Turkey: Heterodox Policy Implementation Ground
· Interest reduction cycle and more
· Inflation factors
· Balance of payments problems
The central bank lowered the policy rate by another 100 basis points and brought it to 12% in a move that created a cycle of surprise rate cuts. As the reason for the decision, as in the previous meeting text, it was pointed out that financial conditions should be supportive in order to sustain the slowdown in economic activity and the acceleration of industrial production in this environment. Contradictory monetary policy outlook with the Fed and the global tightening cycle in developing countries will increase Turkey's disadvantage in terms of comparable global interest rates. In this conjuncture, it is possible for the TL to renew its historical declines in the upcoming period, and this may happen despite the indirect interventions of the Central Bank.
Decisions made by central banks tighten financial conditions globally. Possible reflections on us from channels such as exchange rates and capital flows actually require the Central Bank to keep a tighter hold on interest rates. However, the point of view of both the economic management and the central bank on the liraization strategy, with references in the MTP, is that global tightening poses a risk on economic activity. Since we prioritize growth in this conjuncture, we respond as a rate cut instead of a rate hike. After the Fed decision, the growth perspective was consolidated with this step. Considering that the economic growth phenomenon would be at the forefront in the pre-election conjuncture, the possibility of the CBRT to continue with rate cuts increased with this move. We think that the precautionary plans to keep the Fx-linked deposits unsolved, to ensure liraization by continuing the entries into the system, and to activate the banks with additional rules and obligations to contribute to the transformation under necessary conditions, may also continue.
In September, consumer price inflation increased by 3.08% on a periodic basis and reached 83.45% on an annual basis. While the easing cycle of the Central Bank continues, we think that this rate does not end the upside risks in inflation, and that both loose policy practices and domestic/external price fluctuations will continue to feed inflation in October. In this context, we expect inflation to be at a level very close to the realization of this peak in October as well. We think that inflation will be around 73.5% at the end of the year.
USDTRY, basket rate and CPI-based real effective exchange rate comparison… Source: Bloomberg, CBRT, Tera Yatirim
While rising inflation is broad-based, it also confirms our concerns about inflation stickiness. At the same time, the energy crisis in Europe, the aggressive policy of the Fed affecting global interest rates, the deepening effect of the EURUSD parity on the current account deficit will put us under the influence of inflation, which we will be exposed to from factors such as energy. We believe that it is necessary to focus on the factors that cause problems in the inflation structure rather than the interest rate decrease.
The foreign trade deficit continues to be high within the framework of the limited potential due to the weakening foreign demand in exports and the decrease in the EURUSD parity, the rising energy bill and the cost factors arising from the related uncertainties. Despite the positive contribution in services revenues, the high course of the foreign trade deficit indicates an additional deterioration in the current account deficit in September. According to current and future trade figures, Turkey's 12-month current account deficit should increase from 37 billion USD levels in July 2022. As Tera Yatirim, we expect a total current account deficit of USD 54 billion this year (more than 7% of GDP for 2022).
Headline inflation and its main sub-layers... Source: Bloomberg, TURKSTAT, Tera Yatirim
It has not been fully clarified how inflation will be reduced in line with the current monetary and fiscal policies implemented. Considering the current intense depreciation pressure on the TL and the high current account deficit, it seems likely that exchange rate levels will put pressure on inflation.
On the budget side, on the expenditure side, we now attach importance to exchange rates in a special case such as foreign currency indexed deposits in public finance. Public finance expenditures through foreign exchange indexed deposits after the first 8 months of the year will adversely affect the budget performance as the exchange rate rises. Another factor will be the subsidies applied against rising energy prices and hence the transfers to BOTAŞ. If the increase in energy prices continues, we see the transfers to SEEs as another determining factor that will increase the budget.
It is understood that monetary policy will continue in an unusual trend between the economic perspective of the government and the factors of inflation and global monetary tightening. As a result; It can be expected that the Central Bank will continue to cut interest rates. The next PPK meeting will be held on October 20.
Emerging Markets and Fed Tightening
· Geopolitical risk, commodity price fragility
· Political stories
The impact of Fed tightening may be more severe for fragile countries. In recent months, emerging markets with high public and private debts, foreign exchange risks and low current account balances have seen larger movements in their currencies than in the US dollar. As the IMF highlighted in its October 2021 World Economic Outlook and Global Financial Stability Report, the combination of slower growth and increased vulnerabilities could create negative feedback loops for such economies.
Ukraine and Russia account for more than one-tenth of all grain products traded globally, produce 30% of world wheat exports (as well as 60% of sunflower oil) and provide at least half of the grains for more than 26 countries. Grain already harvested in Ukraine was stranded due to the closure and militarization of ports.
