieving high growth of average 7 percent between 2002-2007.
Unfortunately, what is observed as of today is that cost-driven factors started dominating productivity rise and therefore there is now a cost-driven inflationary inertia in the Turkish economy. This is, however, unique to Turkey, but a prevalent global problem.
In order to minimize this cost-productivity gap, we have to wait for a fall in commodity prices parallel to that of inflationary pressures and the global slowdown in growth rates. Moreover, Turkey must be able to keep positive expectations alive toward the medium-longer term targets so that private fixed capital investment will continue without any major interruptions, and therefore the productivity rise would achieve a new and sustainable momentum.
Obviously, political and economic stability constitutes the sine qua non condition of this longer perspective. This is inevitable, particularly in keeping stability in money markets, i.e., stability in foreign exchange market so as to minimize pass-through effect of FOREX on inflation and interest rates as a major destabilizing factor in cost of production.
Finally, successful management of expectations, as a major dynamic fueled inflationary dynamics in the near past, has been quite efficacious in Turkey's disinflation process. In fact, the central bank's high credibility between 2002-2005 played a crucial role in eliminating existing heresy in inflation. However, as the credibility of the central bank relatively deteriorated for the last two years, this factor would also start negatively contributing consumer inflation as the labor class would start demanding back-pay and compensation by the coming collective bargaining processes.
In sum, for the next few years, Turkey will witness a relatively slower growth path and inflation somewhere around 8-10 percent.
