Playing three monkeys with Turkish inflation
Turkey’s consumer price inflation (CPI) hit its highest level of the last 14 years, surging to 13 percent year-on-year. More disturbing is core inflation, which is now 12 percent. The initial culprits behind poor November inflation figures are transport prices, which rose 18.6 percent due to the increase in global oil prices, and once again higher food price inflation of 15.8 percent, which the government has been trying to tackle since the start of the year. The continuing slide in lira also played an important part in bringing higher costs across the board.
Following the release of November inflation data on Monday, Deputy Prime Minister Mehmet Şimşek said the unexpected spike in inflation was mainly due to unprocessed food prices; calling it “temporary”. Şimşek went on to say that the government expected persistent downward pressure on inflation from December onwards, thanks to the “structural measures taken by the food committee” he has chaired since the start of the year.
Nevertheless, the mathematics behind Turkish inflation, which is almost quadruple the emerging market average of 3.5 percent, is not that simple. Contrary to what the minister claims, high inflation is not temporary in Turkey. Spiraling inflation is the by-product of a series of policy mistakes that have been made over the last four years.
Currency shock has exacerbated inflation since the summer months, that is true. With Turkey’s manufacturing sector dependent on imports, and with import costs rising as the lira loses value, a self-perpetuating cycle feeds inflation momentum in Turkey. But, faster lira depreciation in the last quarter of this year was already on the horizon at the start of the year, given the Fed’s well-flagged stance on interest rates and the upcoming Zarrab trial, which was due to escalate market tension.
The central bank, which adopts a multi-faceted interest rate policy in adjusting the weighted average cost of funding according to lira fluctuations, has upped the “Effective Funding Rate (EFR)” by some 400 basis points since the start of the year. Yet, consumer price inflation also rose by an equal amount, to 13 percent in November from 9 percent. Implementing gradual rate hikes following a rise in the inflation rate, rather rather than pre-emptive action, means the central bank has been ineffective in targeting inflation of five percent.
The formula for getting out of the accelerating inflation cycle so that temporary shocks are absorbed and inflation goals aren’t compromised isn’t rocket science. If, of course, one agrees with the universally-accepted fact that inflation leads to higher rates, not vice versa as President Erdogan likes to espouse frequently.
So, while the central bank of Turkey has been acting rather passively as inflation crept up, it now needs to act proactively as pricing behavior seems to be getting out of its control. It has to rapidly start containing the slide in lira, which has averaged some 15 percent in the last three months alone. And, of course, now we get to the good old question of whether the central bank is willing to raise real interest rates in Turkey to stop the bleeding.
Just a day after the Fed finalizes its last FOMC of the year, in which it will probably raise rates by another 25 basis points to 1.5 percent, Turkey’s central bank has its own monetary policy meeting on Dec. 14. With inflation at 13 percent and the average funding rate at 12.25 percent; the bank is surely behind the curve as rates are negative in real terms, it is not accounting for Turkey’s higher risk premium and it is unable to anchor inflation expectations. So, the bank is likely to make an adjustment to its effective funding costs by increasing the late liquidity rate of 12.25 percent to the tune of 50-100 basis points.
However, as the advantages of the base year will soon kick in for inflation, headline CPI will soon retreat back to single digits, with core inflation remaining significantly above the target of 5 percent. Nevertheless, as headline CPI eases back to slightly below 10 percent in the first quarter, the central bank is likely to ease its effective funding rate as well, as it has been doing since mid-2016. The EFR will thus decline from circa 13-13.5 percent back to 9-10 percent by the end of the first half, helping the government as it prepares for a likely early election in mid-2018. Which brings us back to Minister Şimşek’s observation that the “spike in inflation would be temporary”, meaning in effect that the EFR would be kept relatively higher only temporarily.
So, this gloomy cycle ise set to continue and we will have year-end CPI of 10 percent, at best, by the end of next year. In effect, double-digit inflation seems to be a permanent phenomenon in Turkey due to slack monetary policy.
A few words are also necessary on the subject of Turkey’s structurally high food inflation.
Even though double digit non-food price inflation is of equal significance, the government often blames Turkey’s accelerating inflation on food prices. In fact, whereas global food prices have been in decline over the last five years, Turkey’s food price inflation grew by an astounding 70 percent. Such a picture clearly reflects some deep-rooted problems in the agriculture and food retailing sectors.
The “food committee” created back in February and governed by Minister Şimşek is attempting to solve food price rigidity in Turkey. The Committee has focused on high livestock feed costs, livestock support programs, licensed warehousing and the structural problems of the fresh fruit and vegetable supply chain. Yet, the committee’s first step came in late July with a series of decisions allowing tax-free imports of huge amounts of meat and livestock until the end of 2018. Wheat, barley, corn, a number of pulses and other grains were gradually added to the tax-free import list. The bad news is that previous meat/livestock importing initiatives have all failed to bring prices down and reduced the size of Turkey’s domestic livestock.
Food price inflation is expected to ease in the coming months because of the seasonality of production, not because the committee succeeded in making domestic markets more efficient by encouraging imports of cheaper products. In the longer term, in the absence of a coherent agricultural and food sector policy, food price inflation will not slow to a sustainable level. Turkey has enough resources to be among the world’s top ten countries self-sufficient in food. Relying on imported agricultural and husbandry products is, therefore, a serious policy mistake that will inevitably keep food prices high and volatile for the foreseeable future.