Analysts said that there is a risk of increasing volatility in commodity prices due to decreasing liquidity. The sharp fluctuations in commodity prices recently caused investors to reduce their transactions, resulting in a decrease in market liquidity and increased volatility in prices.
We see a serious movement regarding geopolitical developments and their possible consequences:
· Putin signed documents on the annexation of four regions of Ukraine on Friday: Donetsk, Luhansk, Zaporizhzhya and Kherson. On Saturday, Ukrainian troops liberated the city of Lyman in the Donetsk region, after which Putin announced that the new borders were not officially redrawn.
· A Russian convoy carrying equipment for Russia's nuclear weapons program has sparked fears that Vladimir Putin may be preparing a test to send 'a signal to the West.'
· Korea sent a missile flying over Japan that landed in the Pacific Ocean, causing a national alert in Japan that was later revoked.
· Protests continue in Iran.
Comparison of developing countries adjusted for inflation (real) interest rates Source: Bloomberg, Tera Yatırım
Advanced Economies: Current Inflation Situation
· Global tightening
· Fears of recession
· European financial system
The annual inflation rate in the US fell from 8.5% in July to a 4-month low of 8.3% (above the market expectation of 8.1%) in August 2022 for the second consecutive month.
According to data from Eurostat, the statistical office of the European Union, annual inflation in the euro area rose to 10% in September 2022, from 9.1% in August.
Eurozone annual inflation, September 2022, %... Source: Eurostat
The Fed, Bank of England (BoE) and Bank of Japan (BoJ) held policy meetings and made critical interest rate decisions.
Economic projections of Fed Board members and Fed chairmen, under their individual assumptions of anticipated appropriate monetary policy, September 2022… Source: Federal Reserve
The Fed has increased interest rates by 75 basis points for the third time in a row. The Fed has increased its benchmark fed funds rate by a cumulative 300 basis points since March to combat rising prices as the inflation rate has soared to 40-year highs in recent months.
The Fed is assessing the impact of further economic weakening in the future and acknowledges that it is included in the scenario in monetary policy progress. Looking at the implied interest rate expectations in this period, it is understood that the Fed has found it appropriate to follow a monetary policy with restrictive effects. Although the Fed's true hawkishness has continued since August, the main determinant of this is inflation surprises, the structural details of which include variables very different from energy. Now, within the framework of numerical expectations and action, the Fed has extended this hawkish horizon to a wider time.
The Bank of England increased interest rates by 50 basis points in September. With inflation, which is currently the highest among the G-7 countries and has the fastest pace in the last 40 years, interest rates are expected to increase in the United Kingdom. The BoE previously raised the main interest rate by 50 basis points in August and has now raised the benchmark rate to 2.25%.
The Bank of Japan kept interest rates at record lows, remaining outlier among developed countries. Inflation in Japan is also at the lowest level among developed countries.
In the developed world, the Swedish central bank also decided to increase the interest rate by 100 basis points on September 20.
Warning lights are flashing in the global economy as high inflation, sharp rate hikes and the war in Ukraine are frustrating. According to a probability model run by Ned Davis Research, the probability of a global recession currently is 98.1%. Other times the recession pattern has been this high has been during severe economic downturns, most recently in 2020 and the global financial crises of 2008 and 2009. 'This suggests that the risk of a severe global recession in 2023 is rising for some time,' economists at Ned Davis Research said in a report last Friday.
Europe's top financial regulators have issued an unprecedented warning of 'serious risks to financial stability' after concluding that Russia's invasion of Ukraine could create a toxic combination of economic downturn, falling asset prices and financial market stress.
European banks CDSs and related risk parameters are back in the spotlight due to issues with CS and DB. After the exit of Swiss and European Central banks from the negative interest rate system, the movements in government bonds and bank bonds became determinant, and the profile of derivative assets in the portfolios of banks came into play in this period. During this period, it may be necessary to pay attention to Italian banks.
The European Systemic Risk Board, which is responsible for monitoring and preventing dangers to the region's financial system, issued a warning after its meeting last week and decided on the energy crisis triggered by the war in Ukraine, placing the financial system in an unstable state. This is the first 'general warning' of risk issued on the eve of the eurozone sovereign debt crisis since the ESRB was established in 2010. Headed by European Central Bank chief Christine Lagarde, the agency urged regulators in the 30 countries it oversees to prepare for a potential crisis by requiring financial institutions they oversee to create greater capital buffers and provisions that can cover losses.
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